Refinancing

sealAnother concept that has picked up in recent years is refinancing your student loans. Refinancing is often confused with consolidation, which I covered in the last post, but is completely different.

In consolidation, your different student loans are combined to create a new loan. The interest rate is a weighted average of the interest rates of your loans, so in essence nothing with your loans has changed except you have one loan instead of many.

What happens with refinancing, is that you take out a new loan to repay your current student loans. You are essentially replacing your student loans with a new loan, one that hopefully has better terms than your old student loans.

Because in refinancing you are taking out a new loan, you must go through a private company, unlike loan consolidation which is done through the U.S. Department of Education. Since the loan will be through a private company, there are some very important factors that you should know about:

1. The interest rate is not standardized like federal loans. The interest rate you receive for your loan refinance will depend on a variety of factors, the two most important being your credit score and income.

2. While you can refinance federal loans, since you are refinancing with a private loan you will lose all of the benefits that come with federal loans; such as the variety of payment plans or the ability to consolidate.

3. All of the terms to your loan will be set by the private company, such as the repayment term, interest rate, and whether the interest rate is fixed or variable. It is extremely important to review your loan contract so that you do not get surprised by anything.

4. Many loan companies will charge you an upfront fee, which is generally 2% of the total loan.

So when is refinancing your student loans advantageous? If you have good credit and income, you may be able to get a lower interest rate than your current loans. With a lower interest rate you will save money over time, and/or you might have lower monthly payments. Thus, refinancing tends to benefit those who are already in a good financial position.

People who are struggling to make their loan payments often have poor credit and/or a low income, and thus it is much harder for them to secure a better interest rate through refinancing. If you are struggling to make loan payments, there are other options that can help you out (which I will cover in other posts).

Student loan refinancing has become a large marketplace in recent years. Because of this, many shady companies have jumped into the space, trying to scam struggling borrowers out of their money. While there are many legitimate refinancing companies out there, it is pertinent that you thoroughly research any company you are looking at to refinance, in order to make sure that you don’t get snared by any of the scam artists.

So when is refinancing your loans a good idea? Refinancing can be a very useful too if you have a lot of private student loans with high interest rates. Through refinancing, you can replace those loans with loans with lower interest rates. There are several calculators online where you can plug-in the info for your current student loans, and the proposed refinance, and get an estimate of how much money you save through refinancing. So if you can save money by refinancing your private loans, then do it!

As for federal loans, I would be much more hesitant about refinancing them. While you could potentially get a lower interest rate, you are sacrificing the many benefits and protections that come with student loans. Because of this, the decision to refinance your federal loans has to be weighed very carefully; it is not as clear-cut as refinancing private loans. All of these different points must be considered before making the decision to refinance your federal loans.

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