The below is a guest post from Travis Hornsby, founder of Student Loan Planner. More about him at the end of this post.
Do you get anxious thinking about how you’ll pay off your student loan debt? I’ve met so many people going through the same battle.
We often point our clients toward student loan refinancing. Borrowers can save tons of money through refinancing. But is this money-saving strategy right for you?
The reality is that, although it does save many people thousands of dollars, it’s not always the best choice. Let’s take a look at some of the realities of student loan refinancing that most people miss.
The Reality of Student Loan Refinancing
I’ve had the privilege with Student Loan Planner to consult on $500+ million worth of student loan debt over the years. We’ve been able to save our clients tons of money through customized student loan repayment plans.
We’ve seen it all and I can tell you three things about refinancing your student loans:
- Refinancing is not the right choice for everyone
- It won’t help everyone with their student loan debt
- Refinancing could actually hurt some borrowers, financially
We earn commission when our clients refinance through our affiliate links, but I’d rather not earn that money if it means pushing people toward what could be a terrible financial decision.
Refinancing can be a great option for some borrowers, but it’s not the only option.
Refinancing Your Student Loans Won’t Get Rid of Your Student Loan Debt
Refinancing is one of the best strategies to cut your student loan debt down. Our experience is that refinancing your student loans is a fantastic way to save three, four, or low five-figures, but it won’t save you more than that.
If you have $250,000 in student loans, refinancing isn’t going to wipe out your debt. But depending on your credit, you could knock off a significant chunk of interest charges. However, you will still have to pay back most of your loan.
In general, refinancing student loans is a great idea for borrowers in the private sector who owe less than 1.5 times their salary.
If you owe more than that, options like loan forgiveness and income-driven repayment (IDR) plans start to make more sense. This depends on the type of loans you have, of course, but makes the most sense if a majority of your loan debt are federal loans.
You Lose Access to Valuable Federal Programs When Refinancing Your Student Loans
There are pros and cons to refinancing federal student loans. One of those cons is that you will lose access to several federal protections available to borrowers.
What protections would you lose?
- Public Service Loan Forgiveness (PSLF): Forgives your debt after 10 years, tax-free, after making payments based on income.
- IDR Loan Forgiveness: Income-driven loan forgiveness allows you to repay your loans for 20 to 25 years, based on income. At the end of that period, the government forgives the remaining balance, but you must pay income tax on the forgiven amount.
- Forbearance Protections: Forbearance allows you to pause loan payments for a year at a time, up to three years total. In contrast, most private lenders that offer unemployment protection will only let you pause payments for three months at a time.
- IBR, ICR, PAYE, REPAYE plans: These income-driven repayment options are no longer available when you refinance your student loans. These plans allow you to cap your payment amount at 10% to 15% of income (20% for Parent PLUS).
That’s a lot to give up, especially if there’s a chance you may need them in the future. If you’re thinking about loan forgiveness at all, you should hold off on refinancing your student loans.
Refinancing turns your federal loans into private loans, and then loan forgiveness isn’t an option.
Refinancing Student Loans is Only A Sound Strategy for Financially Fit Borrowers
People often look to refinancing as a way to save themselves from massive student loan debt. Refinancing is a great strategy to save money, but mostly if you are someone who is already in good financial shape. It’s not the best idea if you are struggling to make ends meet or have bad credit.
If you don’t have an emergency fund set up, you could be setting yourself up for financial failure.
What if you become unemployed or have a medical emergency and can’t make your payments? You no longer have the option to pause your payments until you can recover.
If you can’t make your payments, it’s possible that you’ll end up defaulting on your loan.
Refinancing only makes sense if you are in a good financial position and won’t need those federal protections. As a general rule, it’s a good idea to have an emergency fund with at least six months of expenses saved.
One of the major reasons that people refinance is to lower their interest rates and secure better terms.
In order to do that, though, you have to have good credit. A credit score over 700 is ideal for refinancing. If you don’t have good credit, you shouldn’t refinance your student loans.
Refinancing is Just the Beginning of Paying Off Your Student Loans
Many borrowers use refinancing as a way to get lower monthly payments. They do this by extending their term.
Here’s the thing with that, though: no one will force you to pay off your loans. Only you can do that. Just because you refinanced your loans doesn’t mean the work is done. In fact, the work has just begun.
Now that you’ve lowered your payments and improved your interest rate, now is the time to get to work paying off your loan. This is how you take advantage of student loan refinancing.
If you simply wanted lower payments, federal repayment plans would have been enough. Now is the time to attack your student loan debt, make extra payments, and get rid of your student loan debt sooner.
Next Steps
If you are on the fence about whether to refinance your loans, take time to weigh all your options. If you need help determining if it’s right for you, try using a student loan calculator to compare all your options.
Seek out help if you aren’t sure what to do. What you do about your student loan debt will be one of the biggest financial decisions you’ll make in your lifetime. Spend time determining your best financial option before making the decision to refinance your student loans.
About the Author:
Travis Hornsby founded Student Loan Planner after helping his physician wife navigate ridiculously complex student loan repayment decisions. To date, he’s consulted on over $400 million in student debt personally, more than anyone else in the country. He is a Chartered Financial Analyst and brings his background as a former bond trader trading billions of dollars.
He brings that same intensity to analyzing the best repayment paths for graduate degree professionals with six figures of student debt. He’s helped over 1,700 clients save over $80 million dollars on their student loans, and he’s been featured in U.S. News, Business Insider, Forbes, Huffington Post, Rolling Stone, ChooseFi, Bigger Pockets Money, and more.