One of the biggest debts that the average American has is their student loans from college. Recently there’s been a lot of talk about “refinancing” a student loan and today we’ll take a look at a number of different factors that you should know about before making a decision on whether to do this or not. Enjoy.
The first question is simply this; should someone refinance their private student loan into a loan with a lower rate? Most private student loans feature variable interest rates that have been based on a specific borrower’s credit history. When that person first takes out their private student loan, he or she probably has a limited credit profile and will be treated as a higher credit risk by most lenders. What this means is that, for most student loan borrowers, a private student loan comes with interest rates that are quite high.
That being said, there are a number of borrowers who, after graduation, and obtained a job and gotten excellent credit. These people may be able to qualify for a refinance of their existing private student loan and turn it into a new private loan at a much lower rate.
For many borrowers however the situation is, unfortunately, not available. Not only that but there are few financial institutions that actually offer this type of financial product. If you do happen to find one there are a number of things to consider.
First, look closely at the APR. While the monthly payment on your new student loan might well be lower, the interest rate could actually be higher due to the fact that your new long-term may be spread out over a longer period of years. If you are an active-duty service member, you might wish to consider that if you refinance its possible you’ll lose the rate benefits on your pre-service obligations.
You also need to closely consider the tax consequences as your new loan may not be considered a student loan and might not qualify for the interest tax deductions that student loan’s qualify for. If claiming this deduction is something you do every year you definitely will want to take a look at whether or not you’ll be able to continue doing the same.
As far as federal student loans are concerned, refinancing them as private student loans with a lower rate depends on a number of factors. The fact is, Congress has not lowered the rate on federal student loans in quite some time, including the most common loan the Unsubsidized Stafford Loan. If you’re a borrower with excellent credit you may be able to qualify to refinance your federal student loan with a newer one at a lower rate.
There are a number of risks however. First you need to look closely at whether you’ll be switching from a fixed loan to a variable rate loan. Since most federal loans have fixed rates you won’t have to worry about your monthly payment increasing if interest rates rise but, if you’ve switched to a variable rate loan and interest rates rise, your loan amount could rise with them.
Lastly you want to be sure to understand what you’re giving up with your federal student loan before you make the choice to change it into a new private student loan, mostly forgiveness options. On the other hand, if you have sufficient emergency savings, a strong credit history, a secure job and likely won’t need any forgiveness options, refinancing to a new private student loan may well be worth considering.
Indeed, it could help you take advantage of today’s historically low interest rates as well as the improved credit profile that you (hopefully) have today. It’s definitely a useful way to lower your monthly college loan payments as well as build your savings and retirement fund, but you need to closely consider all of the risks before signing on any dotted line.