When to Consider Refinancing Your Student Loans

October 28, 2022

To refinance or not to refinance – that is the question. The arena of student loan refinancing can be a confusing one. Even if you can nab a lower interest rate by doing a refi, it still might not be your best move. There are a lot of important things to consider before you consider refinancing your student loans.

First things first, when I say refinancing I mean taking your federal student loans (or your existing private student loans) and replacing them with a new private loan in order to reduce your monthly payments, lower your interest rate, or change your loan terms. This is different than a consolidation within the federal system.

A Direct Consolidation Loan allows you to consolidate (combine) multiple federal education loans into one federal loan. Also check out our post on Pros and Cons of Consolidating Student Loans.

When you already have private student loans, refinancing can be a great way to reduce your overall cost over time if you can obtain a lower interest rate. Shopping around makes a lot of sense, especially if you have a larger balance. Bonuses like this one can make that refinance even more lucrative. If you have federal student loans and you are wondering if refinancing into a private loan makes sense for you, read on.

Refinancing rules of thumb:

  1. If your federal student loan debt balance is lower than your annual income: I would prioritize paying your loans down quickly to minimize your cost over time. A refinance can be a great way to achieve this.
  2. If your balance is +/- $10k of your annual income with no major pay-raises in the foreseeable future: I would strongly suggest not refinancing to leverage your flexibility within the federal system until you get your balance lower.
  3. If your balance is 1.25x your annual income: refinancing your federal debt to private is DEFINITELY not the best move for you.

Private student loan debt and federal student loan debt are not an apples-to-apples comparison. I always suggest looking beyond just the interest rate when considering private refinancing.

Refinancing Student Loans – Federal to Private:

Here are the top things to consider when refinancing student loans from Federal to Private.

Private loans have NO forgiveness opportunities.

None. Zip. Nada. If you qualify for PSLF (Public Service Loan Forgiveness), teacher forgiveness, state forgiveness opportunities, or you may be better off going towards private sector forgiveness (reaching your IDR plan’s max-repayment period), privatizing your federal loans is NOT the right move.

Private loans do NOT have income driven plans.

Think long and hard about this. It’s important to know if you will be able to commit to that private monthly payment for the length of the term. There is a lot of benefit to having access to the federal income-driven repayment plans to keep your payments proportionate with your income year over year.

Deferral & forbearance for financial hardship

Federal loans have options to defer or go into forbearance if you have a financial hardship, disability, illness/health issues, etc. Private loans are more limited in those flexibilities or do not have them at all. Private debt is still due even if you die, standing first in line before any money goes to your family.

Different interest calculations

Interest is not charged the same while negative amortization is occurring (when your payment does not cover the interest charge per month): On the private side, any unpaid interest capitalizes (aka: compounds) which is the addition of unpaid interest to the principal balance of your loan. This means the debt balance can stay stagnant or actually grow.

The math for compound interest is: principal x interest = your new balance, which interest is then charged off of, usually at a daily rate! On the flip side if federal loans have negative amortization, interest does NOT capitalize – it accrues in it’s own “bucket”. This means interest is only charged on the initial principal amount, not principal + accumulated interest. This is a HUGE deal for those with high debt-to-income ratios.

Relevant again in times of negative amortization: Federal student loans have interest subsidies or discounts/credits on how the interest is charged to you. This really depends on your plan. But, generally unpaid interest can be waived or cut in half for time periods on certain loans.

Private student loans require a great credit score

The average credit score needed to be even get approved for a refinance in 2018 was a FICO score of 764. If you don’t have a score in that range, be prepared to get declined altogether.

Refinancing is final.

Lastly, refinancing into a private student loan is a decision that cannot be reversed. You can’t just take it back once you do it. So it’s really important to think a few years into the future to see what’s best for you long term.

With all that said, refinancing looks like the worst option in the world, right!? There are still compelling reasons for many folks to consider refinancing their student loan with a private lender. 

The Benefits of Refinancing Student Loans: 

  • With a lower interest rate, you can:
    • Reduce your overall cost of the loan
    • Pay off your loans sooner
    • Reduce your required monthly payment
  • Often you can choose your repayment terms
  • Combining multiple loans into one for simplicity
  • Change a variable interest rate to a fixed interest rate

If a refinance does seem to make sense for you, and you have good credit, your next step will be to compare rates with a few companies.

Best companies when refinancing student loans:

  • Credible – Credible shops your rate with some of the top lenders which can make a big difference when you are trying to score the lowest possible rate and best terms.
  • Splash Financial – Splash Financial is one of the best places to refinance your student loan. They make it simple to check rates with a network of repubtable lenders. And they get rave reviews from borrowers who have used them in the past.

For a limited time, HTM listeners can snag a $300 bonus when they refinance $50k or more in student loan debt with Splash Financial! Click this link to compare rates.

Find out your pre-qualified rate(s) through a soft inquiry. Unlike hard inquiries, soft inquiries won’t affect your credit score since soft inquiries aren’t connected to a specific application for new credit. You will need to provide basic information on your financial situation, your existing loan balances, the purpose for wanting to refinance, and information on your school, graduation date, and degree.

If your pre-qualified interest rate/range looks to be promising (lower than your current rate), go ahead and formally apply with that specific lender (hard inquiry). But make sure you read ALL THE FINE PRINT.

Make sure your lender offers all of these:

  • No fee associated with that refinance
  • No prepayment penalty – this allows you to accelerate payments if you want to
  • Cosigner release clause – if you apply with a cosigner
  • Fixed interest rates – Variable rates can (and will) increase on you over time

If you are declined, it’s smart to apply with 1 or 2 other lenders in the same sitting. Credit Karma says: “FICO may record multiple inquiries for the same type of loan as a single inquiry as long as they’re made within a certain window (usually between 14-45 days). The VantageScore model gives you a two-week window to shop for the best interest rates for certain loans.” A hard inquiry could lower your scores by a few points. But it is unlikely to play a major role in whether you’re approved for a new loan. Plus, the damage to your credit scores usually decreases or disappears in short order, often before the inquiry drops off your credit reports for good.

Refinancing your student loans can save you thousands of dollars in interest over the life of your loan. But refinancing your student loans is not a slam dunk easy decision. There are a slew of factors to consider and refinancing your student loans isn’t necessarily the best option for everyone. It’s important to make sure you consider the facts and considerations laid out above. A student loan refinance can be incredibly helpful in the right situation!

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One comment on “When to Consider Refinancing Your Student Loans

  1. Amy B Sep 27, 2019

    Thank you, thank you, thank you…I’ve been paying on Student Loans for what feels like FOREVER (4 years actually) and I have been eyeing those lower interest rates for a few months thinking that was the way to go. After reading the breakout, pro & cons, I will happily keep the “flexibility” of my federal loans.
    Love the PODCAST – Thank you for breaking it down for us!