The Student Loan Situation Is Still Up in the Air – Here’s How to Decide if You Should Refinance : Inside UK

Refinancing student loans can save you money under the right circumstances. It could be helpful to score a lower interest rate, to change from a variable interest rate to a fixed rate, to consolidate your loans to a single monthly payment, or to release a co-signer.

At the same time, you could lose protections and benefits from your original student loan. Before you refinance, make sure you understand your choices, including any trade-offs.

In 2021, student loan refinance interest rates were among the lowest they’ve ever been. But actions by the Federal Reserve throughout 2022 to combat inflation have pushed refinance rates higher, minimizing or even erasing potential savings entirely.

Learn more about the student loan refinance environment so you can make the best decision.

In 2022, the Federal Reserve hiked its federal funds rate seven times in an attempt to fight 40-year-high inflation rates, and more increases are likely in 2023. That rate influences short-term interest rates on consumer loans and, as a result, student loan refinance rates have nearly doubled since their record lows in 2021, according to online marketplace Credible.

“There are several good reasons people may have for refinancing their federal student loans, but in each case it is important for the outcome to result in a new loan with lower interest rates,” says Bruce McClary, senior vice president of communications for the National Foundation for Credit Counseling and former U.S. News contributor. “At the moment, interest rate increases have made it more challenging for borrowers to achieve that objective.”

Many federal student loan borrowers have held off on refinancing due to the moratorium on payments, interest and collections for most federal loans, provided for by the Coronavirus Aid, Relief and Economic Security Act. In August 2022 The Biden administration also announced plans to forgive up to $20,000 in federal loans.

Shortly after the plan was announced, it became tied up in legal battles. At the end of February 2023, the U.S. Supreme Court will consider at least two of the challenges. The federal student loan payment pause was set to expire at the end of 2022 but is now continuing until 60 days after the forgiveness program is implemented or the lawsuits are resolved, or 60 days after June 30, 2023, if they are not.

With higher interest rates, uncertainty over debt cancellation and still no monthly payments to make, it may be wise for most federal borrowers to sit tight in 2023.

“If the Biden administration does forgive student loans, the borrower might refinance with a private lender and give up the chance to have this amount of debt wiped off their balance sheet,” says Jamie Hopkins, managing partner of wealth solutions at Carson Wealth.

“If you are struggling to repay your federal student loans and refinancing isn’t an option, consider applying for one of the affordable repayment programs available through the Department of Education,” says McClary.

Unlike federal student loan borrowers, private loan borrowers have not enjoyed a break on monthly payments in recent years, and they also don’t qualify for the Biden administration’s forgiveness program.

While rising refinance rates may be an obstacle for some, borrowers who have even higher rates on their current loans could still enjoy some savings with a new lender. And if you’re waiting for rates to go down again to maximize savings, keep in mind that there’s no limit to how often you can refinance your student loans, and lenders typically don’t charge fees.

First, know that federal student loans cannot be refinanced through the U.S. government, only consolidated. You cannot swap your federal student loan for another federal loan with a lower interest rate or change your private student loan into a federal loan. In fact, consolidating federal student loans through the Department of Education will result in a slightly higher interest rate.

In contrast, private student loan refinancing allows you to refinance a private or federal student loan – or both together – into a new private loan. But refinancing may not make sense for many federal student loan borrowers.

In doing so, you’ll lose eligibility for government assistance programs. This includes, notably, the ability to enroll in an income-driven repayment plan. All plans reduce your payment to a fraction of your discretionary income and forgive any remaining loan balance if you haven’t fully repaid your federal loans at the end of the repayment period.

Likewise, teachers and certain public service employees working toward loan forgiveness under one of the programs offered by the government would no longer qualify for that benefit if they refinanced.

Finally, while many private lenders offer the ability to temporarily reduce or stop payments and avoid default through deferment or forbearance, terms may not be as generous compared with federal student loans.

Is refinancing your student loans the right choice for you now? Seriously consider it if:

Your credit score is strong enough to qualify for a lower interest rate than your current one. You may qualify for student loan refinancing with a FICO score of about 650, but a higher score can get you a better rate and possibly more cash flow. “If refinancing an existing loan allows the borrower to have more access to money for their current lifestyle, future retirement or pay down more expensive debt, it’s worth considering,” says Hopkins.

Your private student loan has a variable interest rate, and you want to refinance to a fixed-rate loan. With a variable-rate loan, at some point you could see your interest rate go up as market rates change. If that happens, a new fixed-rate loan might be cheaper. The same goes if you have a private loan with a high interest rate.

“Borrowers who have older private student loans with high balances and higher interest rates may find an opportunity for savings with a drop in the rate,” says McClary.

You want to reduce the number of monthly payments you make. If you have multiple private student loans, you might want to refinance them into a single loan so you can make one monthly payment. If you want to reduce the number of federal loan payments but not change to private, the process is called a loan consolidation, not a refinance. Your new federal direct consolidation loan would have a weighted average interest rate, or an interest rate that is the weighted average of your current loans, rounded up to the nearest one-eighth of 1%.

You want to release a co-signer. If you can refinance a private student loan in your name alone, you could free a co-signer from liability for your debt. However, some lenders offer a co-signer release only after a number of consecutive on-time payments, up to four years. You’ll also need to meet certain credit criteria after you’ve made the required number of payments.

You’re willing to give up federal benefits. If your financial situation is in good shape and the benefits of refinancing outweigh the costs of ditching your federal loans, it might be the best path forward for you.

If you can secure a lower interest rate on a refinance loan, it could ultimately save you hundreds or even thousands of dollars.

As an example, let’s say you have $30,000 in student loan debt with a 10-year repayment plan and an average interest rate of 6%. Your monthly payment would be $333, and you’d end up paying $9,967 in total interest over the life of your loans.

Now, let’s say you were to refinance the loans into a new one right out of college with a 4% interest rate and the same repayment plan. Your new monthly payment would be $304, which doesn’t sound like a big difference. But over 10 years, that reduced payment would save you $3,519 in interest.

When the benefits of refinancing are unclear, don’t do it. There is no hard and fast rule about how much you need to save to make a refinance worthwhile, but it should be worth the hassle and any potential costs.

If you are struggling to make payments or need a lower monthly payment, staying in a federal program with many payment and emergency options is a better choice than refinancing.

Roughly 45% of the federal Direct Loans were being repaid on an income-driven repayment plan in 2017, according to the Congressional Budget Office’s 2020 report. If you’re one of those people or you’re working toward loan forgiveness, refinancing may not make sense.

If you’re a parent who took out one or more federal or private loans to pay for your child to go to school, you might also be wondering if it’s worth it to tap your home equity through a home equity loan or cash-out refinance mortgage loan to refinance your loans that way. However, these loans typically have high upfront costs, and they use your home as collateral. If you default, you could lose your home, which is a significant risk. Plus, under the Biden administration plan, parents who took out federal loans to help their children pay for college are also eligible for up to $20,000 in loan forgiveness.

The decision to refinance is not one to be taken lightly. “Once you commit to refinance, you can’t turn back after the loan is finalized,” says McClary. “It’s important to clearly understand the pros and cons before making a decision that cannot be reversed.”

But if you’ve weighed the advantages and disadvantages of refinancing and decided to proceed, you can prepare now to take advantage of a lower interest rate when it becomes available. Here are some steps you can take: