Student Loan Refinancing: What to Know Before You Refinance

What is student loan refinancing?

Student loan refinancing is a process where a private lender pays off your existing federal or private student loans and issues you a new loan with new terms. This new loan can come with a different interest rate, repayment term, and monthly payment amount.

Refinancing can be a useful tool for borrowers who want to potentially lower their interest rate, reduce their monthly payment, or combine multiple loans into a single monthly payment. However, it's important to understand the trade-offs, especially when federal loans are involved.

Sources: Dandarah Wealth Management, LendKey

Differences between refinancing and consolidation

People often use the terms 'refinancing' and 'consolidation' interchangeably, but they refer to different processes. Federal loan consolidation is a specific option for federal student loans: it combines multiple federal loans into a single Direct Consolidation Loan, with an interest rate based on the average of your existing loan rates. This process keeps your loans in the federal loan program.

Refinancing, on the other hand, involves a private lender paying off your existing federal and/or private loans and issuing a new loan with new terms. If you refinance federal loans with a private lender, those loans are no longer federal, and you lose federal loan benefits like income-driven repayment plans and loan forgiveness options.

A key difference is that refinancing can combine both federal and private loans into a single private loan, which can simplify repayment into one monthly payment. Federal consolidation only applies to federal loans.

The table below summarizes the key differences between federal consolidation and private refinancing.

Sources: LendKey, Consumer Financial Protection Bureau, Sallie Mae, Dandarah Wealth Management

Refinancing Federal and Private Loans: Benefits and Drawbacks

The decision to refinance depends on your loan type and financial situation. For private loans, refinancing may offer a lower interest rate or better terms. For federal loans, the trade-offs are more significant because you would lose federal protections.

Below are the potential benefits and drawbacks of refinancing, based on information from the Consumer Financial Protection Bureau and other sources.

• Potential benefits of refinancing:
• Your interest rate might be lower, especially if your credit is strong.
• You can combine multiple loans into one monthly payment.
• You might be able to release a cosigner from the loan.
• You can switch from a variable-rate loan to a fixed-rate loan for predictable payments.
• Potential drawbacks of refinancing federal loans:
• You lose access to income-driven repayment plans.
• You lose eligibility for loan forgiveness programs, such as Public Service Loan Forgiveness (PSLF).
• You may lose deferment and forbearance options that are more generous than those offered by private lenders.
• If you extend your repayment term, you may pay more in total interest over time.

Sources: Consumer Financial Protection Bureau, Sallie Mae, Debt.org, Saving for College, Dandarah Wealth Management

When refinancing makes sense (and when it doesn't)

Refinancing can be a good idea if you have private loans with high interest rates and you have a strong credit profile, allowing you to qualify for a lower rate. It can also be helpful if you want to consolidate federal and private loans into a single payment, or if you want to release a cosigner.

Refinancing is generally not advisable if you have federal loans and you depend on federal benefits like income-driven repayment, loan forgiveness, or generous deferment options. If you might qualify for Public Service Loan Forgiveness (PSLF), you should not refinance federal loans because those benefits would be lost.

Always weigh the potential savings against the value of the federal protections you would give up.

Sources: Consumer Financial Protection Bureau, Sallie Mae, Saving for College

How to compare refinancing offers

If you decide to refinance, it's important to compare offers from multiple private lenders. Lenders evaluate your creditworthiness based on factors such as your credit score, income, and debt-to-income ratio.

When comparing offers, consider the interest rate (fixed or variable), the repayment term, any fees, and the monthly payment amount. A longer repayment term can lower your monthly payments, but it may increase the total interest you pay over the life of the loan.

Remember that private lenders' terms and rates can vary, so it's wise to shop around. However, keep in mind that applying for refinancing may involve a hard credit inquiry, which can temporarily affect your credit score.

Sources: Sallie Mae, Debt.org, HESC Loans

Impact on credit score and loan features

Refinancing affects your credit in several ways. When you apply, lenders typically perform a hard inquiry, which can have a small, temporary negative impact on your credit score. Once you take out a new loan, your old loans are paid off and closed, which can also affect your credit history.

It's also important to understand that refinancing with a private lender means your new loan is a private loan. This means you lose any federal loan features you had, such as income-driven repayment plans, loan forgiveness options, and possibly deferment and forbearance options that are more generous than what private lenders offer.

Sources: Consumer Financial Protection Bureau, Saving for College