Refinancing Student Loan Debt could save you Thousands
According to a 2016 study, nearly 70 percent of seniors achieving an undergraduate degree will leave college with more than $35,000 of student loan debt! Resulting in monthly payments around $350 (average in 2012), that’s a decent chunk of money that students have to repay over terms usually ranging from 10 to 20 years.
Common interest rates for student loans are between 4% to 10% per year. As an example, let’s say your $35,000 student loan has a 7% interest rate. If you choose to pay that over a 20 year period ($270-ish a month), you will pay the original loan balance plus another $30,000 in interest; basically paying $65,000 for your education! If the rate was 10%, you would be end up paying over $80,000!
This is where refinancing can come into play (and impact your financial future significantly). There are a number of popular third party lenders (like SoFi and Earnest) that are offering refinancing services to help you bring down your rates. However, there are pros and cons to the process.
You will pay significantly less money over the life of the loan.
As an example, let’s say you decide to refinance your 7% student loan and bring the rate down to 5% over the same 20 year term. Paying $230 a month, you will pay $55,000 over the next 20 years; $10,000 better than your old rate). If you shift that to a 10-year term, you will come out even better paying $44,000 over the life of the loan. The downside is that your payment would go up slightly. But that’s a $10,000 to $20,000 difference in your bank account over that time period!
Savings are even more evident for future doctors and lawyers graduating with a few hundred thousand in debt. Let’s someone with $250,000 in debt shifted from 7% at 20 years to 5% at 10 years. While their payment would move up by about $700 a month, the total interest paid over time would drop by nearly $150,000! They would end up paying around $318,000 for their graduate education instead of $465,000.
You can focus on a single monthly payment rather than payments across a collection of loans.
Basically identical to consolidation, you can roll all your loans into a single loan with a single payment. However, you would want to avoid doing that if one of your loans has a lower interest rate than the refinancing rate. You could refinance the rest of the loans though.
You can remove a cosigner from your original loans.
If you had a parent or friend cosigner your original paperwork for a federal or private loan, refinancing will remove them and release them of any further responsibility. Once a cosigner is released, it’s possible that their credit score would be impacted positively.
You can still claim student loan interest as a tax deduction.
Even if you refinance, you will have the ability to claim up to $2,500 in student loan interest off your taxes each year (assuming you make less than a specific income threshold, $80K for single filers, $160K for joint).
You lose protection benefits on your federal loans.
Easily the most risky issue with refinancing, federal loans come with a variety of attractive repayment plans (full list); particularly ideal for someone starting at their first job. For instance, Income-Based Repayment sets your monthly payment at a maximum of 10 percent of your discretionary income. This can be ideal for a recent graduate that’s trying to pay all their living expenses for the first time and a student loan payment as well.
If you plan on moving into a public service career or teaching, you would also be forgoing loan forgiveness options like PSLF. Basically, the Public Service Loan Forgiveness program forgives the remaining balance on your Direct Loans after you have made 120 qualifying monthly payments while working full-time for a qualifying employer. That’s can be huge savings, possibly better than refinancing if you plan on sticking with the same line of work for ten years.
Of course, these federal benefits do not apply to private loans. In addition, if you see a greater opportunity to make more money in the private sector (compared to public service), you may actually be doing yourself a disservice to utilize a loan forgiveness program.
You lose deferment and forbearance options.
If you lost your job for some reason, federal loans have the option of postponing your payments. that can also be used when reentering college, such as attending a graduate program. A refinanced loan won’t offer the same option and will continue to require payments over time.
So What Should You Do?
I’d say refinancing your student loans is most ideal when you have a stable career, a decent emergency fund built up, and consistent cash flow each month. The potential to save tens of thousands of dollars over the life of loan can impact your financial future in an extremely positive way, especially if you invest that money into your retirement.
Personally, I’ve helped my wife refinance her graduate school student loans twice, each time a different company. The first time, we reduced rates between 7% and 8.5% on multiple loans down to a 6% fixed rate. The second time, we reduced the rate down to 4.4%, a move that will save us an additional $30,000 over the next 6 years.
Assuming you have a majority of federal loans, take a look at the full list of federal benefits to see if you want to give those options up in favor of saving money. If you have private loans, refinancing is a no-brainer; especially if your interest rates are high.