Paying off student loans is never a pleasant process, especially if you have a high interest rate, loan life, or monthly payments. Just ask the 44 million debtors in America who owe over $1.48 trillion in student loan debt.
As depressing as those numbers look, at least you’re not alone! Millions of Americans are struggling to pay off their student loan debt, and millions more have already paid it off with smart savings strategies such as refinancing loans. In this article, we’ll be taking you through 5 essential questions to ask before refinancing your loans.
1. What is refinancing?
When you refinance a loan, you replace it with a new loan which completely pays off your current debt. However, in order for refinancing to improve your finances, the new loan should have a lower interest rate or better repayment terms than the old loan. There’s no point in replacing your existing loan with a worse one, especially since refinancing is a time-consuming and expensive process.
You’re not getting rid of your debt, you’re just replacing it with something that might be easier to pay off in the long-run. Of course, refinancing isn’t for everyone, but if your credit score has increased since you first took out a loan and you now qualify for better interest rates or lower monthly payments, it might be worth looking into.
2. Can refinancing student loans help me manage or lower my debt?
People refinance student loans for two general reasons: to lower debt, or to manage debt. Debt decreasing strategies include refinancing student loans for variable interest rates (which are usually lower) and paying off loan debt faster by shortening the loan’s life to avoid accruing interest payments. Refinancing to manage debt could mean extending the loan life through refinancing to make monthly payments more affordable, or consolidating multiple federal and private loans into one loan to make the payment process easier.
3. What are the pros and cons of refinancing student loans?
Of course, you should keep in mind that refinancing gets rid of the old loan entirely, including any benefits of the old loan. Let’s say you want to lower the fixed rate of your loan by replacing it with a variable rate loan that offers a lower interest rate. This could benefit you in the short term by reducing your monthly payments and total interest owed, but variable rates and the markets which decide them are unpredictable. That 3.5% variable rate could easily shoot up to 8% in five years and end up costing you more in the long-run than your original loan.
If you’re looking for a lower monthly payment on your student loans, you can accomplish this by replacing your old loan with a new one which either has a lower interest rate or gives you a longer time to pay the loan off. A lower interest rate means paying less money in the long-run, but extending the life of your loan usually means paying more interest as it accrues over time.
Refinancing to get rid of your co-signer will give you financial freedom, but at the cost of higher interest rates and monthly payments (especially if you have bad credit). Refinancing your variable rate loan for a fixed rate gets rid of the anxiety of unstable markets and rising monthly payments, but at the cost of a higher interest rate and higher monthly payments. Basically, every potential benefit of refinancing your loan comes with a potential cost as, so you need to weigh all your options before you decide.
Student loans can be especially tricky to refinance when it comes to federal student loans. If you’re looking to refinance a federal student loan with a private loan that offers a lower interest rate, you risk losing the special protections of federal student loans, including loan deferment and loan forgiveness programs offered to public servants. Similarly, if you’re trying to consolidate your private and federal loans into a single loan to simplify the payment process, you should compare the benefits of the new consolidated loans with what you stand to lose by replacing those old loans.
4. Should I refinance?
You should only refinance if it will save you money or solve a problem, such as getting rid of complicated loan payments by consolidating. If you find yourself wanting to refinance for other reasons besides saving money or solving a problem, you should just stick with your old loan.
Before you contact a loan refinancing service, you should check your credit score, finances, loan terms, and the potential costs of refinancing. Besides costs such as higher interest rates and losing the benefits of your old loan, refinancing itself is a costly and time-consuming process, often involving closing fees for thousands of dollars. Run the numbers to find out how much money you’d pay in the long run if you stick with the new loan vs. refinancing for a new loan. If you more than break even, you should consider refinancing.
5. Which refinancing services can I trust?
If you do decide to refinance your student loans, or would like to speak to a professional, we recommend contacting LendKey or SoFi, student loan refinance services which have some of the most competitive interest rates available for students looking to pay down their debt quickly and easily. Better yet, both companies’ websites allow visitors to check their rates without affecting their credit scores, so you can make an informed decision about your eligibility and need for refinancing.
In the end, refinancing is a balancing act which comes with many pros and cons. However, if you play your cards right and have a good credit score, you could save yourself a lot of money and headaches in the long run by refinancing your loans.