The Truth About Student Loan Refinancing and Your Money
Lowering your interest rate by even 1 percentage point can save you thousands in interest payments over the life of your loan.
When it comes to student loans, most people don't realize that they don't need to be stuck with high interest rates, impersonal lenders, or confusing payment plans. Even savvy borrowers may be put off by the complex eligibility requirements and unclear ROI that often accompany refinance and consolidation loan options.
Refinancing, however, is an important consideration for anyone who’s serious about managing his or her money – it can save you thousands of dollars to put towards your other financial goals.
Why look into refinancing now? Because it gives you the chance to choose a new loan that better fits your present financial needs and lessen the burden of student debt. Put another way, the sooner you refinance, the sooner you can save more money.
How refinancing and consolidation work
When you refinance a student loan, you are paying off your old loan through a new loan that covers the outstanding amount you owe. Consolidation simply means refinancing multiple loans into one new loan. In either case, you have the freedom to select a whole new loan, with a new term, a new rate, and a new lender, so that you can pay down your debt at rate that fits your lifestyle.
For example, let’s say a typical lawyer graduates with $140,000 in debt, and he or she is paying at a rate of 7% over a 15-year term. Refinancing that debt to a new 10-year loan at a rate of 5.99% reduces his or her overall interest payments from about $83,000 to just more than $46,000—that's over $36,000 in savings.
An added benefit to consolidation is simplicity: you’ll be making all your student loan payments on one monthly bill to one loan servicer. Since many people who borrow to finance their degrees must take out multiple loans at different terms and rates – e.g., a mix of Stafford Loans, Direct Unsubsidized Loans, Direct PLUS Loans, private loans etc. – consolidation means you no longer need to calculate your debt at different rates, terms, or monthly payment amounts.
The benefits: savings, flexibility, and better service
From a financial standpoint, the main benefits of refinancing are: the chance to save money on your loans and the ability to take full control of your repayment plan. Depending on the level of your debt, lowering your interest rate by even 1 percentage point can save you thousands in interest payments over the life of your loan. Lowering your interest rate by even 1 percentage point can save you thousands in interest payments over the life of your loan.
Beyond a better rate alone, the chance to choose a new term offers a new flexibility to support your savings goals: choose a shorter term loan if you want to save on total interest payments, and choose a longer term loan if you want a lower monthly payment.
How does this work? For one, lenders typically charge higher rates on loans with longer terms because they incur more risk. Therefore, you can probably get a better rate simply by consolidating to a loan with a shorter term, e.g., moving from a fixed 25-year term to a fixed 10-year loan.
On the other hand, if you need lower monthly payments now in order to support your present goals, consider refinancing to a longer term. (This carries some net savings caveats – see “Why it May Not Be Right for You” below.)
Another issue you can overcome with refinancing is the headache of a lender who doesn’t make your loans transparent or easy. The pain points in traditional student lending are well known, so we’ll steer clear of customer service horror stories to focus on the positive: refinancing means you don’t need to be stuck with your lender. Since you’re already signed up with at least one lender, you know from experience what kinds of changes and improved services you’d like to see. Take time to vet new lenders for their customer service offerings and payment options.
Even better, many lenders will offer a discount of 25 basis points on your interest rate when you set up automatic payments for your loans, increasing your savings potential and offering additional peace of mind that you’ll never miss a payment.
Why it may not be right for you
You should be especially careful when considering your refinancing options if
You’re on a nonstandard repayment plan.
You’re near the end of your loan repayment term.
The reason? In the first case, many refinancing options do not offer special repayment plans – if you’re on the U.S. government’s Income-Based Repayment Plan, for instance, you’ll find very few refinancing options that offer the same flexibility.
On the other hand, if you’ve been aggressively paying down your student debt or you’re nearing the end of your loan’s term, be careful when crunching the numbers on refinancing. Refinancing to a longer term means that you pay interest for more months, thus increasing the overall cost of interest payments as compared to the same loan – same principal and interest rate – with a shorter term. You might be seeing lower monthly payments but actually paying more in interest over the life of your loan. This still may not be a bad choice if you need the lower monthly payments in the short term, and if you’re satisfied that the tradeoff in long-term savings is worth it for added spending flexibility now.
Should you do it?
There are many calculators out there to help you understand what refinancing student loans can do for your personal loans.
Beyond what the calculators say, consider refinancing in light of your personal financial and investing goals so that you can determine the best repayment plan in order to you build wealth at your target pace. A final consideration is any effect on your taxes, as significant changes in your student debt may alter your payments come April.