Should You Refinance Your Federal Student Loan? – Forbes Advisor
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If you have student loans and are considering refinancing your debt, recent interest rate hikes may make you nervous about missing out on historically low rates. But before you rush into refinancing, consider some important drawbacks of federal student loan refinancing.
While refinancing a student loan might make sense for some borrowers, it’s not something you should do without understanding the pros and cons.
Why refinancing your student loans could be risky
Can you refinance federal student loans? Yes, most lenders will allow you to refinance federal debt. And if you have a mix of private and federal loans, refinancing lets you combine them into one.
The big question is whether you should refinance federal loans — and the answer is a bit more complicated.
Refinancing can help you get a lower interest rate, lower your payments, and save money. But refinancing federal loans has several potential drawbacks.
1. You will no longer be eligible for federal reimbursement plans
As a federal borrower, you can take advantage of alternative payment options such as income-contingent repayment (IDR) or graduated repayment plans. With these options, you can significantly reduce your monthly payments to make them more affordable.
Once you refinance, your loans are private and they are no longer eligible for federal repayment options. This means you’re limited to the payment options offered by your refinance lender, which are often less flexible than federal plans.
2. You Can’t Qualify for Federal Loan Forgiveness
If you work for a nonprofit or government agency and have federal loans, you may qualify for the Public Service Loan Forgiveness (PSLF) after making 120 monthly payments and working for an employer. eligible for 10 years.
However, only federal borrowers are eligible for PSLF and other forms of federal loan forgiveness. Once you refinance, you will no longer be eligible for loan forgiveness, even if you meet the other program criteria.
3. You can’t take advantage of federal forbearance or adjournment
As a federal borrower, you can take advantage of federal forbearance or deferment programs to suspend your payments under certain circumstances. For example, you can defer your payments if you go back to school, deploy to the military, lose your job, or experience a medical emergency.
Once you refinance, you will no longer be eligible for federal forbearance or deferment programs. Although some private student lenders offer temporary forbearance in hardship, the requirements tend to be more stringent and the duration much shorter than federal forbearance.
4. You will not be eligible for the federal payment freeze
Since March 2020, the government has suspended federal student loan repayments and set the interest rate at 0%. Currently, the student loan forbearance period is scheduled to end on August 31, 2022; however, it could be extended again.
If you refinance your loans, you will no longer be eligible for the payment freeze. With your loan refinanced, your payments will be due shortly after disbursement and interest will accrue on your loan.
5. You will not be eligible for future federal pardons
During President Biden’s campaign, one of his proposals was the partial cancellation of student loans. In recent months, there have been new discussions about loan cancellation measures.
However, all of Biden’s student loan initiatives will likely only apply to federal student loans. If you refinance, your debt will be transferred to a private lender and you will not qualify for any loan forgiveness provisions.
When Federal Student Loan Refinancing Might Make Sense
Despite the drawbacks of federal loan refinancing, there are certain scenarios where it may still make sense.
1. You have very high interest rates
Depending on the type of loans you have and the year you took them out, your federal loans can have high interest rates. In the past, undergraduate student loans had rates as high as 6.8%, while parent and graduate PLUS loans had rates as high as 7.9%.
If you have high rate loans, refinancing can be a good idea to get a lower rate and save money.
2. You want to transfer the loans from the parents to the student borrower
Parent PLUS loans are federal loans taken out by parents to pay for their child’s undergraduate education. Unlike other federal loans, there is no cap on how much you can borrow and they can have much higher interest rates and fees than other loans. The parent is solely responsible for repaying the loan; the child has no legal obligation to make payments.
The federal government does not offer any way to transfer responsibility for the loan to the student. But some student loan refinance lenders allow parents to transfer student loans to the child borrower if they meet the lender’s criteria and the child consents.
Once you refinance, your child is responsible for the loan, and the debt will no longer be your responsibility and will no longer impact your credit.
When You Shouldn’t Refinance Federal Student Loans
While student loan refinancing can be an effective way to manage your loans, it’s not for everyone. While there’s no one right way to manage your loans, if you find yourself in any of the following situations, refinancing may not be a good idea:
- Your income or finances may change: If you are planning a big change, such as having a child, quitting your job, or changing careers, you may want to take advantage of federal IDR plans. IDR plans base your payments on your discretionary income and family size, so this can be a good option if your income changes. But once you refinance, you will no longer be eligible for IDR plans.
- You work in a volatile industry: If you work in a volatile industry that experiences frequent layoffs, you may need the protection offered by federal loans and deferments in times of economic hardship. If you refinance your loans, you will lose this option.
- You work for a non-profit organization or a government agency: If you have federal loans and work full-time for a nonprofit organization or government agency, you may qualify for the PSLF. A significant portion of your loans could be canceled, so refinancing could be a costly mistake.
Alternatives to Federal Student Loan Refinancing
The downsides of refinancing federal student loans can be significant. If you decide not to refinance your student loan, there may be other ways to achieve your goals and make your debt more manageable:
If you want to reduce your payments
If your current monthly payments are too high, there are several ways to lower them without refinancing your debt, including:
- Income-driven repayment plans. Federal borrowers can enroll in IDR plans that extend your repayment term and calculate your payments based on your discretionary income.
- Abstention. If you are sick or have lost your job, you could benefit from a federal forbearance period and temporarily suspend your payments.
- Alternative Payment Plans. If you are not eligible for IDR plans, you can opt for an alternative payment plan like Extended Repayment or Tiered Repayment.
If you want to adjust your repayment term
The standard repayment term for federal student loans is 10 years. Extending your repayment term may lower your monthly payment, but you may pay more interest over the life of the loan. Here’s how you can adjust your repayment period:
- Sign up for an income-driven repayment plan. When you enter an IDR plan, your term will be 20 or 25 years, depending on the plan you choose.
- Consolidate your debt. If you consolidate your loans with a federal direct consolidation loan, your repayment term can be up to 30 years.
- Opt for an extended refund. Under an extended repayment plan, your repayment term can be up to 25 years.
If you want to save money
If you want to save money and reduce accrued interest on your debt, consider the following tips:
- Sign up for automatic payment. When you sign up for automatic payments, you reduce the risk of missing payments and racking up late fees. And there’s another benefit: Federal loan servicers will cut your interest rate by 0.25%. Over time, this discount can help you save hundreds of dollars.
- Make additional payments. If you only pay the required minimum each month, you will be reimbursed for the duration of your loan. To pay off your debt faster (and lower interest costs), you need to pay more than the minimum. Even small changes of $10 to $50 per month can make a big difference over time.
For example, suppose you have $20,000 in student loans at 3.73% interest, which is the current federal undergraduate student loan rate. Here’s how much you’d save by signing up for autopay and adjusting your monthly payments:
By making these small changes, you could save over $1,000 in interest charges and pay off your loans more than two years sooner.
If you want to streamline your payments
You probably had to take out several loans to cover your college education. Juggling all those loans, payment due dates, and loan managers can be confusing. Refinancing can be attractive because you can combine your debt into one loan.
However, there is another way to achieve this goal: federal loan consolidation. You can consolidate your federal student loans with a direct consolidation loan. Once your loans are combined, you’ll have just one loan to manage and one easy payment.