Student Loans & Refinancing: What to Know Before You Proceed

07 Aug

Student Loans & Refinancing: What to Know Before You Proceed

Student loans are big business. According to the Federal Reserve Bank of New York Quarterly Report on Household Debt & Credit released May 2020, outstanding student loan debt climbed to $1.54 trillion. This further cemented student loans as the second-highest consumer debt category, second only to mortgage debt. If you are one of the 45 million borrowers, you may be looking for a way to find relief.

While many of us are currently experiencing financial setbacks, the pandemic has provided a silver lining in the form of lower interest rates. In fact, the interest rate on new federal student loans for undergraduates fell to a record low this summer. Those applying will pay a rate of 2.75 percent on loans for the coming academic year, down from 4.53 percent last year. These lower rates are certainly tempting, but before you rush to refinance your student loans it is important to see if this is the right move for you. Here are some ramifications to think about before you refinance your loans.

1. You would lose access to the federal loan forgiveness program and other federal loan repayment options.

All refinancing lenders are private companies, and as a result, only work in the space of private loans. By refinancing with one of these companies you may be able to get a lower interest rate but at a cost. Private loans are not eligible for the benefits of federal loans such as Public Service Loan Forgiveness (PSLF), which would forgive the outstanding balance of federal student loans after 10 years of working in a qualifying public service organization. It is not just the forgiveness program you would be giving up. If you are taking advantage of income-driven repayment plans, refinancing would take this option away. If you have low or unstable income, this move could have negative consequences.

Bonus benefit. The CARES Act directly aided federal student loan borrowers during the COVID-19 national emergency. This provision placed federal student loan borrowers into an automatic administrative forbearance, which allows the borrower to temporarily stop making their monthly loan payment. This suspension of payments will last until Sept. 30, 2020. If you opt to continue making payments during this time, you are allowed, and those dollars will go directly to the principal balance of the loan.

2. You will not see a major cost or time saving benefit by refinancing.

While lower interest rates are enticing, refinancing is still not always the cheapest route. Private lenders may charge application or processing fees that can quickly offset any savings you may have experienced. Interest rates have been low for some time now and many borrowers may be surprised to find that their average interest rate is not too far off from the current rates.

Lenders, and most salespeople for that matter, use a technique known as framing to help push borrowers to their products. By showing you a payment that is lower than your current monthly obligation they can create the illusion you are saving money. It is important to thoroughly review the terms of the loan. If the payment is lower because they extended the term of the loan, you may be paying more over the life of the loan. Make sure you understand the difference between a fixed and variable rate. The variable rate may be lower today, but can change (and potentially rise) throughout the loan period, while a fixed rate remains constant throughout the life of the loan.

3. You have weak credit or unstable income.

This one is self-explanatory, nonetheless it is important to note. Creditworthiness and income are key metrics in the loan application process. If your credit score needs work, you may be required to have a cosigner with a higher score. This puts them on the hook for your debt, which may not be a burden they want to take on. If your income fluctuates or you are concerned you may lose income soon, refinancing may not be appropriate for you. Private lenders are often not as flexible with their repayment options as federal loan services are.

So, who is a good candidate for refinancing? If you have good credit, stable and steady income, are not eligible or taking advantage of the federal loan forgiveness or income-based payments, or hold multiple high interest loans that could benefit from consolidation, this might be a prudent cost saving move. We encourage everyone to think about their personal situation before moving forward. If you do not fall into this category today, do not fret. Creating financial stability takes time, and we are facing unprecedented challenges both fiscally and holistically. Start by building good credit habits and putting the foundation in place to improve your creditworthiness.  Lastly, before you do move forward it cannot be stressed how important it is to understand the new terms of your loan and how that differs from your current loan. Often, our biggest financial regrets stem from decisions we make based on a lack of information.  Take the time to understand the loan terms and make an informed decision before acting.

Where to find help.

Here are some government sponsored websites with more information about student loans:

For general information on Federal Student Aid visit:

https://studentaid.gov/

For information on Coronavirus and Forbearance Info for Students, Borrowers, and Parents visit:

https://studentaid.gov/announcements-events/coronavirus

For information on FAFSA and loan forgiveness visit:

https://www.ed.gov/