Pros and Cons of Refinancing Federal Student Loans
May 8, 2019
“I’ll never be able to repay these loans.”
"I can’t afford my rent, let alone loan payments.”
“I would have so much more freedom if I didn’t have student loans.”
If any of these thoughts sound familiar to you, you’re not alone. Among the class of 2017, 65% of college students left school with student loans.
If you’re focused on paying off your debt as soon as possible or want to save money, you’ve likely considered student loan refinancing. But should you refinance federal student loans? Here’s what you should know before submitting your loan application. You can refinance some or all of your student loans, and you can even refinance private student loans with your federal loans.
What is student loan refinancing?
Student loan refinancing is a process where you work with a private lender to take out a loan for the amount of your current debt; you use the new loan to pay off your old ones. The refinance loan has different repayment terms than your old ones, including interest rate, monthly payment, and length of repayment.
Benefits of refinancing federal student loans
Refinancing your student loans is a quick and easy process. Even better, it offers several benefits.
1. You can save money
When you refinance, you can qualify for a lower interest rate. With a lower rate, more of your payment goes toward the loan principal rather than interest, allowing you to save a significant amount of money.
For example, let’s say you had $35,000 in student loans at 6.6% interest — the interest rate on Direct Unsubsidized Loans for graduate students for the 2018-2019 school year — and a ten-year repayment term. Over the course of ten years, you’d repay a total of $47,904.
But if you refinanced those loans and were approved for a ten-year loan at 5% interest, you’d repay just $44,548. Refinancing would help you save over $3,300. You would also lower your monthly payment by $28—if you use that money to make and extra prepayment on your loan each month, you’ll pay off your loans even sooner.
Find out how much you can save with Purefy’s rate comparison tool, which lets you see your rates and savings with multiple lenders, so you get the best deal.
2. You can reduce your monthly payment
When you refinance, you can extend your repayment term or qualify for a lower interest rate. Either way, you could be eligible for a lower monthly payment, freeing up more money in your monthly budget.
For example, if you had $20,000 in student loans at 6% interest and a ten-year repayment term, your monthly payment would be $222 per month. If you refinanced and qualified for a loan with a 5% interest rate and a 15-year term, your payment would drop to just $158 a month. Refinancing would free up an additional $64 a month from your budget, allowing you to pursue other financial goals.
3. You can pay off your debt faster
With more of your payment going toward the principal rather than interest, refinancing can help you pay off your debt ahead of schedule.
For example, pretend you had $30,000 in student loans at 6.6% interest, and a $342 monthly payment. It would take you 120 months to pay off your loans. But if you qualified for a lower interest rate of 5%, but kept making a monthly payment of $342, you would cut down your repayment term by almost a year. You’d save money and get out of debt much faster.
4. You’ll have one easy payment
Chances are that you took out more than just one student loan. You may even have a mix of federal and private student loans. If that’s the case, juggling multiple loans, monthly payments, and due dates can be confusing. Refinancing can help streamline things for you.
When you refinance, you consolidate your student loans together. Going forward, you’ll have just one loan to manage and one easy monthly payment.
Drawbacks to refinancing federal student loans
Student loan refinancing can be extremely beneficial, but it’s not for everyone. There are risks involved, especially if you have federal student loans.
1. You’ll lose access to income-driven repayment plans
Under an income-driven repayment (IDR) plan, the loan servicer extends your repayment term and caps your payments at a percentage of your discretionary income, dramatically reducing your payments. However, you no longer qualify for IDR plans once you refinance your loans.
If you’re in a low-paying field, or your income fluctuates from year-to-year, refinancing may not be a smart option for you. It may be a better idea to keep your federal loans as is so you can qualify for an IDR plan.
2. You won’t be able to enter your loans into deferment or forbearance
With federal loans, you can enter into deferment or forbearance if you experience a financial hardship, such as an illness or job loss. Under these programs, you can postpone making payments without entering into default, giving you time to get back on your feet.
Once you refinance, you lose out on this federal benefit. Some refinancing lenders do offer forbearance options, but their versions tend to be stricter and shorter in duration.
If you work in a volatile field, or have recurring health issues, it may be wise to postpone refinancing so you have the option of placing your loans into deferment or forbearance.
3. You won’t qualify for federal loan forgiveness
Some federal student loans are eligible for loan forgiveness programs, such as Public Service Loan Forgiveness. But once you refinance, you no longer qualify for loan forgiveness. And no private lender offers forgiveness options.
If you work for a non-profit organization or government agency and plan to do so for the next ten years, it may be financially wise to pursue loan forgiveness rather than student loan refinancing.
Should I refinance my federal student loans?
Student loan refinancing is an effective way to manage your debt, helping you save money, reduce your payment, and streamline your loans. However, refinancing has some significant drawbacks you should consider before applying for a loan.
Refinancing is a smart choice for those with good credit, a stable income, and who don’t plan on using federal loan benefits. By doing your homework, you can ensure you make the right decision for you. The best place to start is by comparing your rates with Purefy to see what you can save.