Vanessa and I both had student loans after graduating, and we fought hard to pay those loans off. We didn’t refinance or consolidate our student loans, because we put 100% of our available income toward repayment. This allowed us to knoc_k out nearly $30,000 in student loan debt within our first year of marriage.
Our personal plan won’t work for everyone, and it can take years to eliminate debt if you are prioritizing other financial goals. If you anticipate making loan payments for many years, refinancing or consolidating might be your best available option.
As I discussed in my last post, consolidation is the process of exchanging one or more federal loans for a new federal loan (at the same interest rate). This can be advantageous if you want to qualify for income-driven repayment plans (and loan forgiveness), but it does not save you money on interest.
Alternatively, you can refinance your student loans. Refinancing is similar to consolidating – you exchange one or more existing loans for a new loan. The difference is that refinancing can include both federal and private loans, and is done through a private lender. The primary reason to refinance your student loans is to obtain a lower interest rate and reduce the amount of interest paid over the life of the loan.
How to Obtain the Best Interest Rate When Refinancing
When refinancing, your interest rate will depend on your creditworthiness. Refinancing is best for people whose financial position (employment, cash flow, and credit) has improved since they graduated from school. Many of the private lenders consider the following information when determining the interest rate on a new loan:
- FICO score
- Monthly gross income
- Monthly debt-to-income ratio
- College degree and career outlook
To qualify for the best rates, you need to show great credit, stable monthly income, and low levels of existing debt.
Should You Refinance Your Student Loans?
It’s possible to refinance both private and federal student loans. For either type, the decision involves two primary considerations:
- Does it save you money?
- Does it offer better terms and conditions?
The first consideration is very simple. Compare your existing loan rates to the rate offered by the new refinanced loan. A lower interest rate saves you money over the life of the loan.
After comparing rates, compare any other benefits are you receiving. If one offers significantly better terms, you should consider that in your decision. Many of the larger companies in the refinancing space (LendKey) have started offering more favorable terms and conditions than many of the private lenders who originate student loans. However, federal loans carry several special borrower protections that you need to consider before refinancing.
Special Considerations for Federal Loans
1) Income-driven repayment plans
If you refinance your federal loan(s) through a private lender, you lose the ability to qualify for the repayment plans offered by the Government.
2) Loan Forgiveness
Many of the repayment plans mentioned above also provide loan forgiveness after 20 or 25 years of continuous payments.
Even better, the Public Service Loan Forgiveness (PSLF) program forgives the remaining balance on your Federal Loans after you have made 120 qualifying monthly payments under a qualifying repayment plan (all income-driven repayment plans qualify) while working full-time for a qualifying employer (Government organizations at any level and non-profit organizations).
The most incredible part is that after 120 monthly payments (10 years), your remaining loan balance is forgiven tax-free. You don’t owe any tax on the forgiven portion.
3) Borrower Protection
Federal student loans offer protections like deferment and forbearance that allow you to postpone payments if you have financial difficulties. If you have subsidized federal student loans, you can defer your loan payments interest-free. Some of the best companies in the refinancing space now allow temporary unemployment protection, among other borrower perks. Even then, private loans are generally less flexible and less forgiving than federal loans.