Many people want to better manage their student loans and optimize how they repay them. There are a variety of ways to achieve this, but (as is the case throughout many aspects of the student loan world) understanding the confusing array of options can be challenging.
In my next several articles, I’m going to give you a crash course in student loan “consolidation,” “modification,” and “refinancing.” People often casually use these terms interchangeably, but they actually can mean very different things, and it’s important to understand their definitions.
Over the past couple of weeks, I have discussed student loan consolidation, where you take out a new student loan to combine several different student loans, and student loan modification, where you change the terms and conditions of an existing loan. Today, the topic is student loan refinancing.
Student Loan Refinancing
Refinancing a student loan specifically means changing the loan’s interest rate, usually by taking out a new student loan with a lower interest rate to pay off and replace the loan with the higher rate. Refinancing can also act as a consolidation if you are including multiple student loans in a single refinancing program. If you lower your interest rate, you can potentially lower your monthly payments and pay less money in total over the course of the loan’s repayment term.
For federal student loans, there is no true refinancing mechanism within the federal student loan system. Federal student loan consolidation is an interest-neutral option (the interest rate of a federal Direct consolidation loan is the weighted average of the loans included in the consolidation), so it can’t really be called refinancing, although federal Direct loan consolidation can open up some new repayment plan options, which can result in lower payments for certain borrowers. Senator Elizabeth Warren proposed a bill to allow federal student loan borrowers to refinance their loans within the federal student loan system without needing to take out a new loan, but this bill failed to pass the Senate, and it doesn’t look like it will be revived anytime soon.
As for private student loan refinancing, options mostly dried up following the 2007-2009 financial crisis, but during the past few years I’ve been seeing a steady increase in private student loan refinancing options available to borrowers. Generally, these programs are limited to borrowers in good standing on their existing loans, with good credit and steady income.
As with private student loan consolidation, many of these programs allow borrowers to refinance private student loans, federal student loans, or both. But I would caution people about refinancing federal student loans via a private refinancing program. Federal student loan interest rates are high and will only be getting higher, and a lower interest rate is attractive and important; but borrowers should consider whether losing out on federal student loan program benefits (such as income-driven repayment, loan forgiveness programs, and generous deferment and forbearance options) is worth it, since refinancing your federal loans through a private loan program is a one-way ticket out of the federal student loan system. This really comes down to your goals and circumstances.
Whatever you do, if you’re thinking about refinancing, be sure that you fully understand what you’re gaining from refinancing, and what you may be losing.