Written By Travis Hornsby, CFA®, CFP®
Refinancing your student loans is an excellent option to lower your interest rate and get your debt paid off faster. However, the CARES Act suspended monthly payments and dropped most student loans to 0% interest – and 0% is hard to beat.
The student loan interest freeze will expire on September 30, 2020. Congress may pass a bill to extend the relief, though it will end eventually, and you must pay your loans again.
And that means you need a plan. In some situations, refinancing is the best option to save the most money while paying off your loans.
Refinancing student loans during the pandemic
The recent economic turmoil has had a tremendous impact on whether you refinance your loans. Our advice has always been more conservative. It’s likely to be even more conservative since borrowers are juggling increasingly high levels of unemployment and financial setbacks because of the pandemic.
Most anti-debt crusaders tell you to just pay off your student loans. That’s just bad advice because a significant number of borrowers can take advantage of forgiveness. Historically, our advice has been that if you could benefit from Public Service Loan Forgiveness (PSLF), do not refinance.
If you’re not pursuing PSLF or another type of student loan forgiveness, the benefits of refinancing could help you pay off your student loan debt more quickly.
Student loan repayment after the election
Vice President Joe Biden’s student loan proposal would change income-based repayments. Instead of paying 10% of your income for 20 years, Biden’s plan would be to pay 5% of your income and have no tax bomb.
This is extraordinarily generous, though it won’t automatically be enacted if Biden wins the election in November. The student loan change must go through proper channels to go into effect.
President Trump’s outlook on student loan repayment also includes changing the current program. He wants to increase the payment from 10% of your income for 20 years to 12.5% of your income for 30 years.
This plan would be much worse for borrowers. Not only does it increase the percentage of your monthly payments, but it also makes borrowers make payments for an extra 10 years. If that were the case, refinancing would be a much more common solution to paying down student loan debt.
A common thread among republican proposals includes grandfathering in existing borrowers based on rules in place today. I’ve never seen a proposal from a republican that eliminates the ability to use the current repayment plan that you’re already on.
When to consider refinancing your student loan
Refinancing your student loans can carry significant weight for federal student loan borrowers. You lose access to forgiveness programs and income-based repayment options. But refinancing makes sense for several borrowers because it can save money over the life of the loan.
Under current student loan rules, refinance your federal loans if:
- You owe less than 1.5x your income
- You work in the private sector
- You have an emergency fund
For private loans, you should refinance as often as you can find a better interest rate.
If Biden’s plan passed and you could pay just 5% of your income and not have a tax bomb, the advice on when to refinance student loans will change drastically.
To justify refinancing and paying back all of your student loan debt, you would need to have a debt to income ratio lower than 0.6. For example, you must owe less than $60,000 on your student loans if your income was $100,000, which is a low threshold.
The pandemic and the impact it’s had on the economy have caused us to adjust the advice we give to borrowers about when is the best time to refinance. Now, we’re recommending you refinance if:
- You owe less than what you earn
- You work in the private sector
- You have an emergency fund
It’s a minor change, but one that makes a big difference.
Will the CARES Act be extended?
The CARES Act brought relief to many student loan borrowers. While interest rates are 0%, you should wait to refinance your federal loans even if you’re a clear-cut candidate for refinancing. But there is a way to take advantage of the low interest rates lenders are offering. If you know you want to refinance, you can apply as soon as the first week of September, and your offer will be good for 30 days.
Of course, that’s if another stimulus isn’t passed that extends student loan payment suspension. I don’t have a crystal ball, but we should know if there will be an extension in mid to late July. Although, it may not be announced until late July or early August.
Managing your student loans
At the end of the day, you are not your debt, and your debt is not a death sentence. Unlike some medical conditions that might not have a 100% cure rate, student loans are virtually 100% curable. You just need the right repayment strategy.
If you get a plan, know all the rules and hacks, and can handle your finances, student loans might be a problem, but they’re a problem with a cure.
If you have less debt than what you earn, and you’re in the private sector, refinance to take advantage of the low-interest rates. But if you owe more than your income or you’re not in the private sector, sticking with your federal loans makes more sense. If you’re not sure, book a student loan consult to get a crystal clear path to student loan repayment.
Not sure what to do with your student loans?
Take our 11 question quiz to get a personalized recommendation for 2024 on whether you should pursue PSLF, Biden’s New IDR plan, or refinancing (including the one lender we think could give you the best rate).
