If you have high-interest student loans — some loans have interest rates over 11% — student loan refinancing can sound like a dream come true.
You can lower your interest rate, save money, and pay off your loans years ahead of schedule.
What could possibly be the problem?
Well, there is a downside to refinancing your student loans. Before submitting your loan application, make sure you understand both the benefits and drawbacks of refinancing your debt.
What is student loan refinancing?
Student loan refinancing is a strategy some people use to manage their debt. You apply for a loan from a private lender to cover the amount of your current debt and use it to pay off your existing loans. After that, you’ll have just one loan to manage instead of several. And, you’ll have only one monthly payment to remember to make to one loan servicer.
The new loan is entirely different than your old ones. It has a different interest rate, loan length, and minimum payment.
Why would someone refinance? There are some major benefits:
1. You can save money
If you qualify for a loan with a lower interest rate than your current debt, you can save thousands of dollars over the length of your loan.
2. You can lower your monthly payment
When you refinance, you can opt for a longer loan term. Extending the loan length can reduce your monthly payments, making them more affordable.
3. You can pay off your debt early
With a lower interest rate, more of your monthly payment will chip away at the loan principal instead of interest charges. If you keep up with the payments, you can pay off your refinanced loan months or even years ahead of schedule.
The downside of refinancing student loans: 5 things to consider
While refinancing can be very beneficial for some, it’s not for everyone. There is a downside to refinancing student loans. In fact, here are five reasons why refinancing may not be a good idea.
1. You may not be able to reduce your interest rate significantly
The biggest benefit to student loan refinancing is the ability to qualify for a lower interest rate. However, that perk is only helpful if your current student loan rates are high.
If you have loans with lower interest rates, such as the current 4.53% rate on Direct Subsidized and Unsubsidized Loans, you may not be able to qualify for a loan with a lower rate.
Even if you opt for a variable-rate loan, which tends to start off quite low, the rate can fluctuate over time. If the market changes, you could end up with a higher rate than what you had originally, even if you save more money initially.
2. You may not have access to deferment or forbearance
If you have federal student loans, you have the option of entering forbearance or deferment. Through these programs, you can postpone making payments on your loans without becoming delinquent or entering default. This benefit can be a big help if you’re facing financial hardship, such as a medical emergency or job loss.
When you refinance, your federal loans become private ones. You’ll lose the ability to defer your payments under the federal program, which tends to be more lenient than deferment and forbearance options from private lenders. If you work in a volatile industry where layoffs are common, that’s a big drawback.
3. You won’t be able to use an income-driven repayment plan
If you have federal student loans and don’t make a lot of money, you can apply for an income-driven repayment (IDR) plan. With IDR plans, the loan servicer caps your monthly payment at a percentage of your discretionary income and extends your repayment term. Depending on your family size and income, you could have a payment as low as $5.
Once you refinance, you’re no longer eligible for IDR plans. You’ll have to make the full monthly payment each month, even if your income changes or your family grows. If your income is low or if you expect it to fluctuate, it may be better to keep your loans as federal loans.
4. You won’t qualify for loan forgiveness
Some federal loan borrowers can qualify for loan forgiveness through programs like Public Service Loan Forgiveness or Teacher Loan Forgiveness. After completing a service term and making qualifying payments, the remaining balance on your student loans is completely discharged. If you had a lot of student loan debt, that means you’re no longer responsible for repaying thousands of dollars.
Unfortunately, you’re not eligible for those programs once you refinance your loans. If you’re a teacher or work for a non-profit or government agency, student loan refinancing may not be for you. It may be more cost-effective to keep your loans as federal debt so you can qualify for these forgiveness options.
5. You may not be able to get approved
To qualify for a refinancing loan and to get a low interest rate, you need to have good to excellent credit. Otherwise, you’re unlikely to get a loan at all.
If your credit is less than stellar and you don’t have a co-signer to help you, student loan refinancing is probably not an option for you.
If that’s the case, don’t give up! Instead, work on boosting your credit score and improving your income. By doing so, you’ll increase your chances of qualifying for a refinancing loan in a year or two.
Managing your student loan debt
If you are struggling with education debt and want to pay off your loans as quickly as possible, student loan refinancing can be a smart strategy. However, it’s not an approach that works for every borrower. Especially if you have federal loans, think twice about refinancing, as it affects what benefits and programs you can use.
If you’ve weighed the pros and cons and think refinancing is right for you, use Purefy’s Compare Rates tool to get offers from multiple student loan refinancing lenders at the same time — quickly and simply — with one easy form.