Similar to mortgage interest rates, student loan interest rates have been dropping this year. That decrease in rates, along with the pause in payments and interest accrual under the CARES Act, has led many to wonder whether they should be doing something with their student loans. One of those options is whether or not to refinance them.
The main idea behind refinancing a student loan is to move from a loan with a higher interest rate to one with a lower interest rate. Moving to a loan with a lower interest rate allows you to pay less in interest over time, lower your loan payment, and potentially pay the loan(s) off faster.
Reasons You Shouldn’t Refinance
Student Loan Forbearance Extended Through January 31, 2021
On December 4, 2020, the US Department of Education announced that federal student loan forbearance and the pause in interest accrual which were enacted under the CARES Act were extended through January 31, 2021.
If you have federal student loans and you’re benefiting from this extension, then I don’t see a reason to refinance them yet. It’s hard to beat a 0% interest rate.
The Potential Biden Student Loan Plan
The Biden Emergency Action Plan to Save the Economy calls for Congress to “forgive a minimum of $10,000 per person of federal student loans.” Additionally, several senators have called for up to $50,000 to be forgiven.
Who knows if anything like this will actually happen, but given that forbearance and interest accrual are extended through January 31, coupled with the fact that Biden will be inaugurated on January 20, it makes sense to delay refinancing student loans for now.
You’re Pursuing PSLF
If you’re pursuing Public Service Loan Forgiveness (PSLF), or any other type of federal student loan forgiveness, then you shouldn’t refinance your loans – ever. Doing so would make you ineligible for forgiveness programs.
You Need An Income-Driven Repayment Plan
One advantage of federal student loans is having access to income-driven repayment plans, which limits the amount of your income that goes towards student loan payments (between 10-20%, depending on the plan).
If you don’t have a stable income and/or there are other circumstances affecting how much you can pay towards student loans, then you might not want to refinance and lose these options.
You Have Bad Credit
If you have bad credit, then it might not make sense to refinance your student loans since you may not receive much of an interest rate decrease (and you might not qualify to refinance, anyways).
Refinancing Will Increase Your Repayment Period And/Or Interest Rate
Hopefully this goes without saying, but refinancing into a significantly longer repayment period or a higher interest rate just doesn’t make sense.
Reasons to Refinance
You Will Decrease Your Interest Rate
The number one reason to refinance a student loan is to decrease your interest rate, your monthly payment, the amount of interest you’ll pay over the life of the loan, and potentially the amount of time it takes you to pay off the loan.
You Don’t Need Federal Student Loan Protections
If you don’t need any of the protections and benefits offered by federal student loans, and you can decrease your interest rate, then refinancing may make sense.
You Have Private Student Loans
If you have private student loans, then you don’t have to worry about losing the benefits that federal loans offer if you refinance. If you can decrease your interest rate without significantly extending your term, then refinancing your private student loans could be a good idea.
Given this, there’s no reason to wait to refinance private loans if the numbers work out. However, just because you can refinance to a lower interest rate doesn’t mean that you should. If you only have 3 years left on a loan, then it probably doesn’t make sense to refinance to a 10 year loan to get a lower rate. The answer comes with running the numbers.
You Have Variable Rate Loans
This one could be a little tricky, depending on what the interest rate on your variable rate student loan is right now. If you can lock in a low fixed rate now at a good interest rate, then you could potentially be better off over the long run than having loans with interest rates that can continue to increase.
A Few Things to Consider Before Refinancing
Life Insurance
If you’re planning on refinancing federal student loans, then it’s prudent to make sure that you have proper life insurance coverage in place prior to doing so. While federal student loans are discharged at death, private student loans are not.
Disability Insurance
Similar to life insurance, it’s prudent to make sure that you have proper disability insurance coverage in place prior to refinancing to a private student loan. If you become disabled, which is more likely to happen to a young professional than dying is, then a private student loan may not provide payment flexibility if you become disabled and lose your income.
Check Your Credit
As I mentioned above, it might not make sense to refinance your student loans if you have bad credit. If you do have bad credit, and you don’t check first, then you’ll probably find out by being denied for refinancing by the lender.
The Long-Term Effects
As always, it’s important to consider all of the long-term effects of refinancing your student loans within the context of your overall financial plan.
- What will the new payment be compared to your current payment? How much cash flow will this free up over the life of the loan? What will you do with the extra money?
- How much will you save in interest over the life of the loan?
- What will the new expected payoff date be compared to your current loan?
These are just a few things to consider. It’s important to remember that personal finance is personal. Your situation could be the polar opposite of someone else’s. Just because someone you know refinanced their student loans that doesn’t mean that it’s right for your personal situation.
Financial decisions like this should be made in the context of your entire financial life.
