It's a popular question on Google: "Should you refinance your federal student loans?" Here’s what you need to know.
Student Loan Refinancing
Student loan refinancing is the process of consolidating your existing student loans—federal, private, or both—into a new, single student loan with a lower interest rate. When you refinance student loans, you make one monthly payment to one student loan servicer. With a lower interest rate and lower monthly payment, student loan refinance is a smart tool to save money and pay off your student loans faster.
Student loan refinancing makes sense for private student loans, since they can have higher interest rates and do not qualify for federal repayment plans or student loan forgiveness.
But what about federal student loans?
Here are several points to consider:
1. Determine if you plan to use income-driven repayment plans
The federal government offers several income-driven repayment plans for student loan repayment of federal loans. Income-driven repayment plans include Income-Based Repayment (IBR), Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE), among others. Income-driven repayment plans can lead to student loan forgiveness for federal student loans after 20-25 years. However, there are advantages and disadvantages to income-driven repayment plans.
Advantage: You can lower your monthly payment and choose forbearance or deferral if you lose your job or face economic hardship.
Disadvantage: If your monthly payments are lowered, your student loans still accrue interest, which can increase your overall student loan payment if you don’t receive student loan forgiveness. If you receive student loan forgiveness, there’s a catch: you may owe income taxes on the amount of student loan forgiveness that you receive.
2. Determine if you plan to enroll in Public Service Loan Forgiveness
The Public Service Loan Forgiveness Program is a federal program that forgives federal student loans for borrowers who are employed full-time (more than 30 hours per week) in an eligible federal, state, or local public service job or 501(c)(3) non-profit job who make 120 eligible on-time payments.
Even if you qualify for public service loan forgiveness, you may not want to wait to make 120 monthly payments, or 10 years, to receive student loan forgiveness, or you may not plan to work in public service for that duration. Therefore, in addition to refinancing private student loans, you also may want to consider refinancing federal student loans.
3. Determine how much money you can save with student loan refinancing
Student loan refinancing is uniquely personal to your financial situation, so it's important to see how much you can save when you refinance student loans. It's also important since you will no longer have federal student loans and won’t have access to federal repayment plans, including federal deferral or forbearance options. That said, many lenders now permit you to defer or pause your student loan payments from 12—18 months if you lose your job or face economic hardship.
A student loan refinancing calculator can help you calculate how much money you can save from refinancing your federal student loans, private student loans, or both.
For example, let's say that you have $50,000 of student loans at a 7% interest rate and 10-year payment plan, and you can refinance student loans to a 3% interest rate and 10-year payment plan. With student loan refinancing, you would lower your monthly payment by about $100 each month, and save $11,729 in interest payments.
4. Focus on your new student loan refinancing terms
Interest rate: Since student loan refinancing has no fees, any interest rate lower than your current interest rate can help save you money.
Fixed vs. variable: One benefit of student loan refinancing is that you can choose a fixed-rate or variable-rate student loan. In contrast, federal student loans only have fixed-rate student loans, and everyone receives the same interest rate regardless of their underlying credit score. Therefore, student loan refinancing provides flexibility if you want to change your rate type.
Loan term: Another benefit of student loan refinancing is that you can choose a loan period from 5-20 years, compared with federal student loan repayment which can last 10-30 years. Since student loans have no prepayment fees, you can pay them off at anytime with no financial penalty.
Check your rate: Before you refinance student loans, you can check your new rate online for free within 2 minutes. Lenders may do a "soft" credit pull, but there is no impact to credit score. If you choose to apply for student loan refinancing, you should apply to multiple lenders at once to increase your chances for approval. If you apply to multiple lenders within a short period of time, the good news is that it should only count as one hard credit pull on your credit reports.
Student loan refinancing: If you have a strong credit profile, steady income and want to pay off your student loans as fast as possible, then student loan refinancing is a viable option.
Federal student loans: If you plan to enroll in Public Service Loan Forgiveness or an income-driven repayment plan, you may choose to keep your federal student loans outstanding and try to refinance your private student loans.
Parent PLUS or Grad PLUS loans: If you are a parent or guardian with Parent PLUS Loans or a student with Grad PLUS Loans from graduate schools, the interest rate on your loans can be high. If you have a strong credit profile and steady income, student loan refinancing may help lower your interest rate and save you money.