Worried about making your student loan payments? You’re not alone. The Federal Reserve said that as of the second quarter of 2018, Americans owed more than $1.5 trillion in student loan debt. The College Board added that students who took out loans and graduated in 2016 with a bachelor’s degree owed an average of $16,900.
The challenge comes when your monthly student loan payments are too high for you to comfortably afford. If you are struggling, you might be considering working with a private lender to refinance your student loan debt.
Private lenders offer refinancing options as a way for consumers to lower their interest rates and monthly payments. Basically, these private lenders pay off your existing student loans and leave you with a new student loan at a, hopefully, lower interest rate and lower monthly payment. When you make your monthly payment, you are now sending your payments to this new lender.
Refinancing, then, can save you money each month in the form of a lower student loan payment.
But it’s important to note that lenders don’t refinance student loan debt for free. They charge you for their services. Your new refinanced student loan might also come with a longer term, meaning it will take you more time to repay it in full. And if the term is longer, you might end up paying more interest over the life of your loan, even if your monthly payment is lower.
Know, too, that if you refinance a federal student loan you will lose some key financial protections that only federal student loans provide.
How do you know if refinancing student loan debt can help you? Here are some tips to consider.
You Might Lose Protection If You Refinance Federal Student Loans
You know that there are two types of student loans: federal loans and private ones. Federal loans are widely considered to be a better option because they usually come with lower interest rates and they offer financial protection to borrowers who are struggling to find employment or who aren’t earning as much money as they’d expected.
The federal government offers a range of income-driven repayment plans with its loans – plans that will lower your monthly payments if your income level is low. This includes such options as Income-Based Repayment, Income-Contingent Repayment and Pay As You Earn programs.
These programs operate differently, but they all adjust your monthly student loan payments based on your current income. Your payment will fall if you aren’t making enough money. They can be important safety nets, then, if you lose a job, struggle to find employment or have to take a salary cut.
If you refinance your federal student loan with a private lender, you will lose out on these protections. The new monthly payment you get from refinancing might be affordable now, but if you lose your job or take a pay cut, it may no longer be. When you refinance student loan debt from the federal government to a private lender, you won’t have those income-based repayment options to lower a payment that you can no longer afford. (Your only option may be forbearance.)
This is why financial experts say it often makes sense to keep any federal student loans you have and only refinance private loans.
“Before giving up these protections, determine the likelihood that you’ll need them in the future,” said Megan Robinson, financial coach and personal finance expert with consumer website DollarSprout.
Robinson said that refinancing out of federal student loans might make sense if you have an emergency fund with at least nine months’ worth of daily expenses, an employment contract for a set number of years with your current job and lots of discretionary income.
“If you’re working in a temporary position and are not sure where your next job will be, you may want to reconsider,” Robinson said.
You Could Lose Out on Forgiveness Programs
Federal student loans also offer forgiveness programs to people who work in public service, education, health care and other fields. For instance, the Public Service Loan Forgiveness program is designed for people working in public service careers, such as social workers, police officers and members of the U.S. military. After you make 120 payments through this program, you might not have to pay back the rest of your federal student loan.
If you’re eligible for student loan forgiveness – depending on how close you are to any qualifying milestone – it might not make sense to refinance your federal student loan to a private one that doesn’t offer this perk.
“Are you pursuing student loan forgiveness? If so, have you already accrued some years toward forgiveness?” asked Autumn Campbell, a certified financial planner with the Tulsa, Oklahoma office of The Planning Center. “Do all loans qualify or only a portion of them? Private loans may be able to offer better interest rates but do not have the same income-based, deferral or forbearance options. There is also no loan forgiveness on the private side.”
Know Your Interest Rate
You can save a significant amount of money each month if you can refinance your student loan that comes with a far lower interest rate. Of course, if the interest rate on your existing student loan is already low, refinancing won’t bring much of a financial benefit.
Jacob Lunduski, financial industry analyst with Syracuse, New York-based Credit Card Insider, says that it usually makes sense to refinance your student loans if they come with an interest rate higher than 6.5%.
Qualifying for a refinance, though, could be a challenge. Lenders want to make sure they are lending money to borrowers who will pay back their debt on time each month. You’ll need to demonstrate a history of paying your bills on time. You’ll also need to show that you’ve managed your credit cards properly and that you don’t have thousands of dollars of credit card debt.
“Most lenders will offer you a refinance loan when you’ve shown you are both trustworthy and that you have a positive income-to-debt ratio,” Lunduski said. “Make sure you pay all your bills on time.”
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