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Washington, D.C.

  • Kevin Mahoney, CFP®

Should I Refinance My Student Loans? The Decision Hinges on More Than Just Market Interest Rates.

certain student loans offer benefits that you must consider before you refinance with a private lender

About the author: Kevin Mahoney, CFP® is a fee-only financial advisor in Washington, D.C. Kevin's work with his clients focuses on paying off student loans, buying a house, investing savings, and budgeting. Kevin is the founder & CEO of Illumint, a virtual financial planning firm specifically designed to help couples and young families with their financial decisions.

If you have student loan debt, you may feel compelled to take action whenever you see news headlines about falling interest rates. Your intuition isn’t wrong, either. Generally speaking, new opportunities to secure a lower interest rate for your student loans do arise when market interest rates fall. However, certain student loans -- federal student loans, to be specific -- offer additional benefits that you must review and consider before you refinance with a private lender.

Private Student Loans: Refinancing Opportunities

If you have private student loans, your refinancing decision typically is pretty straightforward. Christoper Murray summarizes at Money Under 30 the situations in which refinancing these loans makes sense:

As soon as you have a stable income (and good credit)

“This probably means you won’t be able to finance right after you graduate. Jobs most people take right after graduation are likely not permanent and, depending on the job, don’t pay a whole lot.”

If you have loans with high interest rates

Variable interest rates “mostly applies to private loans. Federal student loans no longer offer a variable rate (if you have loans that originated before 2006, you might still have a variable rate), but rather a fixed rate that isn’t subject to change.”

You have multiple, expensive loans

“If you less than $10,000 in loans, refinancing probably isn’t worth it. Since most borrowers have much more debt than this, lenders offer lengthy plans that allow you to pay smaller amounts over time with an interest rate that won’t force you to pay tens of thousands of dollars more than you borrowed.”

After grace periods

“Federal student loans offer a six-month grace period right after you graduate from your undergraduate program. …These grace periods exist for a reason—chances are you will need them.”

Private Student Loans: Refinancing Cautions

Even if interest rates move in your favor, you will want to keep in mind that refinancing is still a financial transaction that can involve fees and new terms. As Matt Becker of Mom and Dad Money writes, you might want to pay close attention to the following refinancing dynamics:

  • “You’re likely to get the best deals when you have a good credit history AND when your credit score is significantly higher than it was when you originally borrowed.

  • Watch out for fees. Even with a lower interest rate, up front and ongoing fees could wipe out and cost savings.

  • Some of these loans have variable interest rates that could rise quickly if overall interest rates rise, which could significantly increase the cost of the loan.

  • Read the terms and conditions. Some loans offer more protections than others, such as the ability to pause payments during disability or unemployment. You’ll want to make sure that you’re not giving up anything important by refinancing.

  • Refinancing to a lower interest rate could still cost you more money over time if your new loan has a longer repayment period than your old loan. Of course, you could always choose to pay off your new low-interest loan in a shorter period of time to offset the difference, but that takes some purposeful planning.”

Federal Student Loans & RefinancinG

The prospect of paying less in interest each month is so enticing that some student loan borrowers may neglect to consider what they stand to lose from their federal loans if they refinance into a private loan. As Kendall Little at Bankrate notes:

“When you refinance your federal student loans, you forfeit the opportunity to take part in federal income-based repayment plans and loan forgiveness programs like Public Service Loan Forgiveness.

If you rely on an income-based plan or you will one day qualify for PSLF, refinancing may not be the best solution for your long-term goals. It’s important to look at how much you’ll be paying over the lifetime of the loan using both options.”

When federal student loans are refinanced, they’re replaced with a new, private student loan. Unlike the options one may have to change loan repayment plans, the decision to refinance into a private loan is irreversible -- and with that decision, you lose the relatively significant flexibility that federal loans offer compared to most private loans.

Managing a Combination of Federal and Private Student Loans

Many graduates, especially those who have completed grad school, may have a mix of both federal and private student loans. This scenario doesn’t necessarily need to be any more complicated than the decision considerations described above. If, for example, a borrower has a private student loan with a significantly higher interest rate than current market rates, refinancing or paying off that individual loan (without changing how you approach any of the other loans) may make sense.

In some cases, certain personal and financial circumstances may make refinancing both the private and federal student loans appealing. Melanie Lockert, author of the book Dear Debt, offered an excellent breakdown at Student Loan Planner on when you might refinance federal student loans:

You’re not interested in loan forgiveness

“If you’re not working in the public sector and the idea of paying your loans for 20 to 25 years makes you cringe, student loan forgiveness probably isn’t in your future. If you’re absolutely sure that this is not a route you want to pursue, refinancing could be a better fit to reduce your interest rates and help you pay off your student loan debt faster.”

Your job is (fairly) stable

“Your job should be fairly stable if you want to refinance your student loans. You’ll need the income from your job to get approved for refinancing and then to make the appropriate payments on your new loan. Also, you’ll no longer have access to an income-driven repayment plan if your income plummets, and you won’t have the same student loan deferment or forbearance options if you’re suddenly out of work.”

You have good credit

“When you take out a loan with a private lender, they want to know you have good credit to pay back your loan. Student loan refinancing companies run a credit check to determine if you’re a good candidate for a loan.”

Your monthly payments are manageable

“Refinancing can help an interest rate problem but not a monthly payment problem. Making sure your payments are manageable on the Standard Repayment Plan can be a good benchmark to see how much you can afford monthly payments when you refinance. If you’re struggling to make payments on the Standard Repayment Plan, it’s best to stick with federal student loans in that case and opt for an income-driven plan which can lower your payments based on your income.”

Your interest savings can make a dent on your principal balance

“Ideally, you can get a couple of points shaved off of your interest rate. Even then, you should do the math and calculate how much you’re really saving on your current student loan balance. If you don’t have that much left to pay back it may not be worth the hassle, or if the rate isn’t much better, stick with your federal student loan repayment plan.”

Ultimately, refinancing your student loans can be a great way to put you on a path to student loan repayment success. In many cases, though an attractive interest rate doesn’t outweigh the advantages that your federal student loans or personal financial circumstances offer. Refinancing may seem like an easy decision, but it’s best to proceed cautiously.