A more appetizing way to save money is to refinance federal student loans with a private lender at a lower interest rate. Proponents of this option point out tens of thousands of dollars that refinancing can reduce a borrower’s debt.
But what they don’t point out is that refinancing isn’t right for everyone. In fact, it can be a big — and irreversible — mistake for some federal borrowers.
When you refinance a loan, you replace existing debt with new debt that has its own repayment terms. For many borrowers, the benefit is a lower interest rate and the promise of short-term savings, in terms of lower monthly payments, as well as long-term savings on the total amount repaid.
But borrowers often overlook the rest of the refinance terms, especially what’s no longer included.
Federal student loans come with a number of repayment plans, protections, and benefits that private loans don’t offer. By refinancing a federal loan into a private loan, you voluntarily and definitively waive access to these options.
In effect, a refinanced loan pays off the balance of an old loan – your original loan no longer exists and you cannot recreate or regain its terms or consolidate a private loan into the federal loan program if you run into problems on the road.
Benefits of Federal Student Loans
The biggest difference between federal student loans and their private counterparts is flexibility.
If you can’t afford your monthly payments, federal loans come with mechanisms to help, including income-based repayment plans and the ability to temporarily suspend payments through deferral or forbearance.
Current federal student loan borrowers may also be able to have their balance canceled or canceled under certain circumstances.
These options are more difficult to find with private lenders. Private student loans don’t offer forgiveness, and other federal loan benefits — like debt relief if the borrower dies — vary by lender. And if your loan allows you to defer repayment, you may have to pay a fee to do so.
Consider the pros and cons
Refinancing a federal student loan is a risk that borrowers should carefully consider. That doesn’t mean you should never take the plunge – for some borrowers, the pros outweigh the cons.
Before you refinance student loan debt, answer a few high-level questions about your goals, such as reducing monthly payments or decreasing the number of bills you deal with. If you’re considering refinancing federal student loans, ask yourself these additional questions:
• Will you ever qualify for a federal student loan forgiveness program?
• Is your salary high enough that you never need an income-tested plan?
• Are you sure about your job security and your health?
• Do you have a substantial emergency fund?
If you answered yes to all of these questions, refinancing your federal student loans may be a good idea.
Refinancing also works best for borrowers who have recently left school or just started repaying because refinancing will add more years to your repayment period.
If you’re halfway through the standard 10-year repayment plan for federal student loans, for example, you might want to complete those remaining five years — and keep federal benefits — instead of extending your repayment period. at 10 years or more. . The latter may lower your payments now, but make sure the savings add up in the long run by extending your payment plan.
Before refinancing, you will also need to confirm that you have a stable income and excellent credit. Both can help you get the best possible interest rate on the refinanced loan.
Remember that you may not qualify for the lowest advertised interest rate. This rate may also require you to pay off your loans faster, such as in five years instead of 10, 15 or 20 years, which could result in a higher monthly payment than your current payment.