If you’re one of the 44.2 million Americans with student loan debt you’ve probably found yourself asking “should I refinance my student loans” at least once.
Refinancing is a common strategy for people who have multiple loans or loans with high interest rates. If you’re wondering when it makes sense to refinance, it’s worth taking the time to run the numbers before deciding.
Reasons to Refinance Your Student Loans
Refinancing for Lower Payments
If you have multiple student loans you probably find yourself sending multiple payments to different companies, and sometimes sending separate payments to the same company. One big reason to refinance student loans is to cut down on the headache of dealing with multiple lenders and multiple loans.
As an additional benefit to refinancing your loans, you might find yourself with a lower monthly payment. If you have trouble paying all your bills because your student loans’ minimum payments take up all your cash flow, see if consolidating them into one loan can reduce your monthly payment.
Refinancing for Lower Interest Rates
Another common reason to refinance student loans is to take advantage of better interest rates. When you’re in college you don’t have a very long credit report, so your credit score is probably low. That means lenders can charge you more interest when you take out a loan.
Assuming you’ve used credit responsibly, by the time you graduate, your credit score should be much better than it was when you took out your loans. That gives you an opportunity to take loans at lower interest rates.
Reducing the interest rate on your loans makes a big difference in how much money you’ll spend over the life of the loan. This scenario will illustrate how reducing your interest rate can save you money.
You have a student loan balance of $10,000 at 7% interest. Your payment plan is 10 years, so you’ll make 120 payments in total.
Each monthly payment will be for $116.11. You’ll pay a total of $13,933.20 on your $10,000 loan. Almost $4,000 of your money is lost to interest.
If you refinance your loan to 4% interest, your payments will drop $101.25. In total, you’ll pay $11,756.14 over the 10 years of the loan.
That’s a savings of $2,177.06 from refinancing.
Costs of Refinancing
In the world of finance, nothing comes free. That includes refinancing your student loans.
Many lenders who offer refinancing will charge application fees or loan origination fees to refinance your loans. You might also have to deal with pre-payment fees on your existing loans if you try to refinance them.
You’ll need to run the numbers to make sure that you’re really saving money over the course of the loan after paying these fees.
The easiest way is to multiply the number of payments you have remaining on your current loan, by the amount of each payment. That will give you the total cost of your current loan. Then, do the same for what the payments would be if you refinanced, and add the fees.
If the refinanced loan payments plus the fees are less than what you currently pay, then you’ll save money by refinancing.
Something else to remember is that student loans offered by the federal government have a number of benefits that you may lose if you refinance them. Two of the biggest are the option to make income-based payments and to get on a loan forgiveness plan.
If your income is unstable or you’re hoping to have a portion of your loan forgiven, refinancing might not be the right choice for you.
Another benefit of federal loans is that subsidized loans do not accrue interest while you’re taking classes. If you’re still in school or considering going for an advanced degree, keeping your federal loans as is may be the best choice.
How to Refinance a Student Loan
The most common way to refinance student loans is called consolidation.
When you consolidate your loans, what you’re really doing is taking out a new loan and immediately using that money to pay your existing loans. Consolidation lets you turn multiple student loans into a single loan at the company of your choice.
Sometimes, lenders will let you refinance your existing loan to a lower interest rate if your credit score has improved significantly, but that’s less common that consolidation.
Most companies don’t let you consolidate your federal and private student loans together, but there are a few that do. One of the best ways to refinance student loans is with a company called SoFi. As another benefit, SoFi does not charge any origination fees or application fees, so you’ll only need to worry about pre-payment fees on your existing loans.
One thing to remember is that consolidating federal and private loans together is a sure way to lose the protections and benefits that federal loans have, so make sure you won’t be taking advantage of any of the benefits before you do.
Refinancing student loans can be complicated and incur unexpected fees. Make sure that your refinancing plan will truly reduce the total cost of your loan before pulling the trigger.
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