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It can be a challenge to figure out the best way to manage your student loan in the best of times, but the COVID-19 pandemic, which triggered record-high inflation and a possible recession, has made this question even more complex. On one hand, refinancing student loans may save you money and help you eliminate debt faster. But taking out a new loan to replace your existing student loans isn’t the right move for every borrower, especially during a time when payments and interest on many federal student loans remain paused, mass student loan forgiveness has been announced and interest rates on private loans are increasing.
Refinancing student loans during the COVID-19 pandemic: Considerations to keep in mind
There are a number of factors that could make refinancing your student loans a great idea or a bad one. And while the types of student loans you owe — federal or private — is likely the first consideration that comes to mind, you’ll want to dig a little deeper before you make such an important financial decision.
Most federal student loan payments are on pause
For most federal student loans, both payments and interest have been paused for years. This began with the Coronavirus Aid, Relief, and Economic Security (CARES) Act in 2020 but has been extended through Dec. 31, 2022.
If you have eligible federal student loans that are currently paused, refinancing with a private lender would change your situation. Once you take out a new private loan, your lender will expect you to start making payments right away, and those payments will include interest.
“Many borrowers go on the open market to refinance and get private loans. People who did that during the current deferral lost a great deal of money, as payments and interest on government loans are being waived,” says Michael Sullivan, a personal financial consultant with Take Charge America. The COVID-19 payment and interest suspension applies many types of loans, including:
- Direct Loans (nondefaulted and defaulted status).
- ED-owned FFEL Program Loans (nondefaulted and defaulted status).
- Non-ED-owned FFEL Program Loans (defaulted status).
- Federal Perkins Loans (nondefaulted and defaulted status).
- HEAL Loans (defaulted status).
Interest rates on private loans are increasing
In the height of the COVID-19 pandemic, interest rates reached historic lows, making private loans appealing to many borrowers. But with inflation sweeping the nation, the Federal Reserve has begun to hike rates and is expected to announce several more rate increases throughout 2022 to help control rapidly climbing consumer prices. With interest rates offered by private lenders going up accordingly, it could be hard to find a competitive interest rate through refinancing.
However, if you have excellent credit and have private student loans with a variable interest rate, now may be a good time to consider refinancing to a fixed-rate loan, as this will protect you from further rate increases.
Private (and some federal) student loan payments are still due
With private student loans, your lender still expects you to make your payments as scheduled. There’s no payment or interest pause in effect for the following types of federal loans, either:
- Nondefaulted FFEL Loans owned by a commercial lender.
- Perkins Loans held by a commercial lender.
- Nondefaulted HEAL loans.
If you currently have outstanding loans that fall into any of the above categories, then refinancing might make sense if you are able to secure a lower interest rate or better loan terms. You can use a student loan refinance calculator to crunch the numbers and see how much a lower interest rate could save you.
Refinancing federal student loans takes away benefits
By replacing your federal student loans with a private student loan, you would be giving up certain benefits, including:
- Income-driven repayment.
- Access to student loan forgiveness programs.
- Federal student loan consolidation.
Most importantly, you’d be missing out on the one-time targeted relief recently announced by the Biden Administration. Biden’s new plan not only extends the repayment pause until the end of the year but can also shave off up to $20,000 from your federal student loan balance if you earn less than $125,000 a year.
It can be challenging to refinance student loans with bad credit
When you apply to refinance your student loans, the lender will check your credit report and score as part of the process. If your credit is in poor shape, you could have a hard time qualifying. And even if a lender approves your loan application with credit problems, you might not receive the most attractive interest rate or terms.
Working to improve your credit before you apply for a new loan may be helpful. But keep in mind that many private lenders offer a prequalification process. Prequalification lets you see if a lender is likely to approve you for a loan (and at what interest rate) without any negative impact on your credit score.
What other steps can you take if you’re having trouble making payments?
Refinancing your student loans has the potential to lower your monthly payment by securing you a lower interest rate, extending your repayment terms or both.
But there are also other options to lower your monthly student loan payment if you’re struggling financially. In addition to refinancing, you might consider one of the following alternatives:
- Apply for forbearance: If you have private student loans and can’t keep up with your monthly payment, contact your lender to see if you could have your payments suspended temporarily through forbearance. Although interest will continue to accrue during this time, pausing your payments while things improve can save you from damaging your credit.
- Ask for an adjusted repayment plan: Even if a lender doesn’t have an established forbearance program in place, it may be willing to temporarily adjust your payments. In many cases, a lender would rather work with you on creating a plan than let you default, so it’s always worth asking.
- Apply for income-driven repayment if you have federal student loans: Although federal student loans aren’t due for another few months, if you were struggling to make payments before the payment pause started, applying for an income-driven repayment may be the best choice. With an income-driven repayment plan, your monthly payment is limited to between 10 and 20 percent of your discretionary income and can be as low as $0, depending on how much you earn.
If you can reduce the interest rate on your private student loan debt, now might be a good time to refinance before rates get any higher. But if you can’t secure a better interest rate, or if you’ll have to sacrifice valuable federal loan benefits, refinancing your student loans may not be the right move.
Just be sure not to rush into a decision. It’s important to take time to consider all of your options. Then, if you’re leaning toward a new loan, you should shop around to find the best student loan refinance rates available.