Do you have student loan debt? If so, chances are it takes a significant bite out of your monthly income. A recent survey by Citizens Bank found that nearly 18% of college graduates’ paychecks are going toward monthly student loan payments.
What is student loan refinancing?
Student loan refinancing is the process of getting a new loan with (hopefully) better terms. Typically, borrowers refinance their student loans to get a better rate but for many, the primary goal is to reduce monthly payments by taking more time to pay off the loan. You can refinance both your federal and private student loans. However, if you refinance your federal student loans you may lose valuable consumer protections.
When you refinance student loans, you’re essentially renegotiating the terms of an existing student loan or multiple student loans, into a brand new loan. Your interest rate, the type of rate you have (fixed or variable) and your repayment term are all up for negotiation.
The federal government doesn’t refinance its own loans, meaning that your federal Stafford or Direct loan can’t be refinanced into a new federal loan. What the U.S. Department of Education does do is consolidate your federal loans into one new loan. The new loan will have the weighted average of all your old loans (rounded up by 1/8 of 1%).
What is the difference between consolidation and refinancing?
Strictly speaking, consolidation only applies to federal student loans. When you consolidate student loans, the rate doesn’t change significantly. It’s just a matter of combining multiple loans into one loan. Student loan refinancing involves negotiation new terms for a new loan. The new loan may combine several loans into one, but it could also just refinance a single student loan. However, many use both terms interchangeably, which can be confusing.
Consolidating your loans will not reduce the interest you pay but it may lower your monthly payments. However, lower monthly payments will probably increase the total interest you pay on the debt.
Student loan refinancing works on both private and federal. If you reduce your rate you could lower your monthly payments and the overall cost of the loan. However, you may lose some of the consumer protections that come with federal student loans.
How much can you save by refinancing your student loans?
It all depends on how much you owe, the length of your loan term and the difference between your current interest rate and refinancing rates you qualify for.
Let’s say you owe $100,000 in student loans, which is what 1 in 4 postgraduate degree holders owe, according to the Pew Research Center. If you lower your rate from 7% (the rate for a Direct Plus loan in 2018) to 4.5% you will save nearly $15,000 over the life of the loan and pay $125 less a month.
The median balance for borrowers with student loan debt is $32,731, according to the Federal Reserve. In that case, a reduction from 7% to 4.5% would save you $4,900 over the life of the loan and $41 a month.
Remember that refinancing will only save you money if your rate drops or you reduce the term of your loans. Many borrowers who refinance their loans end up paying more in interest because they increase the repayment period to lower their monthly payments.
Should you refinance your student loan?
If you have good credit and a stable job, you should consider it. Refinancing can save you a lot of money. The median borrower can save $5,000 by refinancing a federal loan with a private loan. If you have a postgraduate degree, you could easily save three times that amount.
On the other hand, if you’re struggling financially or you don’t have good credit, refinancing may not be the best option at this moment. In such a case, consolidation may be a smart option if you have federal student loans. Your line of work is an important factor to consider also. If you work for the government or a not-for-profit organization, you may qualify for Public Service Loan Forgiveness, and no refinancing loan can compete with free money.