With the price tag on higher education growing steeper every year, it’s become routine for most graduates to head into the real world not only with a degree, but also with about five figures of debt. In fact, the Wall Street Journal reported stats from student loan pro Mark Kantrowitz that show the average borrower from the class of 2016 left school with more than $37,000 in student loans — adding to the $1.3 trillion in total college debt the Federal Reserve reports that Americans now carry.
Typically, these balances are spread out across multiple loans that may carry varying conditions and interest rates. Some people may mistakenly believe that because they’ve signed those promissory notes, they are stuck with the loan terms they graduated with — but it is possible to refinance student loans in much the same way you can refinance a mortgage or car loan.
Refinancing can be a worthwhile strategy for borrowers hoping to ease the burden of repayment, because it could mean you’ll pay less over the life of your loan. That said, it may not be suitable for everyone’s situation, and there’s much to consider before you decide whether it’s the right option for you.
To help you understand the basics, we pulled together the quick primer below with five things you need to know about student loan refinancing.
1. Refinancing is not the same thing as consolidation.
Refinancing “means that you take out a new loan that pays off your other existing loans,” says Robert Farrington, founder of TheCollegeInvestor.com, a website that helps millennials manage their student loan debt. Your new interest rate and terms depend on what you qualify for with your lender. Reasons why you may choose to refinance include getting better loan terms and a lower interest rate than what you’re currently getting, Farrington adds.
It is possible to refinance multiple student loans, whether they are public or private, into one loan, but be careful not to confuse refinancing with consolidation. Typically, when people talk about consolidating their student loans, they are referring to the federal government’s direct consolidation loan program, which only applies to federal loans. This enables you to combine multiple federal loans into a single loan, so you can make a single monthly payment. Your new interest rate is based on the weighted average of the interest rates on all the federal loans you’re consolidating, and it is fixed for the life of the loan.
2. When you refinance federal student loans, you’re privatizing them.
Both federal and private loans can be refinanced, but if you choose to refinance your federal loans, then you’re opting to pay back a private lender as opposed to the government — and there’s no reversing back to federal-loan status. “[Student loan consolidation] is a free service and it only impacts federal loans,” Farrington says. “Refinancing, on the other hand, is done by private banks and companies.”
Refinancing could give you a lower interest rate on both private and federal loans, but refinancing a federal loan may mean giving up some federal loan benefits that you might qualify for, such as income-driven repayment options, loan forgiveness or deferment and forbearance programs. Not all private lenders offer these options.
3. Your credit score — among other factors — will help determine your interest rate.
The interest rate for federal student loans is based on whatever federal law mandated at the time you borrowed the money and remains fixed for the duration of the loan. Private lenders, however, will look at your credit score to determine what kind of interest rates to offer you and might even consider other factors like your college degree and how much income you’re currently earning, says Pamela Capalad, CFP®, a Brooklyn, New York-based financial planner.
And, as with other types of loans, if your credit score isn’t strong enough to nab a lower interest rate than what you’re currently paying, you may be asked or required to get a cosigner for the loan, Farrington says. Just remember that your cosigner is potentially putting his or her credit on the line for you, so it’s worth looking to see if your lender offers features like a cosigner release, which removes the cosigner from the loan after a predetermined period of time in which you’ve proven you can make your payments.
4. You may be offered fixed or variable interest rates.
As we mentioned, federal student loans are fixed, which means their interest rate won’t change for the life of the loan unless you decide to consolidate them. But if you decide to go the refinancing route, you may be offered either fixed or variable interest rates, which means your interest rate could change after a specified period of time, generally anywhere from a month to a year.
Typically, variable rates start low, but they have the potential to shoot up once the introductory period is over, which means you potentially put yourself at risk of paying a much higher rate down the line. On the flip side, if you qualify for a loan that offers a really low interest rate for an extended period of time, it could save you on total interest paid, particularly if you pay off the loan before the interest rate goes up.
Another thing to keep an eye out for when it comes to calculating the total cost of refinancing a student loan is the amount you may end up paying in origination fees, says Capalad. If you see these costs, it “basically means that the loan company is charging you a certain percentage of the amount you borrow to actually switch the loan over,” she says. “So that’s something to take into consideration as well.”
5. You may or may not be able to change the terms of a refinanced loan.
Because refinancing means you’re taking on a new loan with new terms, once you’ve chosen to refinance you’ll be responsible for keeping up with your new monthly payment. Some private lenders do allow flexibility when it comes to changing your terms down the line. But it is typically harder to get deferment or forbearance options for private loans than it would be for federal loans.
So it’s important to weigh various factors before deciding to refinance. These can include how much in interest you’ll end up paying over the life of your loan; whether you’re willing to shorten or lengthen your repayment period; how much your monthly payment amount could be; and how stable you expect your income to be (which can help you determine if you may need to rely on federal income-based repayment options in the future).
Ultimately, what you’re trying to balance are your short- and long-term goals. “What makes the most sense for my budget now? And what will make the most sense for my budget later?” says Capalad. “I think those are the questions you should ask yourself when you’re considering refinancing.”