Read This Before You Refinance Your Federal Student Loans
For many people, refinancing your student loans can save on interest. You can refinance just one loan, or you can consolidate multiple student loans into a single loan with just one monthly payment to keep track of. In many cases, refinancing or consolidation can help lower your payments, get you out of debt faster, or both. But it’s not a great idea for everybody. For some borrowers, refinancing student loans can be a serious mistake.
Before you sign the refinance documents, read this.
Lenders often have conflicts of interest.
Refinance lenders are salespeople. They are paid based on how many borrowers they can get to refinance, and how much money they can lend. They may not tell you all the material facts, including the downsides to refinancing federal loans and leaving the federal system.
You may lose borrower default protections.
Federal student loans come with significant protections to help you avoid default. For example, if you are unemployed or otherwise going through a rough patch, it’s usually simple to get a forbearance from your federal student loan servicer. This means you can skip payments for a while without trashing your credit. If you refinance student loans to a private lender, you may not be able to get a forbearance when you need one.
You lose income-based repayment options.
Federal student loans now frequently offer the option of pegging your payments to a percentage of your household income. Under the Revised Pay as You Earn program (REPAYE), you can cap your payments at 10 percent of your income.
This could be a valuable benefit if you or your spouse wants to leave the work force to become a stay-at-home parent, or if one or both of you experience a job loss or pay cut. Many people face low incomes while starting a business or in their first few years in a new career, such as insurance sales and real estate.
You lose forgiveness options in the long run.
With federal loans, if you make all your payments on time, and you’re still making payments on them after 20 or 25 years (high balances combined with low income-based repayment programs can cause this to happen), you may be able to have the balance forgiven. Once you refinance, this option goes away.
You may lose eligibility for public service loan forgiveness.
If you’re in a public service job or working as a schoolteacher – or even if there’s a good chance you could be working in these jobs in the future – refinancing means you won’t be eligible for loan forgiveness under PSLF or teacher loan forgiveness programs.
Refinancing your existing federal student loan(s) may be a good idea under if these circumstances apply:
- You are very secure in your job, with no plans to change careers and little chance of layoff or job loss.
- You have good credit
- You don’t anticipate being able to qualify for forgiveness in the future
- You can save a significant amount of interest
- You have a number of years to go before the end of your student loan repayment period.
- You can easily afford the new monthly payments.
- You don’t need a cosigner.
- You want to release an existing cosigner from your student loans.
Your new lender may not work with you if you hit a rough patch.
When you are looking at your loan refinance documents, it’s important to look beyond just the new payment amount and the new interest rate. Look at the terms they provide you in writing. Are there provisions for flexibility if you’re unemployed? Disabled? What does it take to qualify?
If flexibility isn’t there in writing in the original loan documents, don’t accept verbal assurances. If it’s not in the contract, you can’t count on it.
Remember – once you refinance, you can’t unring that bell! Before you sign that refi contract, you should be absolutely sure the decision is the right one.
Jason Van Steenwyk is an experienced financial industry reporter and writer. He is a former staff reporter for Mutual Funds, and has been published in SeekingAlpha, Nasdaq.com, NerdWallet, Value Penguin, RealEstate.com, WealthManagement.com, Senior Market Advisor, Life and Health Pro and many other outlets over the past two decades. He is also an avid fiddle player and guitarist. He lives in Orlando, Florida.