The Pros and Cons of Refinancing Student Loans
“Loan” is a four-letter word.
According to a 2019 study conducted by PwC, 71% of Millennials say that their stress level related to financial issues has increased over the last 12 months.[1] I’d be willing to bet a large piece of that stress comes from student loans.
Whether you’re new to the workforce or a seasoned veteran, student loan payments likely occupy a significant percentage of your monthly budget, and managing those payments can be nerve-wracking.
One viable option to alleviate stress is refinancing your loans.
But is refinancing right for you?
Understanding the pros and cons of refinancing your student loans will allow you to make an informed decision on how best to manage your student debt.
Let’s dive in!
The Pros of Refinancing
A Lower interest rate
When applying to refinance your student loans, the bank or lending institution is financially underwriting you as a credit risk. In other words, the bank is trying to answer the question of are you a good borrower, or are you a lousy borrower. Whether they approve you for the refinance loan will depend on several factors, including your credit history, credit score, and debt-to-income ratio (the percentage of your paycheck going towards debt). Assuming everything goes according to plan, you could get approved for a lower interest rate. A Lower interest rate is beneficial for a multitude of reasons. However, the most significant is that it will save you money. A person who has $50,000 in student loans at 10% will pay $29,290 in interest over a decade. If they refinanced their loans at 6%, they would save $12,679 of interest during the same ten year period!
An Extended Loan Term
Stretching out a piece of debt over a longer period will lower the monthly payment. Having a lower monthly payment could give you more room in the budget to protect your income, become a world-class saver, or pay down other higher interest debt (ex: credit cards). All those options would be a better use of a dollar! Now, before anyone loses their mind about taking longer to pay off debt, you’re right. The longer you take to repay a loan, the more interest you’re going to pay. However, paying less interest does not mean you are going to have more MONEY all things considered. If you’re a disciplined saver and invest the difference, extending your repayment shouldn’t cost you money in the long run. Instead, it will give you the breathing room to start saving immediately (read the full explanation here).
Relieve your co-signer of debt obligations
Moms and dads are the best. They invested in an 18-year old you and penned their name to tens of thousands of dollars in debt so you could go “experiment” in college. If you haven’t recently, thank your parents. They deserve some gratitude. Nevertheless, I’m assuming that most people reading this are happily employed. By refinancing your student debt, you can take their name off your loans and help them improve their credit score. This is an excellent gift for birthdays and holidays.
The Cons of Refinancing
Lose Federal Repayment Options
Federal student loans have multiple repayment options available that give borrows a lot of flexibility to manage their payments. With just the click of a button, you can go on an income-based repayment plan, consolidate, or choose the extended repayment options. It’s entirely up to you. However, by refinancing your federal student loans, you exchange these flexible repayment plans for fixed credit terms with a bank or lending institution. Don’t get me wrong. Refinancing can still make sense, but you have to carefully weigh your options and understand what you’re giving up.
Lose Federal Public Student Loan Forgiveness
What is Public Student Loan Forgiveness (PSLF)? It is a program that may forgive the remaining balance on your Direct Federal student loans, assuming you qualify under the current following criteria[2]:
- Must be employed by a U.S. federal, state, local, or tribal government or not-for-profit organization
- Work full-time
- Have Direct Loans (or consolidate other federal student loans into a Direct Loan)
- Repay your loans under an income-driven repayment plan
- Make 120 qualifying payments
Public student loan forgiveness is not available to privately refinanced loans. If you work at a non-profit or charitable institution and refinance, you give up the opportunity to have your loans forgiven.
Lose Federal Debt Forgiveness in the Event of a Death
If the student or the borrower of a federal student loan passes away before they pay it off, the federal government forgives the balance of the loan.[3] Unfortunately, this exact situation happened to a client at my firm. His father – who co-signed on his loans – passed away unexpectedly, and his federal loans were forgiven. Loan forgiveness can be a significant consolation benefit for those grieving the loss of their parent. Privately refinanced student loans have no such provision.
Summary
Understanding if refinancing is the right for you is going to depend on your specific situation. We as humans tend towards a herd mentality – we want to do what others are doing – but what’s right for one person might not be right for another. It’s imperative to weigh all of the pros and cons before sending your application to the bank. That said, refinancing can be a great option to potentially lower your monthly payment and free up cash flow to improve other areas of your financial life!
Stay savvy, my friends.
Kyle
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Guardian does not issue nor advise for student loans. Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.. The Living Balance Sheet® (LBS) and the LBS logo are service marks of The Guardian Life Insurance Company of America (Guardian), New York, NY. © Copyright 2005-2020 Guardian 2020-93660 Exp. 01/22
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[1] https://www.theexperience.work/wp-content/uploads/2018/06/pwc-2019-employee-wellness-survey.pdf (page 18)
[2] Public Service Loan Forgiveness | Federal Student Aid. https://studentaid.gov/manage-loans/forgiveness-cancellation/public-service
[3] https://studentaid.gov/manage-loans/forgiveness-cancellation/death#borrower-death