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A common question we will get from young professionals is whether or not they should refinance student loans. Over the last several years, with interest rates as low as they are and many people carrying student loans with interest rates above six or seven percent, a number of companies have entered the student loan refinancing game. In a nutshell a company will pay off your existing student loan balance and now you will owe that company money at a presumably lower interest rate. By refinancing into a lower interest rate, this enables you to potentially pay off the loans faster, or reduce the total amount of interest paid over the life of the loan. In certain circumstances, refinancing student loans is a smart move, but it doesn’t make sense for everyone.
You should consider several factors before pulling the trigger on a student loan refinance.
1. Can you afford the new payments?
Many people have federal student loans and are either on an income based payment plan (where the payment amount is calculated as a percentage of your income), or an extended payment schedule over 20+ years. Some people are also on a graduated payment plan, where the payments start out small and gradually increase each year.
When you refinance your loans, most lenders require a fixed monthly payment with a payoff duration of 15 years or less (some will go out to 20 years). This often results in a monthly payment that is considerably higher than the current one. If you can afford the higher payments, then lowering the interest rate can help you accelerate your payoff schedule. If you can’t afford the higher payments, then it probably doesn’t make sense to refinance.
2. Do you expect your income or financial picture to change in the future?
When you refinance your student loans, you are locking yourself into a set payment schedule with limited to no flexibility. If you plan on going back to school, changing jobs, having children, buying a house, or anything that could potentially reduce your income or increase your expenses, then do a thorough evaluation before refinancing.
If you have federal student loans, a big benefit you have is flexibility. There are numerous payment plans you can switch between as your financial circumstances change. You could be on a standard ten-year level payment schedule and switch to an income based payment plan if your income drops. Or do an extended payment plan to stretch the payments out over a longer period of time. Putting your loans into forbearance and pausing payments during an economic hardship is also an option. By refinancing, you will be giving up that flexibility.
3. Are you eligible for Public Service Loan Forgiveness?
A popular avenue some student loan borrowers pursue is the Public Service Loan Forgiveness (PSLF) program. In a nutshell, if you work for a qualifying non-profit organization (the state/city, a school district, most hospitals, the government) or in certain rural settings, after ten years of monthly payments on your federal student loans, the remaining balance will be forgiven. The required payments during those ten years are based on your income, so they should be affordable, regardless of income or student loan balance. For certain professionals with large student loan balances, this is an attractive proposition.
If you refinance your student loans through a private lender, your loans no longer qualify for federal forgiveness. So if you are considering pursuing the Public Service Loan Forgiveness track, it doesn’t make sense to refinance your loans.
It Looks Like Refinancing Makes Sense for Me
If you don’t qualify for PSLF, you have a stable financial situation for the foreseeable future, and you can afford the payments on the new loan, then refinancing your student loans can be attractive.
For example, if you have $100,000 of student loans at 6.8% interest, on a ten-year payment plan, your payments will be approximately $1,151/month. If you can refinance those loans to a hypothetical 4.7% interest rate on a ten-year payment schedule, your new monthly payment will be approximately $1,046. That is a savings of $12,600 over the course of the ten-year payoff period. Or, you can continue paying $1,151 per month and pay off the loans in 8 years, 10 months instead of ten years.
As with many things in life, there is rarely an absolute answer that is appropriate for everyone. It is important to look at your own financial circumstances to determine which path makes the most sense for you.
Readers, what strategies have you utilized to tackle your student loans? Feel free to email us or contact us with your thoughts in the Contact Us section.