You’ve seen the ads, and it seems like a compelling promise: Save thousands of dollars in interest payments.
Imagine what you could save and put toward your principal balance if you could slash your interest rate. Student loan refinancing is an enticing option to lower your interest rate, but you might be giving up more than you realize. Is it worth it? Should you refinance student loans?
Here’s how to figure out if refinancing federal student loans makes sense for you.
Should you refinance student loans?
If you have federal student loans and are interested in refinancing, it’s important to evaluate the pros and cons. Student loan refinancing can save you money on interest, which could help you pay off debt faster.
On the other hand, you could be giving up helpful protections from the Department of Education that can save you if you’re in a bind.
Student loan forgiveness and income-driven repayment are two financial lifesavers available through certain federal student loan programs. If you refinance, you no longer have access to those options as you are essentially going from having federal loans to a private refinancing loan. It’s a big decision, so before applying to refinance student loans make sure it’s right for you.
“If you have federal student loans, work in the private sector, have a solid
emergency fund, and owe federal debt less than 1.5 times your income, you’re a good candidate for student loan refinancing,” explained Student Loan Planner founder Travis Hornsby.
Those are good benchmarks to consider before refinancing federal student loans. On top of that, you’ll find five indicators below that show when student loan refinancing might be the right option for you on your student loan repayment journey.
5 signs refinancing federal student loans will make sense
If you’re wondering, “Should I refinance my student loans?” you want to review all your options and the loan terms for your current loans and your prospective refinancing loan. Below we cover when refinancing federal student loans makes the most sense.
1. You’re not interested in loan forgiveness
One of the major perks about federal student loans is the option for student loan forgiveness. Whether through the Public Service Loan Forgiveness (PSLF) program or with an income-driven repayment plan, there are several ways that federal student loan borrowers can legally get their student loans forgiven.
Have you worked for 10 years in the public sector? You may be eligible for PSLF. Still, have a balance on an income-driven plan after 20 to 25 years? Your remaining balance will be forgiven (though you’ll likely be hit with a tax bill in this case). There’s even student loan discharge if you are disabled.
These options are not available to you after you refinance federal student loans. When you refinance, you’re taking out a “refinancing loan” that pays off your current student loans.
Your new lender that refinanced your loans, which is a private company, doesn’t offer the same federal protections that your original federal loan servicers offered.
If you’re not working in the public sector and the idea of paying your loans for 20 to 25 years makes you cringe, student loan forgiveness probably isn’t in your future. If you’re absolutely sure that this is not a route you want to pursue, refinancing could be a better fit to reduce your interest rates and help you pay off your student loan debt faster. Federal education loans have fixed rates, so refinancing is one way to get a different, lower rate.
2. Your job is (fairly) stable
Job security is a thing of the past, and there are no guarantees for anyone. Can you refinance federal student loans? Your job should be fairly stable if you want to refinance your student loans. You’ll need the income from your job to get approved for refinancing and then to make the appropriate payments on your new loan.
Also, you’ll no longer have access to an income-driven repayment plan if your income plummets, and you won’t have the same student loan deferment or forbearance options that you had with your federal student loans if you’re suddenly out of work. You want to be sure that you can afford the loan payments if your employment situation changes.
So if your job changes frequently or you’re new to your company, refinancing federal student loans may not be the best fit just yet. If your job is pretty stable and you don’t plan to job hop, however, then refinancing could be wise.
It’s also important to think about how stable your job is when — because it is a “when,” not an “if” — the next recession hits. Thinking ahead and looking at all sides can help you understand whether refinancing is worth the investment given your employment situation.
3. You have good credit
When you take out a loan with a private lender, they want to know you have good credit to pay back your loan. Student loan refinancing companies run a credit check to determine if you’re a good candidate for a loan.
Federal student loans typically don’t have credit checks, so this is a bit different. If your credit is not so hot, you probably don’t want to apply for refinancing at this time. If you apply with a credit score that doesn’t meet the lender’s criteria, you likely won’t be approved, and the hard credit check could ding your credit score.
When you apply for a new loan, there is a “hard pull” on your credit that can lower your score by a few points. Work on rebuilding your credit with on-time payments and low credit utilization.
How “good credit” is defined varies by lender, however a good rule of thumb is that 700 or above is a good credit score, according to credit bureau Experian.
4. Your monthly payments are manageable
When you refinance federal student loans, you’re hopefully lowering your interest rate. Along with that, your repayment term and monthly payment amount will change as well, depending on your loan offer.
“Obviously, the main determinant should be getting a much better interest rate. In some cases, you also might refinance to get a lower monthly payment. You also need to be sure that student loan forgiveness strategies won’t save you more money than refinancing,” explained Hornsby.
If you’re currently struggling with your payments, then refinancing is not the cure to your problem.
“You should look at the Standard 10-year Plan and if you can’t easily afford that for federal loans, then refinancing is not for you yet,” said Hornsby.
Refinancing can help an interest rate problem but not a monthly payment problem. Making sure your payments are manageable on the Standard Repayment Plan can be a good benchmark to see how much you can afford in monthly payments when you refinance.
If you’re struggling to make payments on the Standard Repayment Plan, it’s best to stick with federal student loans in that case and opt for an income-driven plan, which can lower your payments based on your income.
5. Your interest savings can make a dent on your principal balance
The major value of refinancing and saving money on interest is being able to direct more of your money toward your principal student loan balance.
It’s no wonder it seems like an attractive option when all you want to do is get out of debt as fast as possible. In this current environment though, interest rates are on the rise, and student loan refinancing companies may not have as many competitive offers as they once did.
How much you save on interest needs to be enough to warrant giving up all those valuable perks that come with federal student loans.
“I usually say you need at least 1% savings on federal loans and a household debt-to-income [ratio] below 1.5 to 1 to make it worth it,” said Hornsby. “REPAYE is great if your debt-to-income is above that level because then you get subsidies that’s basically like a private refi.”
Ideally, you can get a couple of points shaved off of your interest rate. Even then, you should do the math and calculate how much you’re really saving on your current student loan balance. If you don’t have that much left to pay back it may not be worth the hassle, or if the rate isn’t much better, stick with your federal student loan repayment plan.
On the other hand, if you are in the thick of student loan repayment and have years to go, refinancing could be a good fit if you get a better interest rate. Many student loan refinancing companies allow you to check your prospective interest rate without hurting your credit score.
While doing your research on rates, you can also check out any cash back bonuses that might be available. At Student Loan Planner, we offer readers cash back when refinancing using our links, because it’s only fair. That way you can save money on interest and get cash back, putting even more money back in your pocket.
When you should you refinance federal student loans
After reviewing these five signs, you should have a better idea of whether refinancing your federal student loans might make sense for you. But when should you refinance?
You should refinance your federal student loans when you’re in a good position financially, with a stable job and after doing thorough research on lenders.
Check out loan terms, interest rates, repayment terms and eligibility requirements. You want to compare refinancing lenders and apply with several options to see where you can get the best deal.
If you’re in transition with your career or finances or your credit is shot, hold off on refinancing until you get back on your feet again and your situation improves.
Refinance federal student loans only if it makes sense for you
Should you refinance federal student loans? It depends on a lot of factors, but you can use this list as a way to check if you’re a good candidate for refinancing.
Student loan refinancing can be a useful tool for loan consolidation when you want to save money on interest but should be considered carefully.
The process is irreversible, and you give up practical and useful protections from your federal student loans when you refinance. But if you meet the criteria above, refinancing could be worth a shot to cut down your student loan costs.