Now that federal student loan payments have restarted after a three-year reprieve, some borrowers may be wondering if it's a good time to refinance.
And to be sure, companies haven't been shy in pushing the option, said higher education expert Mark Kantrowitz.
“Some lenders seem desperate for origination and refinancing volume, so they are spending a lot on advertising,” Kantrowitz said.
Refinancing is when one or more loans are rolled into another, and borrowers often refinance to obtain a lower interest rate or new repayment terms. But converting federal student loans into private debt can lead to the loss of a number of consumer protections, experts warn.
Refinancing can be a great option for those in a solid financial situation, explained Scott Buchanan, executive director of the Student Loan Servicing Alliance, a trade group for the lenders.
“Borrowers should definitely shop around for the best rate, and educate themselves on benefits they could gain or lose,” Buchanan said.
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Outstanding student loan debt in the U.S. has tripled over the last decade, and burdens Americans more than auto and credit card debt. Average debt at graduation is currently around $30,000, up from $10,000 in the early 1990s.
Here's what to know before you refinance.
Federal loans have more safeguards
The most important thing to keep in mind when considering refinancing your federal student loans is that, should you move forward, your debt will be transferred to a private company, and become a private student loan. As a result, you'll no longer be eligible for the government's relief options.
“Private student loans don't have the same benefits as federal student loans,” Kantrowitz said.
For example, the U.S. Department of Education allows borrowers to put their loans into forbearance for up to three years. You can also pause your payments during periods of economic hardship and unemployment.
Private student loans, on the other hand, typically extend just a one-year forbearance, Kantrowitz said.
Borrowers can also repay their federal student loans through an income-driven repayment plan, which caps the monthly bill at a share of your discretionary income, with some borrowers ending up paying nothing. Such affordable plans are rare among private lenders.
Refinancing eliminates forgiveness eligibility
You'll lose your eligibility for the government's loan forgiveness options when you refinance, including the Public Service Loan Forgiveness and Teacher Loan Forgiveness programs.
The Biden administration is currently in the process of rolling out another broad student loan forgiveness program, after its first plan was struck down by the Supreme Court. Millions of people could still qualify.
Getting a lower interest rate is harder today
Given the loss of consumer protections, borrowers should refinance only if they can save money by getting a lower interest rate, Kantrowitz said.
“But that is harder these days,” he said, pointing out that the Federal Reserve has repeatedly raised interest rates over the last few years.
While federal student loan rates reset annually for new loans, they're fixed once disbursed. Private student loans, meanwhile, have either fixed or variable rates that depend on current lending conditions.
As a result of the rising-rate environment, Kantrowitz said, “opportunities for savings are more limited, even for borrowers with excellent credit.”
Betsy Mayotte, president of The Institute of Student Loan Advisors, a nonprofit, agreed.
“I am seeing a lot of high rates compared to what I've seen in recent history,” Mayotte said.
Borrowers most likely to save money through refinancing are those holding federal student loans from several years ago, when interest rates were higher, Kantrowitz said. Rates on some federal student loans were around 7% or higher between 2006 and 2008. Undergraduate federal student loans disbursed last summer had an interest rate of 5.5%.
Federal student loan borrowers don't need to refinance to get a slightly better rate, Kantrowitz pointed out: Most student loan servicers will offer a 0.25% interest rate deduction when you sign up for automatic payments.
It can't hurt for people who already have private student loans to see if they can pick up a better rate, Mayotte said. If your current interest rate on your private student loan is, say, 12%, you may be able to refinance for a rate around 7%, she said, if you have a good credit profile.
Revising loan terms can add to your overall costs
Borrowers shouldn't get excited too quickly about a refinancing offer with a lower monthly payment, Kantrowitz said.
In some cases, a lender may extend your repayment timeline to get you a lower monthly payment, but increase the total amount you'll need to pay.
Kantrowitz provided an example: A borrower with a $30,000 loan and a 5% interest rate will have a monthly bill of around $320 on a 10-year repayment term, and with interest they will pay a total of roughly $38,000. Refinancing their loan to a 20-year-term will result in their monthly payment dropping to around $198, but in the end they'll have shelled out closer to $47,000.
In addition to that math, those considering a refinance should carefully read all the terms and conditions, Mayotte said. Private student loans typically come with either a fixed or variable interest rate.
“Is the interest rate variable, and if so how high can it go?” she said. “Are there options for temporary reduced or paused payments?”
Borrowers should also understand any fees associated with the origination of the refinance, she added.
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