Pros and Cons of Refinancing Student Loans

Refinancing student loans can be a great way to lower your interest rate and monthly payment if you’re struggling to manage your current student loan balance. Combining multiple loans into a single loan also simplifies your budget.

There are some drawbacks to refinancing student loans, however. Since the process usually involves replacing federal loans with private loans, the lower rates you could get through refinancing may not make sense if you need the payment flexibility of federal loans.

Understanding the advantages and disadvantages of student loan refinancing can help you decide if it’s the right choice for you. Take a look at your entire financial portfolio, compare lenders and consider the pros and cons of refinancing student loans before making a final decision.

Pros of refinancing student loans

You can save money with a lower interest rate

If your goal is saving money in the long run, then make sure the new private loan has a lower interest rate than your original loan. A lower rate means that you’ll pay less in interest over the life of your loan and can reduce the likelihood of interest capitalization — when unpaid interest accrues and is added to your principal balance.

Most lenders offer prequalification, which lets you see your eligibility odds and predicted loan terms without impacting your credit score. When you apply for a refinance loan, the lender will do an in-depth review of your credit report, called a hard credit check, which lowers your credit score by a few points. To find the loan with the best rate, it’s important to shop around and compare lenders through prequalifying to minimize the impact on your credit score.

A longer repayment period can lower your monthly payment

Opting for a longer repayment duration for your student loans can lead to significant advantages such as reduced monthly payments. This could lighten your immediate financial load and make your monthly financial planning easier.

It’s crucial to be aware that while your monthly payment is less with a longer term, the total amount you repay will increase due to the extra interest accumulated over the life of the loan.

If you’re able to make a larger payment down the road and want to pay down your balance further, you can simply elect to make a larger payment. That said, you can’t elect to make a smaller payment unless you qualify through refinancing.

One payment is easier to manage

For those who have loans with multiple lenders, keeping track of every payment and the details of each loan can be difficult. Since refinancing involves consolidating multiple loans into one loan with a single payment, it’s much easier to track your monthly expenses.

For those with both federal and private student loans, refinancing can be a great simplification tool — especially because private and federal lenders operate differently and have different regulations. However, only refinance if you’re offered a more competitive rate than your federal loans and don’t plan on using any of the U.S. Department of Education’s federal relief programs.

Cons of refinancing student loans

You could lose federal benefits and protection

Federal student loans carry specific forgiveness and repayment benefits, including programs like Public Service Loan Forgiveness, closed school discharge, total and permanent disability discharge and borrower defense to repayment.

When you refinance federal student loans, you’re essentially swapping them for private loans, which can result in the loss of certain federal benefits and programs.

The Department of Education also offers hardship payment relief — temporary deferment and forbearance periods — to all federal borrowers, which can help reduce the risk of defaulting on your balance. Private lenders don’t offer uniform benefits and some offer more relief and repayment options than others.

Before making a decision, it’s crucial to balance these potential losses with the possible advantages of refinancing. Once you’ve converted federal loans to private loans through refinancing, there’s no way to change them back to federal student loans or reclaim the benefits of federal loans. If you think you qualify for federal debt or payment relief, you may want to put off refinancing while exploring the options available.

It can be difficult to qualify for better terms

Qualifying for a loan without a co-signer can be hard if you have a lower income or a credit score under 650. Most lenders require proof of steady income. While there are lenders that cater to borrowers with low income, most still require a good credit score and relatively low debt-to-income ratio (DTI), between 30 and 36 percent.

Always consider the interest rates when looking for a loan that meets your needs. Loans that cater to borrowers with a less-than-stellar financial record often come with higher rates and less than optimal terms.

Instead of borrowing a loan with non-competitive terms, take the time to conduct an audit of your budget. Look into your credit history and repayment trends to see what can be done to improve your creditworthiness.

Most of your credit score is based on debt repayment, so prioritize paying down high-interest debt every month on time and, if possible, in full. Making at least the minimum payment every month can substantially help improve your credit over time.

If you can’t meet these standards, you might need someone with a good credit score and low DTI to co-sign for you. It’s crucial to remember that meeting these criteria doesn’t automatically ensure a lower interest rate.

Before you decide to refinance, it’s smart to use resources such as student loan refinancing calculators and prequalification methods to gauge potential savings without affecting your credit score.

Bottom line

Before refinancing your student loans, carefully analyze your financial situation and compare lenders to make an informed decision. While refinancing can potentially lower your interest rate and monthly payments, it may also result in the loss of federal benefits and require a good credit score to qualify.

Prioritize improving your credit and explore all options before refinancing. Use resources like student loan refinancing calculators and prequalification methods to make an educated decision. Don’t rush into refinancing and risk ending up in more debt down the road. Take the time to consider all factors and make a decision that is best for your financial future.