Refinancing student loans offers a long list of benefits. With good credit, you can snag a lower interest rate saving you a few thousands on the accrued interest. You can save even more and clear your debt faster by increasing the monthly payments and reducing your loan term. On the other hand, if you’re struggling financially, you avoid default by lowering the monthly payments and extending the loan term. Despite all the benefits, however, refinancing does have a few downsides and may not be the best option for everyone.
These are a few times when you should NOT refinance your student loans.
Federal student loans offer multiple income-driven repayment plans. These plans allow you to cap your monthly payments at a certain percentage of your income. This makes the payments affordable regardless of any drop in monthly earnings. Income-driven plans help you avoid delinquency or default in case of a drop in income. They can be a great lifeline when you’re struggling.
Refinancing changes your federal student loans to private student loans. When you refinance, you lose access to all federal protections including income-driven repayment plans. You should not refinance if you think you may need access to an income-driven repayment plan in the future.
Forgiveness is another powerful protection that’s only associated with federal student loans. You may qualify to get your remaining debt balance canceled if you meet certain requirements. There are two main loan forgiveness programs. You may qualify for Public Service Loan Forgiveness if you work in public service. To qualify for Teacher Loan Forgiveness, you must teach full-time in a low-income school or educational service agency. For both programs, you must have completed a certain number of years of service. You must also have made a certain minimum number of payments to qualify.
If you’re pursuing any of these forgiveness programs, you should not consider refinancing your federal student loans. Refinancing will make you ineligible for forgiveness.
Your credit report is the first thing that lenders will examine to approve your refinancing application. Most lenders will reject your application if your credit is weak. Even the few lenders who do approve will charge you a significantly higher rate of interest. They do this as a way to compensate for lending to a high-risk borrower.
However, you can likely get approved if you apply with a cosigner. Still, if you want a lower interest rate it may be better to wait until you build up your credit score to refinance.
A source of consistent income reassures the lender that you’ll have sufficient funds to cover your loan payments every month. Lenders will even offer you a lower interest rate. However, you will either get rejected or pay a higher rate if you don’t have a steady job. This, again, defeats the purpose of refinancing.
It is especially important not to refinance federal student loans if you’re not earning a consistent income. Under these circumstances, it’s nice to have the option to switch over to an income-based repayment plan. This option is only available with federal student loans. Pegging your monthly payment to your income ensures that you can afford the payments plus your other expenses. More importantly, it eliminates the risk of delinquency or default.
It’s best to wait until you have a steady job and consistent income before refinancing student loans.
Interest rates on private loans are pegged to prevailing market rates. In a strong market interest rates increase. In a weak market, rates decrease. Before refinancing, compare the market rates with your current weighted average interest rate. If the market rates are even marginally higher, don’t refinance. Wait and keep track of the rates instead and apply for refinancing when market rates drop.
Refinancing may not help you save much if you’re almost done paying off your loan. When you refinance, you’ll be able to choose a new loan term. The minimum loan term most lenders offer for refinancing is 5 years. If your remaining term is less than that, you should definitely not consider refinancing. Adding years or even months to your repayment plan will make your debt more expensive.
It’s only worth it if interest rates drop drastically and you’re getting a significantly lower rate on your loan. Make sure to calculate and compare the cost of both options before deciding whether or not to refinance.
We’ve said it before but it’s worth saying again – federal student loans come with several important protections. The most appealing of these is access to income-driven repayment plans and forgiveness programs. In addition, if you’re struggling financially, you can also opt for deferment or forbearance on federal student loans. When you refinance federal student loans you lose all of these protections. Even if you get a lower interest rate on the refinanced loan, you must consider carefully what you’ll be giving up. Only go ahead and refinance if you are absolutely sure you won’t need the protections of the federal student loans.
Private student loans don’t have any of the benefits associated with federal student loans so you have nothing to lose by refinancing. If the rate you’re getting is lower than your current rate, it’s worth going ahead and refinancing. Even a point percentage drop in interest rate could save you a sizeable sum over the life of the loan.
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