5 Common Mistakes to Avoid When Refinancing Your Student Loans

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5 Common Mistakes to Avoid When Refinancing Your Student Loans


Refinancing your student loans can make repaying them more manageable and potentially score you a lower interest rate, effectively saving you thousands of dollars in interest. Sounds like a dream, right?

Not so fast. While refinancing can be beneficial for student loan borrowers, you may want to avoid the following common mistakes to save yourself time, money and hassle.

1. Not doing your research.

One mistake borrowers can make is not doing their research on the various student loan refinancing companies out there. There are many options available, so it's key to find the best fit for you.

For example, refinancing may be a great way to cut down on how much you'll pay in interest during the life of the loan. Interest rates for federal student loans are set by Congress and vary by type, ranging from 4.66 to 8.5 percent as of September 2015 for loans originally disbursed on or after July 1, 2006, and before July 1, 2015. On the other hand, private student loan interest rates can exceed 18 percent, according to Federal Student Aid.

Whether you have federal loans or private loans, if you're at the higher end of these interest spectrums, you may be a good candidate to save money by refinancing. Also, if your credit score has greatly improved since you first took out private student loans, you may stand to save.

When researching, you should make sure the types of loans you have are eligible for refinancing and compare repayment terms as well as any additional perks, such as career support or unemployment protection, that you may lose or gain.

Aside from looking at the terms and conditions, you may also want to check out reviews about the lending company. Refinancing isn't reversible, so consider doing your research and choosing the right company for your situation.

2. Not weighing the cost of losing important federal protections.

There are some advantages you may give up when refinancing your student loans. If you refinance your federal loans, for example, you might forfeit federal student loan protections such as income-based repayment and loan forgiveness, as well as longer repayment terms offered through the Graduated Repayment or Extended Repayment plans.

If you pursue refinancing and opt for a shorter repayment term, you could save money on interest, but it may well result in higher monthly payments. Choosing a longer repayment term will mean a lower monthly payment, but you'll probably pay more in interest.

3. Jumping into refinancing without preparing for it.

Refinancing may make a lot of financial sense, especially if you have private student loans. However, rushing into refinancing is a mistake that could cost you time and money.

Before refinancing, you may want to take few preliminary steps to prepare. Consider checking your credit score and the eligibility requirements of each lender to start. Typically, lenders offer the best interest rates to people with excellent credit so if your credit score is fair or needs work, you may want to reassess whether you want to apply for refinancing now or later if you have the time and capability to improve your credit score.

If you're ready to proceed, consider compiling your financial paperwork, such as your W-2, pay stub and current loan servicer information before you apply. Being prepared may help save you money by expediting the process, which could help you lock in a low rate before interest rates rise.

4. Not understanding the impact of variable and fixed interest rates.

When you refinance your loans, you may have two types of interest rates to choose from: fixed interest rates and variable interest rates. If the variable rates are lower than the fixed rates, don't automatically assume that the variable rate is the most cost-effective option.

Variable interest rates are just that -- variable. They can change at any time based on the economic climate. Interest rates have been relatively low since the Great Recession, but many experts believe they're expected to rise. Fixed rates, on the other hand, remain the same, but tend to be higher than variable rates on average.

If you expect to pay off your student loans quickly (in one to two years, for example), a variable rate may make sense. If it looks like it'll take several years to repay your student loans, it may be safer to opt for a fixed rate.

Dan Macklin, co-founder of student loan refinancing company SoFi, says, "It's a more complex question than just 'will rates go up in the future?' If you think you'll pay off your loans fairly quickly, you could save a lot by taking the lower, variable rate."

To help avoid making a costly decision, you might want to review the variable and fixed interest rate options from your proposed lender and determine how long it should take you to pay off your debt and how much you'll pay in interest with both types.

5. Not taking advantage of discounts.

A common mistake borrowers make when refinancing is not taking advantage of extra discounts offered to them. For example, some refinancing companies offer a 0.25 percent interest rate deduction when you sign up for auto pay.

Auto pay is when borrowers set up automatic deductions from their bank account to make their monthly payments. A discount of 0.25 percent may not seem like much but any reduction in interest can help you put more toward the principal balance of your debt and save you money in the long run.

Bottom Line

Deciding to refinance your student loans is a big decision, and one that should be made carefully. Before you take the plunge, doing your research could help you make sure it is the right fit for you and help you avoid these common mistakes.

About the Author: Melanie Lockert is a freelance writer and editor currently living in Portland, Oregon. She is passionate about education, financial literacy and empowering people to take control of their finances. Her work has been featured on Rockstar Finance, GoGirl Finance, The Globe and Mail and more.

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