Refinancing student loans can save you money under the right circumstances. It could be helpful to score a lower interest rate, to change from a variable interest rate to a fixed rate, to consolidate your loans to a single monthly payment, or to release a co-signer.
At the same time, you could lose protections and benefits from your original student loan. Before you refinance, make sure you understand your choices, including any trade-offs.
In 2021, student loan refinance interest rates are among the lowest they've ever been, which argues in favor of refinancing. However, federal student loan repayment requirements have been paused since the start of the coronavirus pandemic, and the Biden administration is considering forgiving federal student loan debt, two factors which argue for waiting. Learn more about the current student loan refinance environment so you can make the best decision.
Student loan refinancing in 2021
The pandemic has had a significant impact on the U.S. economy. In addition to forcing tens of millions of people to file for unemployment benefits, it's also driven down interest rates, giving many an opportunity to refinance and save.
In 2021, 10-year fixed interest rates for student loan refinancing hit record lows, according to online marketplace Credible. "Money is cheap, and the marketplace is competitive," says Beth Walker, wealth advisor at Carson Wealth, "so (private lenders) may be able to offer more favorable terms."
If your credit is in great shape, the chances of scoring a lower interest rate than what you're paying right now are better than ever.
However, federal student loan borrowers have a couple of reasons to think twice before refinancing with a private lender.
For starters, the Coronavirus Aid, Relief and Economic Security Act implemented a moratorium on payments, interest and collections for most federal student loan borrowers. That pause was initially set to expire at the end of September 2020, but has been extended twice since then. It's currently in place until Sept. 30, 2021.
If you primarily took out federal student loans, it may not make sense to refinance and start making payments again immediately.
Second, President Joe Biden has signaled support for providing $10,000 in loan forgiveness for the same contingent of federal loan borrowers covered under the CARES Act as part of further coronavirus-related relief.
"If the Biden administration does forgive student loans," says Walker, "the borrower might refinance with a private lender and give up the chance to have this amount of debt wiped off their balance sheet."
While it remains unclear if and when that might happen – federal student debt forgiveness wasn't included in the $1.9 trillion American Rescue Plan – the idea of blanket student loan forgiveness is gaining traction among Democratic lawmakers, so borrowers may want to keep at least that much of their debt with the federal government for the time being.
Types of student loans you can refinance
First, know federal student loans can’t be refinanced through the U.S. government, only consolidated. You can’t swap your federal student loan for another federal loan with a lower interest rate or change your private student loan into a federal loan. In fact, consolidating federal student loans through the Department of Education will result in a slightly higher interest rate.
In contrast, private student loan refinancing allows you to refinance a private or federal student loan – or both together – into a new private loan. But refinancing may not make sense for many federal student loan borrowers.
In doing so, you'll lose eligibility for government assistance programs, including, notably, the ability to enroll in an income-driven repayment plan. All plans reduce your payment to a fraction of your discretionary income and forgive any remaining loan balance if you haven't fully repaid your federal loans at the end of the repayment period.
Likewise, teachers and certain public service employees working toward loan forgiveness under one of the programs offered by the government will no longer qualify for that benefit if they refinance.
Finally, while many private lenders offer the ability to temporarily reduce or stop payments but avoid default through deferment or forbearance, terms may not be as generous compared with federal student loans.
When it makes sense to refinance student loans
Is refinancing your student loans the right choice for you now? Seriously consider it if:
|Your credit score is strong enough to qualify for a lower interest rate than your current one||You may qualify for student loan refinancing with a FICO credit score of about 650, but a higher score gets better rates and possibly more cash flow. "If refinancing an existing loan allows the borrower to have more access to money for their current lifestyle, future retirement or pay down more expensive debt, it's worth considering," says Walker.|
|Your private student loan has a variable interest rate, and you want to refinance to a fixed-rate loan||
With a variable-rate loan, at some point you could see your interest rate go up as market rates change. If that happens, a new fixed-rate loan might be cheaper. The same goes if you have a private loan with a high interest rate.
"Borrowers who have older private student loans with high balances and higher interest rates may find an opportunity for savings with a drop in the rate," says Bruce McClary, senior vice president of communications for the National Foundation for Credit Counseling and a former U.S. News contributor.
|You want to reduce the number of monthly payments you make||If you have multiple private student loans, you might want to refinance them into a single loan so you can make one monthly payment. If you want to reduce the number of federal loan payments but not change to private, the process is called a loan consolidation, not a refinance. Your new federal direct consolidation loan would have a weighted average interest rate, or an interest rate that’s the weighted average of your current loans, rounded up to the nearest one-eighth of 1%.|
|You want to release a co-signer||If you can refinance a private student loan in your name alone, you could free a co-signer from liability for your debt. However, some lenders offer a co-signer release only after a number of consecutive on-time payments, such as two to four years. You'll also need to meet certain credit criteria after you've made the required number of payments.|
|You're willing to give up federal benefits||If your financial situation is in good shape and the benefits of refinancing outweigh the costs of ditching your federal loans, it might be the best path forward for you.|
Reasons not to refinance your student loans
When the benefits of refinancing are unclear, don't do it. There’s no hard and fast rule about how much you need to save to make a refinance worthwhile, but it should be worth the hassle and any potential costs.
"Although the low interest rates may make it seem like the right time for federal student loan borrowers to refinance," says McClary, "the timing may not be right for those who would benefit from the administrative forbearance or any of the affordable repayment programs."
If you’re struggling to make payments or need a lower monthly payment, staying in a federal program with many payment and emergency options is a better choice than refinancing.
Roughly 45% of the federal Direct Loans were being repaid on an income-driven repayment plan in 2017, according to the Congressional Budget Office. If you're one of those people, you're working toward loan forgiveness, or if you want to continue to enjoy the coronavirus relief benefits, refinancing may not make sense.
If you're a parent who took out one or more federal or private loans to pay for your child to go to school, you might also be wondering if it's worth it to tap your home equity through a home equity loan or cash-out refinance mortgage loan to refinance your loans that way. However, these loans typically have high upfront costs, and they use your home as collateral. If you default, you could lose your home, which is a significant risk.
How to prepare for refinancing your student loans
The decision to refinance isn’t one to be taken lightly. "Once you commit to refinance, you can't turn back after the loan is finalized," says McClary. "It's important to clearly understand the pros and cons before making a decision that can’t be reversed."
But if you've weighed the advantages and disadvantages of refinancing and decided to proceed, you can prepare now to take advantage of a lower interest rate when it becomes available. Here are some steps you can take:
- Know what type of loans you have and who your servicers are. You can find this information for your federal loans in the National Student Loan Data System database. For private loans, you'll need to contact each lender for information.
- Know the interest rates on your loans.
- Know the benefits of each of your loans, including income-based repayment plans available to you.
- Avoid a forbearance, if possible, because interest will accumulate.
- Check your credit score to see where you stand and make improvements if necessary. You can also check your credit reports to look for issues you can address.
- Get prequalified with multiple lenders before you apply. This process requires just a soft credit check, which won't impact your credit score, and allows you to compare rate offers to ensure you get the best deal.
- Run the numbers to determine whether you can afford your new monthly payment and how much money you'll save.