Is There A Downside To Student Loan Refinancing?
Updated On October 29, 2021
Editorial Note: This content is based solely on the author's opinions and is not provided, approved, endorsed or reviewed by any financial institution or partner.
Many borrowers choose student loan refinancing to lower the interest rate on their student loans, save money, and pay off student loans faster. There are many reasons why you should refinance student loans.
However, student loan refinancing may not be the best choice for every borrower. Based on your individual circumstances, it’s important to understand the upside and downside to student loan refinancing.
Top Picks For Student Loan Refinancing
Before you refinance your student loans, understand whether of any these situations may apply to you. If so, you may want to remain on your current student loan repayment plan. If they don’t apply, then you may be a good candidate for student loan refinancing.
- You don’t have stable and recurring income.
- You have a low credit score and don’t have a qualified cosigner.
- You’re working toward public service loan forgiveness.
- You plan to use federal student loan benefits such as income-driven repayment.
- You want to change your repayment plan in the future.
1.You Don’t Have Stable and Recurring Income
When you refinance student loans, you can get a lower interest rate, lower monthly payment, or both. Your new lender will pay off your old student loans and issue you a new student loan with better terms. With student loan refinancing, you also can say goodbye to your old student loan servicer and get a new student loan servicer instead.
Lenders approve borrowers who can pay back their student loans and who won’t default. Therefore, lenders prefer borrowers with stable and recurring monthly income so that lenders can lower their risk. This enables lenders to ensure that borrowers have sufficient monthly income to pay off their student loans. Some private lenders allow you to pause loan payments if you lose employment or face financial hardship.
If you are unemployed, underemployed or don’t get paid regularly, you may want to wait to refinance your student loans.
2. You Have a Low Credit Score and Don’t Have a Qualified Cosigner
In addition to income, lenders will evaluate your creditworthiness to ensure that you have a demonstrated history of financial responsibility. Most lenders require a minimum credit score of at least 650. If you have a higher credit score, this may increase your chance of approval. If you have a lower credit score, you can apply with a qualified co-signer. A qualified co-signer is another person such as a parent, spouse or close relative who has good income and credit and is willing to become equally financially responsible for your new student loan. A qualified cosigner can help you get approved for student loan refinancing and even receive a lower interest rate.
3. You’re Working Toward Student Loan Forgiveness
If you have federal student loans, the federal government offers several types of student loan forgiveness programs. Examples include the Public Service Loan Forgiveness program and Teacher Loan Forgiveness. These two programs offer forgiveness of your federal student loans after you meet certain requirements.
If you refinance your federal student loans, you will no longer be eligible for these federal student loan forgiveness programs. The reason is that student loan refinancing results in you receiving a new private student loan, and these programs are for federal student loans only.
If you are working toward student loan forgiveness, you may decide not to refinance federal student loans. The good news is that you can still refinance your private student loans since private student loans are not eligible for federal student loan forgiveness.
4. You Plan to Use Federal Student Loan Benefits Such as Income-Driven Repayment
Student loan refinancing is only available through private lenders. If you refinance your federal student loans, you will no longer have federal student loans outstanding. Your new student loan will be a private student loan. As a result, you will not have access to certain federal benefits such as income-driven repayment plans.
If you’re struggling to pay your student loans, income-driven repayment plans can lower your monthly payment. There are four income-driven repayment plans:
- Income-Based Repayment (IBR)
- Pay As You Earn (PAYE)
- Revised Pay As You Earn (REPAYE)
- Income-Contingent Repayment (ICR)
Income-driven repayment plans such as IBR, PAYE and REPAYE cap your monthly payments to 10% – 15% of your discretionary income. After 20 to 25 years, you can receive student loan forgiveness on your remaining student loan balance. However, you are liable for income tax on the amount forgiven.
Private lenders don’t offer income-driven repayment. However, many lenders allow you to pause payments during periods of economic hardship or unemployment. Before you decide to refinance your federal student loans, make sure you won’t need an income-driven repayment plan.
5. You Want to Change Your Repayment Plan in the Future
The standard student loan repayment term is 10 years. When you refinance your student loans, you have more flexibility to choose your student loan repayment term. Most lenders offer repayment terms from 5 to 20 years. A shorter repayment term such as 5 years means higher monthly payments, but you will save interest and pay off your student loans faster. A longer repayment term will lower your monthly payment, but you’ll have higher total payments. Once you choose your repayment term, your student loan payment term cannot be changed until you refinance your student loans again. Before you refinance your student loans, make sure you choose the right repayment term.
Determine if Student Loan Refinancing Is Right for You
Your personal and financial circumstances are unique. That’s why it is important to understand all your options so you can make a fully-informed decision. Student loan refinancing is best for those with good credit, steady and recurring income, and a low debt-to-income ratio. You also must be employed or have a written job offer.
Why refinance your student loans? Student loan refinancing can reduce your interest rate, monthly payment, or both. Refinancing is best for those not pursuing income-driven repayment or federal student loan forgiveness programs. If you’re struggling to make student loan payments, you may want to wait to refinance student loans.
If student loan refinancing is right for you, you’ll also get additional benefits. For example, when you refinance student loans, you can choose a fixed or variable rate, access multiple student loan repayment options, and change your student loan servicer.