Guide to Refinancing Student Loans
Literally millions of Americans are grappling with the agonizing problem of repaying student debt. With outstanding student debt topping $1 trillion, many are asking how to refinance student loans?
It's an overwhelming task to sort through the options for refinancing or consolidating student loans, especially as you can't go back to the terms of earlier loans once you make your move.
Student Loan Refinancing: What to Consider
1. Your Monthly Payments are Sky High
One of the main reasons people refinance their debts is because their monthly payments are unmanageable. By refinancing they may be able to lower the amount they pay each month.
The downside of this method is that the loan payment terms will likely be extended because it's going to take you longer to pay it off.
This is an option if you really can't afford to live because of your student loan debt. For example, if your student loans are impeding you from paying your rent then you may need to consider refinancing.
If this is your case you'll want to take a close look at the monthly APR of the new loan. Your monthly payment may be lower but the interest rate may be higher, meaning you'll end up paying more money in the end.
2. Your Loans Come with High Interest Rates
Another popular reason why people consider refinancing their student loans is to find lower interest rates. This is especially true if they have private student loans.
As I mentioned earlier, private loans rely on a student's personal credit history. Seeing as how it's unlikely that an 18 year old has a credit history, then a young adult may be faced with high interest rates.
Lenders are beginning to understand this and are offering young adults the opportunity to refinance their loans at much lower interest rates. Rather than taking your credit history into account, they also look at current cash flow and level of savings. Some lenders will even take your degree into consideration to determine your capability to pay back the loan.
3. You Need to Consolidate Multiple Loans
According to CNN Money, in 2014 Americans were carrying an average of four student loans per person. When you've got four different loans, from four different creditors, with four different monthly payments, four different interest rates and four different due dates things can get a little confusing.
It gets even more confusing if your student loans are being sold to new banks every few years. Imagine having to figure out who owns your loan when trying to write a check.
By refinancing your student loans you may be able to consolidate your loans into one debt that is easier to track, manage and pay.
For more about consolidating student loans check out our reviews.
Types of Student Loan Consolidation
Private Student Loan Consolidation
Unless you have near perfect credit, you'll likely pay more to borrow private student loans since their interest rates can be much higher than what you would receive with a federal loan. This means often times if you can consolidate your private loans it will be beneficial, particularly if you can receive a lower interest rate.
Private loan repayment plans are lender-specific which means that you should check with your individual lender as to the options available. They offer the least flexibility of repayment plan options where most are either a standard 10-year or 25-year repayment plan. Private lenders typically do not offer income-based repayment plans that are available through some of the Federal loan programs.
Federal Student Loan Consolidation
The main benefit of consolidating federal loans is you make it easier since you make only one payment a month in lieu of multiple ones. There's also the added incentive in that you can stretch your loan term out to 30 years, which will reduce the monthly payments. This can create room in your budget to comfortably make your payments each month as well as set aside money in emergency savings.
However, while lower monthly payments create more room in your budget, is it worth it? These illustrations below explain why lengthening your loan isn't the best financial decision you can make.
Federal loans offer a number of different repayment plan options and it is important for you to remember that just because your loan is a Federal loan does not necessarily mean that all of these plans are available to you. As part of the review process and creating your spreadsheet, you should include those loans that are eligible or ineligible Federal loans. Here are some of the repayment plans available under the Federal loan programs.
- Standard Repayment Plan – this plan allows you to repay your loans at a fixed amount per month (of at least $50) for 10 years on your loans unless you have a consolidation loan. These loans are available for repayment for a period of 10 to 30 years, depending on your total amount of student loan debt. All Federal loans are eligible for this repayment plan and you typically pay the least interest on this repayment type than the others.
- Graduated Repayment Plan – this plan allows you to repay your loans at a lower interest rate initially, and then after two years your payments will increase until the end of your loan term which is typically 10 years unless you have a consolidation loan at which point the repayment period could be 10 to 30 years depending on your total amount of student loan debt. This is a great option if you graduate with a job paying you a lower salary initially; however, you know you will have a higher income later. All Federal loans are eligible for this repayment option.
- Extended Repayment Plan – if you owe more than $30,000 in student loans, then you can qualify for this repayment option. This plan allows you to repay your loans at a fixed or graduated rate for 25 years.
- Income-Based Repayment Plan – this plan allows you to repay your student loans at a monthly payment of 15% of your discretionary income for 25 years. You will need to demonstrate a partial financial hardship to qualify for this type of loan and although you can remain on the plan even though your hardship no longer exists, you need to provide annual documentation of your income to set your payments for each year. As your income changes, so will your payment amounts. If you have a remaining balance that you owe on your student loans after 25 years of making regular payments, then the remaining amount is forgiven. It is important to note, though, that the forgiven amount will be considered income that will be taxable in that year. PLUS loans and consolidation loans with PLUS loans that were made to parents are not eligible for this repayment option.
- Pay As You Earn Repayment Plan – if you demonstrate that you have a partial financial hardship, and then this is another repayment plan option. This plan allows you to repay your loans monthly with a payment that is 10% of your discretionary income for up to 20 years. Any amount that you have remaining at the end of the 20-year period will be forgiven; however, you will be subject to income tax on that forgiven amount.
- Income-Contingent Repayment Plan – Allows you to repay your student loans based on your adjusted gross income, your family size and the amount you owe for up to 25 years. You do not need to show a partial financial hardship to qualify for this repayment plan. If you still have a remaining balance at the end of 25 years, then the amount owed will be forgiven; however, that amount is subject to income taxes.
- Income-Sensitive Repayment Plan – this plan allows you to repay your loans for 10 years based on your annual income. Your payments will change as your income changes; however, there is no forgiveness amount at the end of the period.
- Loan Forgiveness – If you work in the government or non-profit sectors or some related entities, you may be eligible for the Public Service Loan Forgiveness Plan. If you make 120 qualifying payments toward your student loans while working for one of these approving entities over 10 years, then at the end of the 10 years, your remaining loan balance will be forgiven and this forgiven amount will not be consider taxable as income. To qualify for the PSLF, you must be on one of the following repayment plans first, Income-Based Repayment, Pay As You Earn Repayment or Income-Contingent Repayment.
Student Loan Refinancing
While there are government loan consolidation programs out there for refinancing federal student loans, refinancing private student loans can look like a real can of worms at first glance. A good place to start is taking a look at a few of today's top-rated private lenders specializing in student loan refinancing.
Social Finance Inc., known as SoFi for short, offers a choice of repayment terms and a bundle of features making them the pick of the crop for refinancing or consolidating private or federal student loans. They can pause loan payments when you are unemployed, a feature rarely seen from private lenders.
LendKey is close on the heels of SoFi with their own bundle of innovative loan features, including an interest only option for unemployed students.
Earnest offers competitive rates, and gets that rarest of compliments for a lender, they are a highly recommended by customer reviews.
Traditional lenders such as banks they take your credit score, savings, assets, annual income and college degree into consideration for student loan refinancing. Those who don't meet the requirements of such lenders may be able to get approved with a consigner. Today's online lenders open things up nicely for more borrowers, using their own formulas for qualifying lenders, and offering the opportunity to apply and compare services online.
Interest Rates: Key to Refinancing
Before making a move to refinance or consolidate your student debt, take a close look at the terms of your current loan or loans. How much are you paying per month? What is the interest rate, and how much interest will you pay over the life of the loan? Is the rate fixed or variable? How long will it take to pay off your debt? Are their beneficial features to your current loan, such as no payments due while unemployed?
Pros and Cons of Refinancing Student Debt
Compare your current loans to the options you're are considering. Ask the same questions and look at the loans head-to-head. Scrutinize interest rates. Consider whether it's in your best interest to lock in a fixed rate in the current economic climate. Are you thinking of repaying your loan over a longer term with a lower payment? While this will help your monthly budget, you'll be paying more over the life of the loan. Finally, be sure to take a look at any benefits you lose if you refinance or consolidate to a new loan.
Refinancing Student Debt Recap
Bottom line, if you can refinance to an overall lower rate over a term similar to your current loan, you stand to save thousands of dollars. On the other hand, if your current income is low, you can extend the term of your loan or lower payments. In this case, you are signed on to a more expensive payback over time, but can consider refinancing again in the future should your income increase.
If you've been asking, should I refinance my student loans? With a careful analysis of loans both old and new, you will be armed to make an intelligent decision about this keystone piece of your financial future.