An estimated 3 in 10 young Americans cite paying off student loans as their biggest financial challenge, according to Yahoo Finance. Refinancing your student loans is one strategy that could make your debt more manageable, but it doesn't make sense for everyone. Read on to see if it's right for you or if there are better options out there.
Where does my loan come from?
The origin of your loan can impact what options are available to you and whether refinancing is in your best interest. If you have a federal loan, for example, you may be able to simply switch your repayment plan to one that better suits your circumstances. On the other hand, your options will likely be more limited if you took out a private student loan, but you may be able to refinance your loan with a lower interest rate if your financial state has improved.
Is refinancing my only option?
If you took out a federal student loan, you could have several options available to you that don't require you to refinance. Direct loans and FFEL loans, for example, offer a variety of repayment plans with different features. Some plans extend the term of your loan to reduce your monthly payments while others cap your monthly payments at 10 or 15 percent of your discretionary income. You may even be able to find a plan that will forgive a portion of your principal after a certain period of time, although these are generally harder to qualify for. If you took out a Federal Perkins loan, your repayment options will depend on your loan servicer.
It's typically harder to renegotiate private student loans, but it's not impossible. If you're at risk of defaulting on your loan, your lender may be willing to lengthen the repayment period, lower the interest rate, or forgive part of the principal.
What should I consider if I want to refinance?
If you have a federal student loan and you want to refinance, you'll need to look to the private sector. Currently, the government does not offer refinancing for federal student loans, unless you're looking to consolidate them. While refinancing into a private student loan might save you hundreds or even thousands of dollars in interest, there are several factors you should consider before you make the switch.
- Fixed vs. variable interest rates. When interest rates are low, private student loans may offer better rates than federal student loan rates, which are set by Congress. However, interest rates on private student loans are frequently variable, so your monthly payments could rise significantly if interest rates increase. With federal loans, your rates will never go above 8.25 percent, unless Congress votes to raise the rates. Before you refinance to a private loan, check whether your loan features fixed or variable rate interest.
- Credit health. Private lenders typically offer the lowest rates to borrowers with excellent credit, which many graduates don't have. If your financial health is less-than-stellar, you may want to focus on building your credit before you consider refinancing your loans.
- Borrower protections. By switching to a private student loan, you forfeit certain benefits that come with federal loans, like the ability to defer or postpone principal payments under certain circumstances. While some private lenders offer similar benefits, they typically aren't as generous.
If you're refinancing a private student loan, you'll likely have to consider factors like credit health and whether the interest rate is fixed or variable. But you'll also want to check to see if your loan comes with prepayment penalties. These are fees lenders charge if you pay off your loan before the end of your repayment period. In general, lenders don't apply these penalties to student loans. However, it's worth asking about them anyway, because if the fees are large enough, they may offset any savings you could get from refinancing.
If you took out a federal student loan--or even a private student loan--odds are there are ways to manage your debt without refinancing. However, if you have a secure job, solid credit and promising career prospects, refinancing might be in your best interest. Just be sure to be aware of any hidden fees, prepayment penalties and fluctuating interest rates before you sign up.
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