Student loan debt. Those three words are more important to people in their 20’s and 30’s today than any prior generation. The cost of education has continued to rise alongside a growing expectation that most individuals seeking decent salaries should go well-beyond a high school diploma.
It’s increasingly common now to hear presidential candidates address student loans, and eventually one president will propose a comprehensive solution, especially as recent undergraduates and post-graduates begin their careers, start families, and, above all, become the primary voting bloc.
Federal Refinancing Isn’t An Option…Yet
One solution that has been proposed is a federal refinancing option. If you are unfamiliar with the term, refinancing essentially means getting a new interest rate and new repayment terms. Unfortunately, that doesn’t exist for federal student loans now, and may not for a while.
There are, however, many for-profit companies that offer refinancing for those with private loans, and for those with federal loans who are willing to go with a private company to get a lower interest rate.
Should I Refinance My Student Loans?
You may be one of those graduates wondering if now is the best time to refinance your student loans. The answer is both short and long: it depends. Refinancing could be a smart move, particularly for students who have private loans with high interest rates. Federal student loans can’t be refinanced with the government and therefore require you to go private.
Nevertheless, although you may successful lower your monthly payments, no private company offers the generous terms the government offered when you took out the loan. Remember, the federal government is a non-profit entity, whereas private lenders are for-profit.
How To Determine If Refinancing Makes Sense
Figuring out whether refinancing makes sense at first requires a bit of math, but there are many sites out there that can help you see the different ways you can approach repayment.
If you think about your student loan as one large payment (with principal and interest included) instead of many monthly payments, it’s easier to understand why refinancing may be useful for some borrowers.
To put it simply – each month, interest on the loan is calculated and added to the principal. When you make a payment, you pay off the accrued interest plus a small portion of the principal. Sometimes, those with a particularly high interest rate can feel like they are paying and paying and their balance never seems to budge.
When that interest number goes down, the amount you owe is reduced a little as well. At the most basic level, the benefit of a lower interest rate is that, over the life of the loan, the total sum of all your payments will be smaller, thus saving you money.
Factors To Consider Before Refinancing
Once you know what your rate options are, how do you determine if now is the right time to refinance your student loans?
First, you should take honest stock of your current employment status and your future earning potential. These are important factors, because refinancing and exchanging a federal loan for a private one can remove some flexibility in your payment schedule. Stability in a current position as well as the likelihood of a promotion with salary increases work in your favor when refinancing because they allow you to plan with confidence.
Terms and Conditions of the New Loan
If you feel like you could be laid off or terminated in the near future, or if you are seeking a career change, it might not be a great time to refinance. One way that a new set of terms could be less forgiving than your previous ones is that you might not have the forbearance or deferment option. Forbearance allows you to temporarily postpone or reduce your student loan payments.
Another factor may be that the lender requires a loan to be paid off in 10 years instead of 20. Even if you get a lower interest rate, the accelerated payments will result in a higher monthly expense.
Your Credit Score
When considering the option of refinancing your student debt, it is important to research your credit score. If you’re in a good credit score range, you will be eligible for the lender’s lowest interest rates and most generous terms. On the other hand, a bad credit score might force you to hold off until your credit is better.
Fixed vs Variable Rates
Also, take some time to mull over your fixed versus variable rate options. Fixed rates are great if you lock in a low one, meanwhile variable rates are adjustable. Given that we are in a rising interest rate environment, your variable rate is likely to increase significantly over time, so it is best to focus on refinancing for the lowest rate possible.
Read The Fine Print
If you have federal loans, and refinancing them into private loans seems to make sense after the aforementioned considerations, be careful and read the small print. There are a number of programs and perks that came with your federal loans that don’t apply to private loans. These include income-based repayment and loan forgiveness.
For example, if you are employed by a non-profit and you are working toward complete loan forgiveness in 10 years, remember that once you refinance your federal students loans to become private, you will lose that opportunity. In fact, your current employer may even have a program to help pay off your student loans that you aren’t even using yet.
Long-Term Financial Goals
After you do research and know your options, think about your 5 and 10 year plan, both personally and professionally. If you are in a place in your life where you anticipate some bigger purchases, such as a house, car, or business, you should factor those potential buying decisions into the equation. And don’t forget – it’s always best to start saving for retirement early, even if you have to invest with little money.
Similarly, marriage and children maybe critical elements of your future financial planning. The extra few hundred dollars a month that you might be putting toward student loan repayment might be better spent on a down payment for a home or toward saving for costs associated with a growing family.
If refinancing makes financial sense for you, do it sooner rather than later. Each month that you pay your old, higher interest rate is another month that money could have been allocated to something else other than an inflated interest expense. If, after researching your options, you decide that refinancing your student loans might not be a smart move right now, there are still things you can do to make good financial decisions.
If you can afford it, pay more than your monthly payment. The more you can put toward prepayment, the more your principal will be reduced each month and the less you will pay in the long-term.
The choice of if or when to refinance student debt is a personal one. This decision is best made by weighing the pros and cons of all options. You can control some things in life, but not everything, like interest rates. With dedication to smart research and a bit of good timing, you could be on your way to a lower monthly payment that could save you thousands in student loan interest.