Before You Refinance Student Loans, Read This
It might seem like a good way to make payments manageable, but you could be making some major trade-offs that could cost you (or your co-signer — thanks, Mom and Dad) big bucks down the road.
Student loan debt presents a serious financial burden to countless members of Gen X and Gen Y. We may be some of the most educated generations in history, but we’re still struggling to earn enough money to take care of rising living expenses while paying down a massive debt load.
When you have student loans, you may feel stuck. Your monthly payments eat up a lot of money that prevents you from doing other things you need to save for, like getting married, starting a business, buying a house or having a family.
If you’re in this situation, you likely want to find a solution now — and refinancing your student loans can look like an attractive option. Refinancing does make sense for some people, and it can save money or make debt more manageable.
But it's not a cure-all for every single person with student debt. You need to think through some of the following to understand what happens when you refinance student loans — and how it could negatively impact you and your financial situation.
You Start the Clock Over Again (and That Can Cost You)
Here’s a simple explanation of what happens when you refinance student loans:
- You apply for a new loan with a new lender, asking to borrow the sum of all your existing student loan balances.
- The lender approves your loan application and underwrites a loan that includes new terms and a new interest rate.
- The money from the new loan is used to pay off all your existing student loan debt.
- You repay the new loan.
Getting a completely new loan means an opportunity to secure a lower interest rate. That could save you money if the rate is significantly lower than the rates on your existing student loans — a big reason why refinancing sounds so appealing.
But it also means that you get new loan terms, which means you’re starting from square one.
If your existing student loans had 10-year terms and you were four years into paying them off, your new loan could come with a 10-year term — meaning you’ll be paying on that debt for 10 more years, rather than just six more with your existing loans.
Extending the time it takes to repay your debt could negate any savings you might generate by getting a lower interest rate. Before you refinance student loans, do the math. Is the interest rate you can get from a lender low enough to make paying off loans over more months worthwhile?
Don’t forget to take the fees associated with originating and closing a new loan into account, too!
You Can’t Use Repayment Plans (or Get Loan Forgiveness)
If you have federal loans now, you can currently enroll in one of the Department of Education’s many repayment plans or programs. But if you refinance? Well, remember that refinancing means getting a new loan with which to pay off your existing loans. You won’t have federal student loans anymore — which means you won’t be eligible for programs to help you repay your loans. That includes the Public Service Loan Forgiveness program.
That might not be a deal breaker, especially if you don’t qualify for federal programs or if using a repayment plan won’t benefit you (or if, in your situation, refinancing offers a way to save more on repayment than a federal plan does).
But it’s something to know and consider first. Make sure you educate yourself on the programs available to you. Again, do the math to make sure a repayment plan doesn’t provide you with a better option than refinancing.
If you need help running through the various scenarios, consider working with a professional. Fee-only financial planners can help you design a comprehensive financial plan that takes all aspects of your life — including your student loans — into consideration so you can maximize the money you have to work with.
(Just make sure that any financial professional you work with is willing to be your fiduciary. You can find a list of other important questions to ask before hiring a planner here.)
You Lose Benefits and Protections That Come with Federal Student Loans
Along with losing access to repayment plans and programs, you also lose the benefits that come with federal student loans. When you refinance, your new loan is private — and that does make a difference.
Federal student loans offer certain protections to borrowers. Those include options for forbearance and deferment. It also includes the ability to discharge the debt if you were to pass away or become disabled.
You don’t get this with private loans. If something happened to you, your debt would not be discharged after your death. The lack of protections around private loans could leave you (or your family) in a bad spot in the future.
And if you had a co-signer on your original student loans, you need to ask your new lender for a co-signer release form before you refinance. Without that form, your co-signer gets stuck with the remaining balance of your refinanced loan — which they’ll owe immediately — if you were to pass away or become incapacitated.
You Ignore Other Strategies for Debt Repayment
Refinancing does seem appealing, especially if you’ve seen any flashy TV advertisements from companies that offer to refinance your loans. But it’s not the only way to make your student debt easier to manage and pay off — and in fact, there may be better options.
If you’re struggling to make your payments and want to get them under control, look at other aspects of your financial situation first.
Are you overspending? Could saving more money in your everyday expenses help you come up with the money you need to comfortably make your student loan payment? Are there ways to reduce or eliminate expenses so you have money to pay your loans and save for your goals?
If you’re doing your best to save but still can’t manage your student loan payments along with your other expenses, it might time to learn how to make more money. From side hustles to a switch in your full-time job, you have more options — and more control over your income — than you might think.
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About the Author
Founder and CEO, Define Financial
Taylor Schulte, CFP®, is founder and CEO of Define Financial, a fee-only wealth management firm in San Diego. In addition, Schulte hosts The Stay Wealthy Retirement Podcast, teaching people how to reduce taxes, invest smarter, and make work optional. He has been recognized as a top 40 Under 40 adviser by InvestmentNews and one of the top 100 most influential advisers by Investopedia.