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How to Refinance Private and Federal Student Loans – Pros & Cons


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Student loans have evolved. At one time, there was no option to refinance public federal loans (although you could always refinance private loans). Today, there’s a tremendous opportunity to refinance federal loans at a lower interest rate.

Student loan refinancing can save you thousands, but it is not always the right choice. To avoid major, permanent mistakes, you should understand the refinancing process and what it means for you and your debt.

Here’s everything you need to know.

How Student Loan Refinancing Works

Some private lenders, mainly commercial banks and start-up companies, offer student loan refinancing. The federal loan program does not offer refinancing, so when you refinance your federal loans, you convert them into private loans. The private refinancing company pays off the federal loan program, essentially buying your debt.

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Student loan refinancing is similar to refinancing a mortgage or car loan. When you refinance, you trade in your old student loan for a new one. Usually, you also end up with a lower interest rate or with a payment plan that allows you to make smaller monthly payments over a longer period of time. If you have a high interest rate or burdensome monthly payment, refinancing can help.

Companies that refinance student loans often use a peer-to-peer lending model, lending cash that comes from accredited investors, not from consumer bank deposits. Example companies include SoFi, Earnest, Lendkey, and CommonBond. Commercial banks that refinance student loans include Citizens Bank and Darian Rowayton Bank.

As noted, many student loan refinancing companies are start-ups or smaller businesses. These companies often offer perks and advantages not provided by commercial banks. For example, SoFi offers an unemployment protection program that provides some assistance should you lose your job while in repayment.

Student Loan Refinancing Works

Should You Refinance?

Student loan refinancing companies look at different factors when considering whether a person is a good candidate and when determining what interest rate to offer. Your credit score plays a big role when a commercial bank is judging your creditworthiness – however, it matters less with refinancing companies.

In fact, some companies don’t even look at your credit score. Instead, they consider your current job, income or earnings potential, and how much cash you have. Several factors that can help you get a better interest rate when you refinance include:

  • Your Job. You don’t need a high-paying job to get a great rate, but companies such as Earnest and SoFi look at whether you have a full-time job or full-time job offer.
  • Your Savings. Having money in the bank – at least enough to cover a month’s worth of expenses – helps you qualify and get a lower interest rate.
  • Positive Repayment History. Student loan refinancing companies don’t want to see a history of missed payments or late payments.
  • Cash Flow. You need to bring in enough income each month to comfortably pay back your student loans and cover all other expenses.

Some factors or life choices can negatively affect your ability to refinance. Student loan refinancing companies often turn down applicants for the following factors:

  • Job Hopping. A steady employment history tells a lender that you have the ability to pay back your loans. Changing jobs often or going for months without work makes lenders cautious.
  • Lots of Other Debt. If you have a great deal of credit card debt, auto debt, or personal loans, it can be difficult to refinance.
  • Not Finishing School. Many student loan refinancing programs will only refinance loans after you’ve earned a degree or are on track to complete it within the semester. If you left the program without finishing or have years of school ahead of you, you may be out of luck.
  • Overdrawing Your Bank Accounts Frequently. A history of bounced payments or overdrafts can make you less appealing as a borrower.

Advantages of Student Loan Refinancing

If you meet the requirements, there are some advantages to refinancing your loans. These benefits apply whether you’re refinancing federal loans and private loans together, federal loans only, or private loans only.

  1. Lower Interest Rates. Interest rates on federal loans are fixed for the life of the loan. The rates on your loans depend on when you went to school. For example, I attended graduate school from 2006 to 2008, just before the housing crisis knocked interest rates down. The fixed rate on my loans is 6.8%. If I refinance when rates are lower, I can save a considerable amount each month and over the life of my loans.
  2. Simplified Loan Payments. It’s easy to miss a payment when you are juggling multiple loans. Refinancing allows you to combine multiple loans into one, simplifying your monthly bill. Even better, many refinancing programs offer automatic payment plans and can give you a 0.25% interest rate reduction for enrolling.
  3. No Origination Fees. In some cases, various fees eat up any amount you’d save from a lower interest rate. Fortunately, many student loan refinancing companies – such as SoFi, Earnest, LendKey, and CommonBond – do not charge origination fees.
  4. No Prepayment Penalties. Paying extra on your loans each month helps you speed up the payment process and pay less over time, since you pay less interest. That only works in your favor if the refinancing company doesn’t charge a prepayment penalty, an extra fee if you make early payments. Many companies, including SoFi, Commonbond, Earnest, and LendKey, do not tack on a penalty if you pay more than the minimum.
  5. Multiple Payment Term Options. You have a variety of repayment options when you refinance. Repayment terms typically range from 5 to 20 years. If you want to focus on speeding through payments and get the lowest interest rate, choose a five-year term. A longer term, such as 15 or 20 years, can mean a higher interest rate, but lower monthly payments.
  6. Capped Variable Interest Rates. Often, choosing a variable interest rate (as opposed to one fixed for the life of the loan) when you refinance gives you a lower starting interest rate. The risk is that your rate can climb over the years, as the interest rate is tied to the Libor rate or prime rate. Some student loan refinancing companies cap interest rates, so your rate won’t increase over a certain amount (usually between 8% and 10%), even if the Libor or prime rate is higher.
  7. Support During Unemployment. A few refinancing companies allow you to pause payments if you lose your job. Depending on the company, you can pause payments for up to 18 months. Some refinancing companies also provide assistance during your job search to help you find employment more quickly.
  8. Social and Lifestyle Perks. Some companies, such as CommonBond, sponsor networking and social events in multiple cities throughout the year. CommonBond also supports a program called Pencils of Promise, which provides educational opportunities to students in the developing world.
Student Loan Refinancing Advantages

Disadvantages of Student Loan Refinancing

Student loan refinancing does have several drawbacks that you should be aware of, especially if you are refinancing federal loans.

  1. No More Federal Repayment Plans. The federal student loan program offers a variety of repayment plans, from the 10-year standard plan to the Revised Pay As You Earn Plan (REPAYE Plan). The Income Based Repayment Plan (IBR Plan) caps monthly payments at 10% or 15% of your discretionary income. You can switch between plans as your needs and financial commitments change without going through a lengthy refinancing process. The plans offer a safety net should you have financial problems, as your monthly payment can be as low as $0. Once you refinance, you lose access to those plans.
  2. Interest Is Capitalized. It seems helpful that loan refinancing programs let you pause payments if you lose your job (or while you’re searching for a job). However, interest continues to accrue during that time. Unless you pay it off, it gets capitalized – meaning your loan will grow if you experience a prolonged period of financial struggle.
  3. No Loan Forgiveness. Federal loans can be forgiven after 10 years, 20 years, or 25 years, depending on your career and payment plan. After 20 or 25 years on the IBR Plan or the Pay As You Earn Plan (PAYE Plan), the government forgives the balance on your loan, meaning you are no longer responsible for payments on it. If you work in public service, your loans can be forgiven after 10 years. Student loan refinancing companies don’t offer forgiveness.
  4. Minimum Loan Amounts. Depending on the size of your loan, refinancing might not even be an option. Some companies only refinance loans greater than $10,000. Others refinance loans greater than $5,000. If you have a smaller loan and want a lower interest rate, you’re out of luck.
  5. Sticker Shock Due to Variable Interest Rates. Getting a low, variable rate today might seem like a great way to save money on your loan. But what happens if rates rise over the next few years and you find yourself with a rate of 8% or 9%? Lower variable rates can be tempting, but you may be better off choosing a fixed rate loan, unless you know you can pay off the balance before rates increase.
  6. Better Rates Are Not Guaranteed. Interest rates can be lower when you refinance – but they don’t have to be. Many companies offer a range of rates, from 2.2% up to 8% or higher. If you’re a high-earning attorney and meet the other criteria of the refinancing company, you’re likely to get the best rate. But people with more modest salaries, more debt, or a history of late payments might find that the offered rate is similar to (or even higher than) the current rate on their federal loan.

Options to Consider Instead

Refinancing companies aim to make student debt more affordable. If you find that the cons of refinancing outweigh the pros and you’re struggling to make loan payments, you have other options – for federal loans at least.

Federal Income-Driven Repayment Plans

If you find that you can’t make your payments under the standard repayment plan, it’s worth it to consider switching.

Under an income-based plan, your monthly payment won’t be more than 10% or 15% of your discretionary income, which is the amount of your adjusted gross income that is over the poverty line. For example, if your adjusted gross income is $40,000 and the poverty line is $25,000, your discretionary income is $15,000.

With income-driven repayment plans, repayment terms are either 20 or 25 years, after which the balance is forgiven (if not paid off) and you’re no longer responsible for it. The federal student loan program has four income-driven plans:

  1. Income Based Repayment Plan. Under the IBR Plan, if you took out your loans before July 1, 2014, your monthly payments are 15% of your discretionary income and you are responsible for payments for 25 years. If you took out loans for the first time after July 1, 2014, your monthly payments are 10% of your discretionary income and you’re responsible for payments for up to 20 years. Under the IBR Plan, your monthly payment will never be more than the monthly payment amount required under the standard, 10-year repayment plan, so you don’t have to worry about your monthly payment ballooning if your income suddenly increases.
  2. Income Contingent Repayment Plan. Your monthly payment on the Income Contingent Repayment Plan (ICR Plan) is either 20% of your discretionary income or the amount you would pay on fixed payment plan for a 12-year term. You’re no longer responsible for the unpaid balance on your loan on the ICR Plan after 25 years.
  3. Pay As You Earn Plan. Under the PAYE Plan, you need to have been a new borrower as of October 1, 2007. Your monthly payments are 10% of your discretionary income, but never more than they would be under the standard, 10-year repayment plan. The repayment term for the PAYE Plan is 20 years.
  4. Revised Pay As You Earn Plan. While PAYE is only open to new borrowers after 2007, the REPAYE Plan is open to any borrower with federal student loan debt. Your payments are 10% of discretionary income under REPAYE. However, unlike the IBR Plan or the PAYE Plan, you can end up paying more than you would under a standard 10-year repayment plan under REPAYE if your income increases considerably. Payment terms for REPAYE are 20 years if you’re repaying undergraduate loans, and 25 years if you’re repaying graduate loans.
Federal Income Driven Repayment Plans

Federal Consolidation Program

If you have multiple federal loans and a variety of interest rates, consolidating your loans can be the way to go. Federal loan consolidation isn’t the same as refinancing. Instead, it groups a variety of federal loans into one bigger loan. Fortunately, nearly every type of federal loan can qualify for consolidation.

One of the perks of consolidating is the potential to get a lower interest rate. When you consolidate, you end up with an interest rate that is the weighted average of all the rates on your loans, rounded to the nearest eighth. If the interest rates on some of your federal loans are considerably higher than others, consolidation can make sense. If the rates are similar across all of your loans, it might make less sense.

Another perk of consolidating your loans is getting to extend your payment term to up to 30 years. That means a lower monthly payment, but also that you’ll end up paying more in interest over the life of your student loans. If you’d rather not extend your repayment plan, you can choose shorter terms, such as 10 years. You can also choose an income-driven repayment plan after you consolidate your loans.

Although most federal loans in repayment or grace periods are eligible for consolidation, it is not available to borrowers who are in default. If you are in default, you need to make arrangements for repayment with your current loan provider or agree to enroll in an income-driven repayment plan after you consolidate.

Deferment or Forbearance

Like some student loan refinancing programs, the federal loan program also provides support if you lose your job or can’t find work. You can defer your loan payments if you decide to head back to school at least half-time, or for up to three years if you are out of work and unable to get a job. You can also defer your federal loans if you join the Peace Corps or are performing active-duty military service during a war, military operation, or national emergency.

During deferment, the government pays the interest on your subsidized loans, so you don’t have to worry about it being capitalized and added to your principal balance. However, you are responsible for interest on unsubsidized loans when your loans are in deferment. If you don’t pay the interest on unsubsidized loans, it gets added to your principal balance.

To qualify for deferment, you need to contact your loan servicing company directly. If you are deferring payments because you are out of work, you need to actively look for work (such as by registering with an employment agency), or need to prove that you are eligible for unemployment benefits. If you are deferring payments because you’ve gone back to school, you should contact your school’s financial aid office to help you complete the paperwork.

If you are still working but are underemployed or struggle to make ends meet, forbearance can be an option for federal loans. You don’t have to make payments on your loans in forbearance, but you are responsible for any interest. Forbearance allows you to stop making payments or to reduce your loan payments for up to 12 months. To qualify, you need to contact your loan service provider – be prepared to show documents proving that you are having a financial difficulty or illness.

You can qualify for deferment or forbearance no matter which type of repayment plan you are currently participating in. It’s worth noting that changing your repayment plan might help you avoid the need to defer or forbear your loans. Depending on your current income, your monthly payment on an IBR, ICR, or REPAYE Plan can be $0 per month. Carefully weigh all of your options before deciding which one makes the most sense for you.

Qualify Deferment Forbearance

Final Word

Unless the rates on your federal loans are high, you may be better off not refinancing. Student loan refinancing makes the most sense for borrowers with large private loans at a high interest rate.

If you borrowed more than $10,000 from a private lender and are looking at an interest rate above 7%, refinancing can save you a considerable amount of money and stress – and the added perks offered by many refinancing companies, such as unemployment support, can make them a better option than most private student loan lenders.

Have you refinanced your student loans? Has it helped?

Amy Freeman is a freelance writer living in Philadelphia, PA. Her interest in personal finance and budgeting began when she was earning an MFA in theater, living in one of the most expensive cities in the country (Brooklyn, NY) on a student's budget. You can read more of her work on her website, Amy E. Freeman.