Student Loans

Can You Refinance A Federal Student Loan

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 12 minute read

Historically speaking, student loans have developed. Although private loans could always be refinanced, federally-guaranteed ones were not. Presently, borrowers have a great chance to refinance their federal loans at a lower interest rate.

Despite the potential savings of thousands of dollars, refinancing student loans is not always the best option. You should learn as much as possible about refinancing and what it implies for you and your debt as possible to prevent making any catastrophic mistakes. All the information you require is listed below.

How to Refinance Student Loans

You can find refinancing options for student loans from select private lenders, most notably commercial banks and newer businesses. Since refinancing is not an option within the federal loan program, borrowers must convert their federal loans into private loans before doing so. 

To put it another way, the private refinancing firm “buys” your debt from the federal loan program.

You can compare the process of refinancing a student loan to that of a home or auto loan. During a refinancing, borrowers exchange their current loan for a new one. 

More often than not, you’ll also be able to negotiate a more manageable interest rate or a payment plan that spreads out your payments over a longer period of time. If your interest rate or monthly payment is too high, refinancing may be an option for you.

Businesses that specialize in refinancing student loans frequently employ a peer-to-peer lending model, where the funds for the loans come from accredited investors rather than regular customers. 

SoFi, Earnest, LendKey, and CommonBond are just a few of these businesses. Citibank and Darian Rowayton Bank are two examples of commercial banks that offer refinancing for student loans.

Several refinancing firms for education debt are startups or otherwise relatively new enterprises, as was previously mentioned. 

Advantages and privileges that customers of traditional banks do not receive are commonplace at these businesses. If you happen to lose your work during the repayment period, for instance, you can take advantage of SoFi’s unemployment protection service.

Do You Need to Refinance?

To determine whether or not a certain individual is a good candidate for student loan refinancing and, if so, what interest rate to offer them, various variables are taken into account. 

Refinancing businesses place less weight on your credit score than commercial banks do when making a decision about your application, but it still plays a role.
Some businesses will even ignore your credit rating entirely. Instead, they look at your current employment status, your income or earning potential, and your liquid assets. 

There are a number of things that can improve your refinancing interest rate, such as:

  • You’re Good at Your Job. Companies like Earnest and SoFi consider whether you have full-time employment or full-time job offer in order to determine your rate.
  • What you’ve put away for the future. You can qualify for a lower interest rate if you have a month’s worth of living expenses saved up in the bank.
  • A successful past of making payments. Companies that refinance student loans do not want to observe a pattern of late or skipped payments.
  • Money coming in or out. To repay your student loans and live comfortably, you’ll need a steady stream of money each month.

One’s capacity to refinance a loan might be hampered by a variety of circumstances and individual decisions. For the following reasons, many students are denied service by organizations that specialize in refinancing student loans:

  • Changing jobs frequently. Lenders will feel more confident in your capacity to repay a loan when you can demonstrate a track record of consistent employment. Lenders get wary when they hear that you frequently switch jobs or go for long stretches without a paycheck.
  • Lots Many Other Obligations.  It can be challenging to qualify for a refinance loan if you have a lot of outstanding debt from credit cards, auto loans, or personal loans.
  • I dropped out of school. Unless you already have your degree or are on schedule to receive it by the end of the semester, most student loan refinancing programs will not refinance your loans. You may be out of luck if you dropped out of the program early or if you still have a long time ahead of you in school.
  • Repeatedly going above your bank’s withdrawal limit. Borrowers may view you with more suspicion if you have a history of late payments or overdrafts.

Pros of Refinancing Your Student Loans

Refinancing your debts has certain benefits if you meet the requirements. These perks are available whether you choose to consolidate your federal and private loans into one new loan, keep your federal loans separate, or consolidate your private loans exclusively.

  1. Reduced Rates of Interest. Federal loans have a set interest rate for the duration of the loan. Rates for student loans change based on when you started and finished college. For instance, I went to graduate school between 2006 and 2008, right before borrowing rates dropped due to the housing crisis. My current loan rates are a fixed 6.8 percent. To put it another way, if I refinance when interest rates are low, I can save a lot of money over the course of my loans’ repayment terms.
  2. Loan Repayments Made Easier. When you have many debts to pay off, it’s easy to get behind on payments. If you have several loans and want to consolidate them into one, refinancing may be the best option. In addition, if you enroll in an automated payment plan through a refinancing program, you may be eligible for a 0.25 percentage point interest rate reduction.
  3. There are no upfront costs. Sometimes the savings from a reduced interest rate are nullified by other fees. Companies like SoFi, Earnest, LendKey, and CommonBond, which specialize in student loan refinancing, do not impose origination fees.
  4. There will be no costs associated with paying the loan off early. Paying more than the minimum each month helps you pay off your loans faster and save money on interest. That’s a good strategy if and only if the refinancing business doesn’t hit you with a prepayment penalty. When you pay more than the minimum, you won’t be charged a fee by several lenders, including SoFi, Commonbond, Earnest, and LendKey.
  5. Choices in Payment Terms Available. When you refinance, you can choose from several different repayment plans. Typical loan terms allow for payments to be spread out over 5–20 years. The lowest interest rate is available for terms of five years or less, making them ideal if you want to prioritize paying off your loan quickly. A higher interest rate throughout the life of a loan with a longer term (say, 15 or 20 years) can result in lower payments per month.
  6. Limits on the Range of Interest Rates. Refinancing often results in a cheaper interest rate initially if the borrower opts for a variable interest rate rather than a fixed rate that lasts the entire loan term. Since your interest rate is pegged to an index like Libor or prime, it runs the risk of increasing over time. You may be able to refinance your student loans with a company that guarantees your interest rate won’t go up by more than a particular percentage (often between 8% and 10%) regardless of whether the Libor or prime rate goes up or down.
  7. Assistance in Hard Times of Unemployment. In the event of unemployment, you may temporarily suspend your refinancing payments with some companies. You may be able to put a hold on your payments for anything from six to eighteen months. If you’re looking for a job, certain refinancing firms will help you out with your resume and cover letter to speed up the process.
  8. Advantages to One’s Social Life and One’s Way of Life. Companies like CommonBond host annual conferences and social gatherings in a number of different places to facilitate networking and socialization among employees. Pencils of Promise is a global education initiative that has received funding and assistance from CommonBond.

Cons of Refinancing Student Loans

If you’re considering refinancing federal student loans, you should know that doing so comes with a few risks.

  1. We will no longer accept federally sponsored repayment plans. Options for paying back federal student loans range from the traditional 10-year plan to the Revised Pay As You Earn Plan (REPAYE Plan). Your monthly payment under the Income-Based Repayment Plan (IBR Plan) will never exceed 10 or 15 percent of your discretionary income, whichever is lower. As your priorities and budget shift, you can easily switch plans without having to go through a cumbersome refinancing procedure. The plans provide a safety net in case of financial difficulties, with payments as low as zero dollars per month. Inaccessibility to such programs occurs upon refinancing.
  2. The Interest is Accumulated. It’s good to know that certain refinancing plans allow you to put off payments while you look for work or recover from a layoff. Even so, interest will keep piling up during that period. A loan that goes unpaid over an extended period of time will increase in size due to the capitalization process.
  3. There will be absolutely no loan forgiveness. Based on your job and loan repayment history, the federal government may forgive your student loan payments after 10, 20, or 25 years. Loan balances under the IBR Plan and the Pay As You Earn (PAYE) Plan are forgiven after 20 or 25 years, respectively, and repayment is no longer required. Loan forgiveness is possible after 10 years of public service work. A company that specializes in refinancing student loans does not provide loan cancellation.
  4. Lending Quotas. Your ability to refinance may be severely limited by the size of your existing debt. Some financial institutions will only refinance loans in excess of $10,000. Others consolidate debt that is larger than $5,000. Unfortunately, borrowers with smaller loan amounts will not qualify for a preferential interest rate.
  5. High Initial Investment Caused by Changing Interest Rates. To cut costs on your loan, you might think that locking in a low variable rate today is the best option. Worse yet, what if rates continue to grow over the next few years and you end up with an APR of 8% or 9%? To avoid paying more than you have to when interest rates go up, consider a fixed-rate loan instead of one with a lower initial rate.
  6. There is no assurance of lower rates. When you refinance, your interest rate may be lower, but it is not required to be so. A wide variety of businesses provide rates anywhere from 2.2% to 8% or more. You may qualify for the greatest rate offered by the refinancing company if you are a high-earning attorney and meet their other requirements. However, borrowers with lower incomes, bigger debt loads, or payment history of missed or late payments may find that the offered rate is comparable to or even higher than their existing federal loan rate.

Alternatives to Take into Account

Student loan refinancing services work to reduce monthly payments. There are alternative possibilities, at least for federal loans, if you’re having trouble making payments and find the drawbacks of refinancing to be too great.

Plans for Repayment Driven by Federal Income

It’s a good idea to look into alternatives if you realize that you can’t afford your payments under the usual repayment plan.

Payments under an income-based scheme are capped at no more than 10% or 15% of your discretionary income the portion of your AGI above the poverty line. If your AGI is $40,000 and the federal poverty threshold is $25,000, your discretionary income is $15,000.

With income-based repayment arrangements, the debt is written off if it isn’t paid in full by the end of the 20 or 25-year period. 

Four income-based options are available through the federal student loan program:

  1. Repayment Program Linked to Earnings. If you borrowed money for school before July 1, 2014, the IBR Plan sets your monthly payment at 15% of your discretionary income, and you have to pay it back over a period of 25 years. You have up to 20 years to repay any debts you took out for the first time after July 1, 2014, and each payment is 10% of your discretionary income. Your monthly payment under the IBR Plan will never exceed the monthly payment amount required under the conventional, 10-year repayment plan, so you won’t need to worry about your payments skyrocketing if your income improves.
  2. Plans for Loan Repayment Based on Annual Income. With the Income Contingent Repayment Plan (ICR Plan), your monthly payment is equal to 20% of your discretionary income or the amount you’d pay on a fixed payment plan with a 12-year duration, whichever is greater. At the end of 25 years, the ICR Plan will forgive any remaining loan sum.
  3. The Pay-As-You-Earn System. You must have been a new borrower as of October 1, 2007, to qualify for the PAYE Plan. Your monthly payments will never exceed 10% of your discretionary income or be longer than the conventional 10-year payback schedule. The PAYE Plan has a repayment period of 20 years.
  4. Revised Gain-based or salary-based payment structure. While PAYE is restricted to borrowers who took out loans after 2007, the REPAYE Plan is available to everyone who has taken out a federal student loan. The REPAYE program caps payments at 10% of discretionary income. However, if your income significantly increases, under REPAYE you may wind up paying more than you would under a regular 10-year payback plan, in contrast to the IBR Plan and the PAYE Plan. Repayment of REPAYE loans for undergraduates is spread out over a period of 20 years, while repayment of REPAYE loans for graduates is spread out over a period of 25 years.

Program for Federal Consolidation

Consolidating your debts may be the best option if you have many federal loans with different interest rates. Consolidating federal loans does not constitute refinancing. 

Instead, it consolidates multiple government loans into one larger loan. Thankfully, consolidation options are available for almost all federal loan programs. Consolidating your debts may help you save money by lowering your interest rate. 

After consolidation, your interest rate will be equal to the average of all your loan rates, rounded up to the nearest eighth. Consolidating your federal debt may be beneficial if you have loans with significantly different interest rates. If all of your loans have comparable interest rates, this strategy may not be as beneficial.

In addition to saving money, loan consolidation allows you to stretch out your repayment period to as long as 30 years. Although the interest you pay on your student loans will be more in the long run, your monthly payment will be lower. 

Alternatively, you can opt for shorter terms, such as 10 years, if you do not wish to extend your repayment schedule. After loan consolidation, you have the option of selecting a repayment program that is based on what you can afford to pay each month.

Most federal loans that are either repayable or in a grace period are consolidatable, but borrowers who are currently in default cannot do so. If you’re behind on payments when you consolidate, you’ll need to either work something out with your current lender or enroll in a repayment program based on your income.

Forbearance or Deferral

The Federal Direct Loan Program is an alternative to refinancing student loans that offers protections in the event of unemployment or underemployment.

For as long as three years if you’ve been unemployed and are unable to find work, or for as long as six months if you’re going back to school at least half-time, you won’t have to start making payments on your student loans. 

Joining the Peace Corps or serving in the armed forces during a time of war, military action, or national emergency also allows you to delay repayment of your federal student loans.

Interest on subsidized loans is paid by the government while the borrower is under deferral, so that money will not be added to the principal during that time.

If you have an unsubsidized loan, interest will continue to accrue during the deferment period. All accrued interest on unsubsidized loans is applied to the loan’s principal sum if payments are missed.

Get in touch with your loan servicer straight away if you’re interested in a deferment. If you’re unemployed and delaying payments, you must either be actively seeking work by doing things like signing up with a staffing agency or provide evidence that you’re qualified for unemployment benefits. 

Contact the financial aid office at your school for assistance with the necessary papers if you need to delay payments because you returned to school.

Forbearance is a possibility for federal loans if you are currently employed but underemployed or have financial difficulties. During a period of forbearance, you are excused from making loan payments but still liable for any accrued interest. 

If you qualify for forbearance, your loan payments may be suspended or reduced for a period of up to 12 months. You need to get in touch with your loan service provider and be ready to offer proof that you are experiencing financial trouble or illness in order to qualify.

No matter what kind of payment plan you’re on, you may be eligible for a deferment or forbearance. Keep in mind that if you modify your repayment plan, you may not need a deferment or forbearance of your loans. 

A zero monthly payment on an IBR, ICR, or REPAYE Plan may be possible depending on your current income. Evaluate each potential course of action thoroughly before settling on a final choice.

Bottom Line

Some borrowers may be better off not refinancing their federal loans unless the interest rates are exceptionally high. Borrowers with substantial private loans at a high-interest rate are the best candidates for refinancing their student loans.

If you’ve borrowed more than $10,000 from a private lender at an interest rate above 7%, refinancing could save you a lot of money and headaches. What’s more, many refinancing companies offer additional benefits, such as unemployment support, that make them a better choice than many private student loan lenders.

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