Is it a Good Idea to Refinance Federal Student Loans Right Now?
Refinancing student loan debt could help you save money in the long term and streamline your monthly payments. The question is, when is the right time to refinance?
Thanks to the Federal Reserve’s interest rate cut to near zero in early 2020, many private lenders have followed suit in cutting rates on their own loans, and interest rates for many private student loans have dropped dramatically, making refinancing attractive for some borrowers right now who wish to lock in a low rate. At the same time, however, the government, through an executive order, has waived interest and deferred payments on federally held loans until December 31, 2020. (Update: through his executive order, President Biden has extended the payment holiday through September 2021.) So if you have federal student loans, you may be wondering what to do: Should you continue taking advantage of 0% interest and no required payments until the end of the year—or should you refinance your education debt while rates are at historic lows?
Of course, it’s impossible to know if interest rates will stay down, drop even lower or rise. Likewise, it’s unknown whether the government will extend its coronavirus-related student loan relief for even longer. It’s important to weigh your long-term financial benefits of refinancing with the potential downsides. Here’s a closer look at situations where it may and may not make sense to refinance.
What It Means to Refinance Your Federal Loans
Before we get into specific scenarios, it helps to understand what refinancing means. Also, you should know how it’s different from consolidating your federal student loans.
Refinancing federal student loans means taking out a new private student loan to pay them off. Going forward, payments would be made to the new loan servicer. The new loan may have a different interest rate and monthly payment than the old ones. Refinancing your federal student loans also means you forfeit any federal benefits that come along with them, like federal forbearance options and income-driven repayment plans.
Consolidating federal student loans, on the other hand, combines them into a new federal Direct Consolidation Loan. There will still be one monthly payment but the interest rate will reflect the average of the rates being paid across the previous loans, rounded up to the nearest eighth of a percent.
Refinancing May Pay If Your Current Interest Rate Is High
As noted earlier, government action has brought interest rates on federally held student loans down to zero for the remainder of the year. Typically, though, federal student loans carry lower interest rates than private student loans. For the 2020-21 academic year, for example, new Direct Subsidized and Unsubsidized Loans for undergraduate borrowers carry a fixed interest rate of 2.75% while for graduate and professional borrowers like law school students the rate is 4.30%.
Yet for those who have existing federal student loans with higher rates—people who are 10 or so years out of college may be paying as much as 6.8%—the current low interest rate environment may present a good time to consider refinancing. Of course, the bigger the difference between your current rate and the refinance rate, the more the savings, but even small differences in rates can yield significant savings over the life of the loan.
For instance, let’s say there’s a graduate school borrower who just graduated with $40,000 in federal student loan debt at a 6.6% interest rate. They could pay off the loans under the 10-year Standard Repayment Plan or they may be eligible to refinance that debt.
If that new grad does not refinance their federally held loan, they will not have to pay anything until the end of the year (update: until Jan. 31, 2021), thanks to federal coronavirus relief. But say the new grad could shave just 1% from their interest rate and refinance into a new 10-year private loan at 5.6% instead. That 1% reduction in interest could mean a monthly savings of about $20 ($436 instead of $456, which would be due once federal relief ends) and a lifetime savings of roughly $2,416—assuming all payments are made on time. Cut that rate by 2% to 4.6% and the monthly savings in interest could amount to about $39 and a lifetime interest savings of approximately $4,769. Cut that rate by 3% to 3.6% and the monthly savings in interest could be about $58, with the lifetime interest savings amounting to approximately $7,057.
Keep in mind, however, that your getting a lower interest rate depends on such factors as your credit score, credit history and debt-to-income ratio—and every lender has different qualifying criteria.
Refinancing May Not Pay If Your Income Is or May Become Unstable
Refinancing federal student loans into a new private student loan means giving up certain federal benefits and protections, including the option to defer payments on those loans or apply for income-driven repayment.
Private student loan lenders aren’t required to offer any of these benefits or protections, though some do have similar programs. For example, SoFi offers unemployment protection to its members, which allows those eligible to temporarily pause payments on their loans if they lose their job. Another benefit available to all SoFi members is one-on-one career coaching in areas like interview techniques, networking, negotiation, and more.
Refinancing May Pay in the Long Term If Your Balance Is High
When your balance is high (say, five figures or more), the savings from a lower rate are amplified. In fact, depending on your balance, the difference between your old and new interest rates, and other factors, the long-term savings from refinancing could outweigh the short-term savings from not paying the government interest for the remaining months of the year.
For a very simplified example, say you have a graduate federal student loan for $100,000 with a 6% fixed interest rate, you’re enrolled in the Standard Repayment Plan of 10 years (120 months), and you were to start making monthly payments of about $1,110 this November. Over the life of the loan, you would pay a total of about $33,225 in interest. If you made those payments in November and December 2020, when the government has cut the interest rate to 0% and does not require principal payments, a total of $2,220 ($1110 x 2 months) would go toward your principal. As a result, you’ll pay about $31,432 in interest over the life of the loan.
But if you were eligible to refinance to a fixed rate of 3% now, your monthly payments could drop to about $966 — and over 10 years, the total interest you would have paid is about $15,873. So by refinancing now, you could save approximately $15,559 ($31,432 – $15,873) over the life of your loan.
Better yet, if you waited to refinance till the end of the year (when the 0% interest and payment holiday is slated to expire) and made non-required payments of $1,110 for two months on your federal student loans as-is, you could shave an additional $21 from your monthly payments—and an additional $352 in total interest.
These calculations assume fixed rates and do not take into account any refinancing fees or finance charges, however. Your situation will also be different if you have been making payments (before and throughout the forbearance period starting April 2020). That is, the closer you are to paying off your loan, the less you will save by refinancing (this is because near the end of your amortization schedule, you are mostly paying principal).
Refinancing May Not Pay If the Interest Rate Is Variable
When refinancing federal student loans, it’s important to think about whether refinancing to a fixed rate or a variable interest rate would be better for a particular financial situation. With a fixed rate, there is certainty that the rate and payments won’t change over time. But when interest rates are low across the board, variable rates could look even more attractive.
The problem is that variable rates aren’t guaranteed to stay low. If the benchmark rate they track increases, the rate on the loans can increase as well. Borrowers considering refinancing federal student loans may want to think carefully about whether it makes more sense for them to consider a fixed or variable rate loan.
Refinancing May Pay If Your Federal Loan Is Privately Held
First and foremost, a key reason not to refinance is because the government has suspended payments and cut the interest rate to zero for all federally held student loans until the end of the year. But all federal loans are not necessarily federally held. So if your federal loan is actually held by a commercial lender, you have less reason not to take advantage of lower rates.
Which loans are not federally held? Some under the Federal Family Education Loan (FFEL) Program are commercial.
Similarly, some Perkins Loans are held by the school instead of the federal government.
Many private lenders have also granted forbearance during the coronavirus crisis, so you can’t assume your loan is federally held just because your payments have been suspended. To find out who holds your loan, contact the servicer.
Refinancing May Not Pay If You’re Seeking Public Service Loan Forgiveness
Borrowers may want to rethink refinancing federal student loans if they’re hoping to qualify for Public Service Loan Forgiveness (PSLF). They’ll need to keep their loans with their federal student loan servicer and make the required number of on-time payments to maintain their eligibility.
Finding the Right Lender for Federal Student Loan Refinancing
It pays to shop around for the right lender when leaning toward refinancing federal student loans. That means comparing interest rates, loan fees, loan repayment terms, and other benefits to find the loan that fits your needs and budget.
When considering any lender, applicants may also want to look at the credit score requirements to determine if a cosigner may be necessary. SoFi makes it easy to get a rate quote for student loan refinancing. This initial inquiry won’t affect a person’s credit score, as it’s only a soft credit pull at this point.1 A request for an applicant’s full credit report—which is considered a hard credit pull—is not made until they finalize their loan options and submit an application. SoFi members could potentially save money over the life of their loan with flexible terms and no hidden fees.
1Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. A hard credit pull, which may impact your credit score, is required if you apply for a SoFi product after being pre-qualified.
SoFi Student Loan Refinance
IF YOU ARE LOOKING TO REFINANCE FEDERAL STUDENT LOANS, PLEASE BE AWARE OF RECENT LEGISLATIVE CHANGES THAT HAVE SUSPENDED ALL FEDERAL STUDENT LOAN PAYMENTS AND WAIVED INTEREST CHARGES ON FEDERALLY HELD LOANS UNTIL THE END OF SEPTEMBER DUE TO COVID-19. PLEASE CAREFULLY CONSIDER THESE CHANGES BEFORE REFINANCING FEDERALLY HELD LOANS WITH SOFI, SINCE IN DOING SO YOU WILL NO LONGER QUALIFY FOR THE FEDERAL LOAN PAYMENT SUSPENSION, INTEREST WAIVER, OR ANY OTHER CURRENT OR FUTURE BENEFITS APPLICABLE TO FEDERAL LOANS. CLICK HERE FOR MORE INFORMATION.
Notice: SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income-Driven Repayment plans, including Income-Contingent Repayment or PAYE. SoFi always recommends that you consult a qualified financial advisor to discuss what is best for your unique situation.
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