There’s about $1.3 trillion in outstanding student loan debt in the United States. Most of that consists of federal student loans, but there are several hundred billion dollars in private student loans, as well.
Both federal student loan lenders and private student loan lenders charge interest – a percentage of the loan principal balance that acts as the cost of borrowing and a way of reducing risk to the lender. But borrowers have no real control over their interest rate and are largely stuck with it – federal student loan interest rates are set by Congress, and private student loan interest rates are set by the terms of the underlying loan contract. Given these limitations, the only option available to borrowers to lower their rates is to refinance their loans through a private lender (there is no federal student loan refinancing program that results in a lower interest rate). This is a major undertaking, and borrowers who are considering student loan refinancing should be aware of the potential risks and rewards.
Pro: Lower Interest Rates
The most obvious reason to refinance a student loan is, clearly, to get that lower interest rate. And a loan’s interest rate can really make a huge difference. A $50,000 student loan with an interest rate of 7.5% requires monthly payments of nearly $600/month to pay the loan off in 10 years. In contrast, if the interest rate was only 2.5%, the borrower could pay off the loan in 10 years with monthly payments of only $470/month. That’s a savings of over $15,000.
Pro: Fixed Interest Rates
Another interest-related reason to refinance is to convert a variable interest rate to a fixed rate. Variable rates inject an element of unpredictability to loan repayment – if your interest rates change down the line, your monthly payments may also have to change if you still want to repay your loans in the same period of time. And since interest rates are generally low right now, there’s really only one direction that variable student loan rates will go – and that’s up. Refinancing your student loans with a fixed interest rate can restore some control and predictability to your repayment strategy, and also protect against future economic issues that can influence variable rates.
Pro: Better Terms and Conditions (Maybe)
Many traditional private student loans have pretty terrible terms and conditions, with minimal repayment flexibility and unfair default triggers. While no private student loans have the same protections as federal student loans (more on that in a moment), some of the newer private student loan refinancing companies do seem to offer some fairer terms, including more generous options when borrowers are facing economic hardship, as well as options for discharge based on death and disability. You may also be able to get your cosigner released. Be sure to review the terms and conditions of any refinancing contract before signing.
Con: Worse Terms and Conditions (Maybe)
While private student loan refinancing programs may provide better terms and conditions for traditional high-interest private loans, they generally will still be worse as compared to federal student loans. Federal student loans have many consumer protections such as a death and disability discharge, generous deferment and forbearance options, and the right to cure default. These programs are not just provided by contract – they are provided by federal law, which makes them incredibly strong. By refinancing your federal loans with a private loan, you are giving up these protections. The consumer protections afforded to a private student loan borrower are contractual (not statutory), and are often discretionary as well – meaning the lender gets to decide whether or not to enforce them.
Con: Lost Access to Federal Programs
Not only do you give up important consumer protections by refinancing your federal loans into a private loan, but you also will forever lose out on unique federal student loan programs such as income-driven repayment, loan forgiveness, and federal repayment assistance programs. Some of the newer private student loan refinancing companies do offer some similar-sounding programs, but don’t be deceived – these are not the federal programs, and they are entirely discretionary on the part of the private lender.
Because many of the newer players in the private student loan refinancing field have not been around for long, we simply do not know how they will treat struggling borrowers or borrowers who have defaulted. We don’t know how lenient and flexible they will be, or how aggressively they will pursue people. We also don’t know how their approach may change over time. You’re going to be repaying these loans for years – and if most of the consumer protections are at the discretion of the lender, flexibility now does not necessarily mean flexibility later.
So what does this all mean? I think refinancing private student loans to get a lower interest rate and better terms can really make sense (as long as you do your homework first), and it can provide tangible benefits for borrowers and save them a lot of money. But refinancing your federal student loans with a private lender is an incredibly risky thing to do – even with a lower interest rate – and borrowers do so at their own risk.