The U.S. carries a whopping $1.766 trillion student loan debt burden, affecting over 43 million individuals. If you're one of the many borrowers, it's likely challenging to envision a future not hindered by this financial weight. Student loan debt can delay or even impact your ability to hit major life milestones, like buying a home, starting a family, or retiring securely.
While many borrowers are still holding out hope for student loan forgiveness, others are tired of waiting and want to make progress on their student debt now. If you want to soften your debt and improve your financial health, you've likely considered refinancing your student loans. Refinancing can streamline the payoff process and help you save money on interest. Let's take a closer look at the pros and cons of refinancing student loans and alternative options.
Understanding student loan refinancing
When you refinance your student loans, you take out a new, single private loan to pay off your existing student debt. The primary goal is to secure a better interest rate or more favorable terms. In doing so, you’re provided with an opportunity to streamline your repayment process, potentially lowering monthly payments and saving on overall interest costs.
The pros of refinancing student loans
Why should you consider trading in your current debts for a new loan? The most noteworthy benefits of refinancing student loans include:
- Lower interest rates: Refinancing can save you hundreds or even thousands of dollars if you're eligible for a lower interest rate.
- Simplified repayment: Trying to keep track of multiple student loans with different payments and due dates can be overwhelming. By consolidating your loans, you’ll have one payment to focus on — making it much easier to stay on top of your bills.
- New loan term: Refinancing offers the ability to extend or shorten your loan term. If you're in a good place financially and looking to tackle your debt, you can opt for a shorter term and save more on interest — just be sure you can afford the higher monthly payments. Alternatively, if you need more flexibility in your budget, you can extend the term for shorter monthly payments.
- Option to change lenders: While you can work with a current lender, choosing a different lender with better perks, like grace periods or interest rate deductions, may make more sense. Shop around and compare your options to hone in on the best lender for your unique situation.
- Ability to remove a cosigner: While this may not directly impact you, refinancing allows you to release a cosigner from their responsibility.
The cons of refinancing student loans
Like any financial decision, refinancing student loans comes with drawbacks to consider:
- Loss of federal loan benefits: Federal student loans are backed by forgiveness and repayment benefits, like income-based forgiveness, temporary deferment and forbearance, and public service loan forgiveness. Refinancing with a private lender means you'll miss out on these perks – including any future large-scale loan forgiveness.
- May not qualify for a lower rate: To get approved for better interest rates, you'll need good to excellent credit and a steady source of income. Unless you qualify for a lower interest rate or shorten your term, refinancing may actually increase your total debt.
- Impact on your credit score: If you apply for a new loan, your credit will likely be impacted. Your credit score will also go down if you miss loan payments, making it difficult to qualify for low rates and favorable terms in the future.
- Limited hardship options in case of financial struggles: If you lose your job or face another financial challenge, you may not have access to hardship programs. There’s no guarantee that a private lender would be willing to work with you and allow you to defer your payments, for example.
- Variable interest rate risks: Refinancing to a variable-rate loan can be risky. Variable rates make budgeting and future financial planning more difficult. Since variable rates are also influenced by market conditions, there’s no guarantee you’ll have a strong rate throughout the life of your loan.
How to refinance student loans
1. Shop around
First, you'll want to explore various lenders. Every lender has different requirements, terms, protections, and perks — thoroughly vetting them is critical.
Consider interest rates (variable, fixed) and terms as you shop around. Note what fees exist, such as prepayment or late payment fees. Also, determine which lenders allow co-signers if you need to increase your chances of approval. Take into account any special perks or bonuses for refinancing.
It's worth exploring lenders that are also a good fit for your unique situation. For example, one lender may require an earned degree to qualify, while another may not. Others offer refinancing for parent PLUS loans, good deals for teachers, and more.
Prequalify with at least three lenders to check potential terms without impacting your credit.
2. Assess and improve your financial situation
Solid credit, a good source of income, and a low debt-to-income ratio can lead to the lowest rates and best terms. If your financial health isn’t the best, focus on repairing your credit, boosting your income, and paying down unrelated school debt before applying.
Once you’ve zeroed in on your preferred lender and refinancing offer, it’s time to apply for a loan. Be prepared to share various personal and financial information like your Social Security number (SSN), proof of graduation (if needed), government-issued ID, and proof of employment through pay stubs or tax forms. Fortunately, most lenders will allow you to apply online and upload any required documents digitally.
4. Pay off your old loans
Once you accept and close on your loan, your lender may take a few weeks to repay your former loans. Continue to make your old student loan payments to avoid fees or hurting your credit score.
Once the refinance has been completed, you can expect a payoff letter from your old lender. Your new lender will also send you information on how and when to begin making payments on your new loan.
Alternatives to refinancing
You might want to explore these alternatives if you determine that refinancing isn’t the best option for your unique situation.
Federal loan consolidation
When you consolidate your federal loans, you combine them into a direct consolidation loan through the Department of Education. You’ll still have access to benefits, like student loan forgiveness and income-driven repayment, but you only have to worry about a single, more manageable payment. If you’d like, you can also change your loan term to reduce your monthly payments.
Income-driven repayment plans
Income-driven repayment plans base your monthly payment on your discretionary income — the difference between your annual income and 100% of the poverty guideline for your state and family size. There are four main types of income-driven repayment plans, including:
- Income-based repayment: Income-based repayment is based on your adjusted gross income, family size, and total student loan debt. It’s generally 10% or 15% of your discretionary income and only for Federal Family Education Loans (FFEL) and Direct Loans, parent PLUS loans, and consolidation loans.
- Income-contingent repayment (ICR): Income-contingent repayment is based on your adjusted income, family size, and total Direct Loan balance, which doesn’t include parent PLUS loans. ICR is for Direct Loans, parent PLUS loans, and consolidation loans.
- Pay as You Earn (PAYE): PAYE is based on your adjusted gross income, family size, and total federal student loan balance. It’s usually 10% of discretionary income and only for Direct Loans.
- Saving on a Valuable Education (SAVE) Plan: With SAVE, your monthly payment is based on your adjusted gross income, family size, and total eligible federal student loan balance. In general, it’s 10% percent of your discretionary income. SAVE is for certain Direct Loans, FFEL, and Perkins Loans.
Loan forgiveness programs
Loan forgiveness programs are specific to certain situations. Per the Public Service Loan Forgiveness (PSLF) program, you may get your loan forgiven after you make 120 monthly payments. The caveat, however, is you must work for a non-profit organization or government agency full-time while making these payments.
There’s also the Teacher Loan Forgiveness Program, which offers up to $17,500 in loan forgiveness if you teach full-time for five consecutive years in a low-income elementary or secondary school or educational agency.
If you’re a homeowner, you can draw on home equity to repay your student loans. Rates for home equity loan products tend to be lower than credit card and personal loan rates. A few products you can leverage are:
- Home equity loans: You can borrow a lump sum at a fixed interest rate using your equity as collateral. Repayment terms for home equity loans are fixed monthly payments over a set period, typically 5 to 30 years — providing borrowers with a structured plan to pay back the borrowed amount. Learn more about home equity loans.
- Cash-out refinance: A cash-out refinance replaces your existing mortgage for an amount higher than the current outstanding balance and lets you pocket the difference. Repayment terms typically involve a new mortgage with fixed or adjustable interest rates, and you make regular monthly payments over an agreed-upon term ranging from 15 to 30 years. Learn more about cash-out refinances.
- Home equity investment (HEI): A home equity investment allows you to leverage your home's wealth for a lump sum cash payment. There are no monthly payments; instead, you share a percentage of your home's future wealth when you're ready to buy back your equity (anytime during a 30-year term). Learn more about HEIs.
Refinancing student loans can be a great way to simplify your payoff process and save some money on interest. However, it’s not the right choice for everyone. Be sure to consider the pros and cons and alternative options to figure out the best strategy for your unique situation.