With interest rates trending low again, some families might be thinking about ways to lower their monthly student-debt payments
Refinancing—the process of turning federal loans into private loans or taking out a new private loan, generally at a lower interest rate—could be an answer for some. But before deciding, it is helpful to understand the options.
It is a unique time right now, given the coronavirus pandemic. The Cares Act has granted a reprieve to most federal-loan borrowers, suspending payments from March 13 through Sept. 30. No interest will accrue on most federal student loans during this time.
For most borrowers, it won’t make sense to refinance these loans now because they’ll lose these protections and interest rates are likely to remain low in September, says Tobin Van Ostern, co-founder of Savi, a technology startup in Washington, D.C., that helps student-loan borrowers discover new repayment and loan-forgiveness options.
That said, families with private student loans—which aren’t bound by these federal protections—might want to try to get a better deal.
When doing so, here are three mistakes to avoid.
Mistake No. 1: Thinking it is all-or-nothing
Many families have several student loans and think they have to refinance all of them at once. That isn’t the case. Borrowers could simply look into refinancing the private loans they have and leave the federal loans alone—at least for now while the Cares Act provisions are in force.
After the six-month grace period for federal student-loan debt ends in September, holders of federal loans could then look into refinancing those loans into private loans as well. But they will be giving up federal protections by doing so, Mr. Van Ostern says. These may include income-based repayment, public-service loan forgiveness, forbearance and deferment.
It is also important to know what kind of federal loans you have. There are as many as nine million federal student-loan borrowers who hold loans that weren’t covered by the Cares Act even though the loans have essentially the same terms and conditions as the loans that were covered, according to the National Consumer Law Center’s Student Loan Borrower Assistance Project.
These include a portion of FFEL loans, originally issued through the Federal Family Education Loan Program; those not covered are owned by commercial lenders rather than the federal government. Federal Perkins Loans that are owned by the institution the student attended are also outside the act’s purview, though there has been a public outcry to eliminate these exceptions.
Borrowers who aren’t sure whether their federal loan qualifies for Cares Act relief can call their servicer.
In a similar situation, borrowers also can be uncertain whether their loan is federal or private. The loan could have been transferred at some point to a different federal servicer, causing borrower confusion although nothing else changed. Sometimes people just don’t remember, and sometimes paperwork may just list the name of the servicer, which in some cases can be the same for both federal and private loans.
To know whether a loan is federal or private, borrowers can log in at studentaid.gov for details on their federal loans, then match up those loans with the ones listed on their credit report, available from one of the three credit-reporting companies. Borrowers who are still unsure can ask their servicer.
Mistake No. 2: Not shopping around
There are many private lenders, and not all refinancing offers are the same. As a starting point, borrowers can visit third-party comparison sites such as Credible, NerdWallet, Student Loan Hero, Splash, SuperMoney and LendKey. The caveat is that some third-party sites are pay-to-play, meaning lenders pay to be highlighted, so borrowers are advised to expand their search to a broader lending universe.
Borrowers can also visit foryounotforprofit.org to identify refinancing opportunities at nonprofit and state-based private lenders. Banks and credit unions are another option to consider, as well as unions or professional organizations that might have referral relationships with lenders.
The rate is only one factor of many to consider, experts say. Borrowers should also look at whether the loan is variable or fixed. Variable-rate loans might offer a lower rate initially, but that is likely to go up over time—not necessarily ideal in a low-interest-rate environment such as this. On the other hand, a borrower with stable income who knows he or she can pay off the loan quickly, before rates rise, might nonetheless opt for such a loan.
Another question to ask is who will be servicing the loan. Is it done in-house or contracted out? Borrowers should ask about a lender’s credit requirements. Many private lenders require a credit score in the high 600 range or above, among other requirements.
Borrowers should ask whether the lender offers loan forgiveness upon death and whether there is an interest-rate reduction for enabling automated debit. Many lenders offer an interest-rate discount of one-quarter percentage point for signing up for this feature.
Another question to ask is whether having a cosigner can assist the borrower in getting a lower interest rate. Also, can the cosigner be released after a period of on-time payments?
“People look at the absolute lowest rate and they get so laser-focused on that that they don’t consider these other important factors,” says Joe Bird, senior vice president of business development and client relations at Iowa Student Loan, a nonprofit lender that also advises families on refinancing decisions.
Mistake No. 3: Not thinking long-term
Many borrowers fall into the trap of taking a loan with a shorter term—say, five years versus 10 years—to secure a lower interest rate. They need to consider that a shorter-term loan will likely have a higher monthly payment than a longer-term loan.
Borrowers need to be confident in their income stability to choose the shorter-term option, and because things happen and jobs are never guaranteed, it is risky—especially at a time like this, says Will Sealy, co-founder and chief executive of Summer, which helps borrowers track their student loans and find the best repayment plan.
Also, make sure to factor in unexpected costs like a medical emergency not covered by insurance. Will the higher monthly payment allow you to cover such a need? If you’re married and you share income with your spouse, will your spouse have job security or unexpected expenses?
Even if a borrower chooses a longer-term loan at a slightly higher interest rate, he or she can always choose to pay more than the monthly minimum. There are no penalties or fees for making extra payments on student loans.
“By making overpayments on your student loan, you will pay it off faster and reduce the total interest paid overall, which further unlocks additional savings,” Mr. Sealy says.
Also before refinancing, it is worth noting that a number of states have implemented policies to help student-loan borrowers amid the continuing pandemic. It is advisable for borrowers to call their private-loan servicer to see what other types of relief might be available. They can always seek to refinance later, after exhausting these other measures.
Also, the situation is fluid, and there is the possibility of more types of relief becoming available from the federal government and states.
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