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When you refinance your student loans, you combine your federal or private loans into one private loan with a singular monthly payment. In the right situation, refinancing can save you money in the long-run, but it only makes sense if you qualify for better terms and a lower interest rate.
If you’re choosing to refinance, consider these advantages and drawbacks before signing on the dotted line:
Top 5 considerations to make before refinancing student loans
Take a look at your entire financial portfolio, compare lenders and consider the pros and cons of refinancing before making a final decision so you don’t end up in more debt down the road.
1. Pro: You can save money with a lower interest rate
If your goal is saving money in the long-run, then make sure the new, private loan has a lower interest rate than your original loans. A lower rate means that you’ll pay less in interest changes over the life of your loan and can reduce the likelihood of interest capitalization — when unpaid interest accrues and is added to your principal balance.
Most lenders offer prequalification, which lets you see your eligibility odds and predicted loan terms without impacting your credit score. When you apply for a refinance loan the lender will do an in-depth review of your credit report, called a hard credit check, which lowers your credit score by a few points. To find the loan with the best rate, it’s important to shop around and compare lenders through prequalifying to minimize the impact to your credit score.
2. Pro: A longer repayment period can lower your monthly payment
Another perk of refinancing is the ability to elongate your repayment timeline to reduce your monthly payment amount. While a longer repayment will end up costing you more in the long run, it can provide immediate relief to your budget and help you stretch your money a bit further.
If you’re able to make a larger payment down the road and want to pay down your balance further, you can simply elect to make a larger payment. However, you can’t elect to make a smaller payment unless you qualify through refinancing.
3. Pro: One payment is easier to manage
For those who have loans with multiple lenders, keeping track of every payment and the details of each loan can be difficult. Since refinancing involves consolidating multiple loans into one loan with a single payment, it makes staying on top of your monthly payments much easier.
For those with both federal and private student loans, refinancing can be a great simplification tool when communicating between lenders — especially because private and federal lenders operate differently and have different regulations. However, only refinance if you’re offered a more competitive rate than your federal loans and don’t plan on using the Education Department’s federal relief programs.
4. Con: You lose all federal benefits and protections
Federal student loans carry specific forgiveness and repayment benefits, including programs like Public Service Loan Forgiveness, closed school discharge, total and permanent disability discharge and borrower defense to repayment.
The Education Department also offers hardship payment relief — temporary deferment and forbearance periods — to all federal borrowers, which can help reduce the risk of defaulting on your balance. Private lenders don’t offer uniform benefits and some offer more relief and repayment options than others. If you think you qualify for federal debt or payment relief, put off refinancing for a little while you explore the options available.
5. Con: It can be difficult to qualify for better terms
If you have a lower income or a credit score under 650, it can be hard to qualify for a lender without a co-signer. Most lenders require proof of steady income that typically starts at around $20,000 annually. While there are lenders that cater to borrowers with income, most still require a good credit score and relatively low debt-to-income ratio (between 30 and 36 percent).
When looking for a loan that meets your needs, always consider the interest rates. Loans that cater to borrowers with a less-than-stellar financial record often come with higher rates and less than optimal terms. Instead of borrowing a loan with non-competitive terms, take the time to conduct an audit of your budget. Look into your credit history and repayment trends to see what can be done to improve your creditworthiness.
Most of your credit score is based on debt repayment, so prioritize paying down high-interest debt every month on time and if possible, in full. Making at least the minimum payment every month can substantially help improve your credit over time.