If you’ve managed to get a refinance loan for your student loans, congratulations are in order. But before signing your new loan agreement, it’s worth considering whether refinancing student loans or consolidating with a direct federal consolidation loan is the best option for you.
After all, once you refinance with a private lender, you will no longer have federal student loans . And while you can refinance as often as you can get approved for a loan, once you convert your federal student loan loans into private student loans, there is no going back.
So before you make that move, compare the benefits and drawbacks of each private loan offer to what you could gain or lose by opting for federal student loan consolidation.
How to Compare Student Loan Consolidation and Refinance Offers
The main goal of choosing refinancing over consolidation is to save the most money. But you still need to carefully compare the two options to decide which one is right for you.
1. Compare interest rates
The purpose of refinancing is to lower your interest rate, which federal loan consolidation does not. But your federal consolidation loan could still have a lower rate, since federal student loan interest rates on direct loans have historically been low over the past decade, ranging from 3% to 5%.
That rate is hard to beat, even by the best student loan refinance companies . Plus, qualifying for the lowest rates is difficult without excellent credit.
If you don’t have a good credit score or your debt-to-income ratio is too high, applying with a co-signer can increase your chances of getting the best rates. But it’s risky as some lenders don’t have options for a co-debtor release or having co-debtors wait years before borrowers can remove them from the loan.
On the other hand, you don’t have to go through a credit check for a federal consolidation loan. Federal law determines federal student loan interest rates each year based on the performance of 10-year Treasury notes plus a fixed percentage. Whatever the interest rate for the year you borrowed, it is the rate you maintain for the life of the loan, even if you consolidate it.
Typically, student loan borrowers looking to refinance are those with federal loans with higher interest rates. Loans for graduate students versus college students have higher interest rates. For example, for the 2021-22 academic year, the interest rate for direct federal loans for college students is 3.73%. For graduate students, it is 5.28%.
The interest rate on PLUS loans is even higher. For both parent PLUS loans and graduate PLUS loans, the interest rate for the 2021-22 academic year is 6.28%.
If you opt for federal consolidation, your new direct federal consolidation loan will calculate your interest rate as the weighted average of the interest rates of all your previous loans to keep the interest roughly the same as what you paid before. So if you have any of these higher interest rate loans, consolidating could mean a higher interest rate than you would get from a refinance.
Fortunately, it is possible to compare before committing. You can use an online calculator to see how federal loan consolidation could affect your current student loans. But remember that your interest rate will remain roughly the same as the average for all of your current loans.
If you don’t already have refinance offers available to compare, use an online marketplace like Credible , which uses a flexible credit inquiry to compare you to pre-qualified offers. That way, you can see if you can do better with a private lender without hurting your credit score .
It is also essential to consider the impact of a variable interest rate versus a fixed interest rate.
You can generally start with a lower rate on a refinance loan if you opt for the variable interest rate. But variable rates fluctuate with market conditions, which means they could go up. So even if you started with a lower rate than you previously had, you could end up with a higher interest rate.
That is especially important now. According to CNBC , the Federal Reserve plans to raise interest rates in the coming years, so a variable rate loan could end up costing you more in the long run.
But all federal student loans, including federal consolidation loans, are fixed-rate loans. Then your interest rate will not change. The only exception is if your loan servicer (the company that manages your payments on behalf of ED) offers a 0.25% interest rate discount for making automatic payments, which is common among both federal loan servicers as among the best lenders. Therefore, your rate might decrease slightly, but it will never increase.
As such, you may not want to choose a variable rate refinance loan over a fixed rate federal consolidation loan if the difference in interest rates is low. But it could save you money by opting for a fixed-rate private loan over a fixed-rate federal loan if the private loan offers the lower rate.
2. Compare the lengths of the payment terms
Consolidation can lower your monthly payment, but it does so by extending the repayment term. Federal consolidation allows you to extend the payment up to 30 years by choosing one of the federal payment plans. You must select one during the application process. The shortest duration is 10 years with the standard payment plan.
But you can opt for a repayment term of up to five years with refinancing. Typical loan repayment terms for refinance loans are five, seven, 10, 15, and 20 years, although some lenders allow you to choose any annual term you want.
However, you probably shouldn’t consider refinancing student loans if you can’t pay off your loan in 10 years. The purpose of refinancing is to save you money. One way to do this is by getting a lower interest rate. Taking more than 10 years to pay off the loan extends the length of time you are paying interest, which means you could end up paying as much or more on a longer loan with a lower interest rate than on a shorter loan with a higher interest rate. high.
In fact, one of the best ways to save money on your student loans is to pay them off as soon as possible. Regardless of the interest rate, the longer it takes to pay off your loan, the more you’ll pay in total.
For example, if you pay off a loan of $ 10,000 at an interest rate of 5% over five years, you will pay $ 1,323 in interest. But if it takes 10 years, it will cost you $ 2,728 in interest.
Refinancing can be an ideal way to help you pay off your student loans quickly because it can lower the total cost of your loan, but only if you opt for a shorter repayment term.
If your student loan payments are too high on a standard 10-year repayment plan and you’re considering refinancing because you need lower monthly payments , you’d better stick with federal loan consolidation, even if that means a fee of higher interest.
That’s because your main financial concern is not saving money. You are moving from one paycheck to another .
Federal consolidation preserves your access to federal payment options, such as income-based payment , which allows you to make income-based payments. Payments are set at a percentage (usually 10%) of your annual discretionary income, which is generally calculated as the difference between your adjusted gross income and 150% of the poverty level in your state for a family of your size.
It also ensures that qualify for federal student loan forgiveness for students , such as the Program loan forgiveness for public service . When you consolidate your student loans, you can select an income-based plan. After making 20-25 years of qualifying payments, depending on the plan, any remaining loan balance becomes eligible for forgiveness. With public service forgiveness, the government can forgive your loan balance in as little as 10 years if you work full-time in a public service job.
3. Consider the benefits of refinancing
Once you’ve compared the most important ways to save money with a refinance loan versus a consolidation loan, take a look at the special discounts or benefits offered by the specific lenders you are considering.
Most private lenders offer discounts for automatic payment. But so do most federal loan servicers. The best refinance lenders go the extra mile and offer benefits that ED doesn’t offer. For example, Citizens Bank and Laurel Road offer additional fee reduction discounts for opening linked checking or savings accounts.
Earnest allows you to customize your payments to fit your budget or payment goals. You can choose biweekly or monthly payments, increase the size of your payments, make additional payments, or adjust payment dates at any time.
PenFed allows you and your spouse to refinance your student loans into a single loan, which is not possible with a federal consolidation loan. Depending on your situation and whether you can get a lower interest rate than your two previous loans combined, that can be an effective way to tackle debt together.
SoFi offers free financial planning and professional advice to its borrowers. And Education Loan Finance , often referred to as ELFI, connects borrowers with a personal loan counselor, who they can call, text, or email with questions during the application process and the life of their loan.
CommonBond stands out among those passionate about social causes. Its loans help finance the education of children in developing countries.
Also, some private lenders offer special benefits for certain types of borrowers. For example, Splash Financial and Laurel Road offer medical residents the ability to make monthly loan payments of $ 100 per month at a fixed rate during their residencies, which is potentially lower than what you would pay in an IDR plan.
4. Consider the benefits of federal loan consolidation
While refinancing with a private lender can save you money and have special benefits, you also lose a lot when you refinance.
Private lenders rarely offer payment options based on income, and none offer anything like DE plans. Also, although you are asked to choose a payment plan during the application process, the ED allows you to change it at any time if your circumstances change. Private lenders are often not that flexible.
Additionally, the ED has generous deferral and forbearance terms. You can defer your loans indefinitely as long as you are enrolled in college at least half time. And you can put it off due to financial difficulties for three years. But if you can’t repay your loans for a longer period, enrolling in an income-based plan could qualify you for a payment as low as $ 0, especially if you’re unemployed. And that $ 0 payment even counts toward your forgiveness watch.
You can also waive the loans for up to three additional years, although you won’t make any progress toward forgiveness with that option.
But most private refinance lenders only offer a total deferral or tolerance period of 12 to 36 months. And 36 months is rare. If you are considering refinancing your undergraduate student loans before graduate school , private lenders are unlikely to give you enough time to finish before you have to start making your refinance loan payments.
Also, deferral and forbearance with private lenders tend to be added, which means that if they give you 12 months of deferment or forbearance, using four months of deferment means you only have eight months left for deferment or forbearance. So if you use all of that while earning your graduate degree , you won’t be left with any financial hardship deferral if you have trouble finding a job.
But with the ED, no postponement you take will affect your tolerance or vice versa.
Finally, numerous protections for borrowers come with federal student loans. They protect you in cases of extenuating circumstances that make repaying the loan an undue burden. These include:
- Your school closed while you were enrolled
- Your institution educational not reimbursed the loan administrator after you dropped out.
- Your school falsely certified your eligibility for a loan
- Your school misled you or engaged in other misconduct
- You are totally and permanently disabled
- You die
- You declare bankruptcy
Many private student loans do not come with these types of protections, which means that even if you are totally and permanently disabled and unable to work, you are still responsible for repaying the loan. Similarly, many private loans cannot be canceled upon death, which means they become a credit against your estate if you die .
However, some private loans offer at least some protections to the borrower. Therefore, read your loan agreement in its entirety before signing it.
Most student loan experts agree that refinancing federal student loans is generally not a good idea because you lose access to all federal repayment programs, generous deferral and tolerance terms, and the protection of borrowers. Even if you think you won’t need them, no one can predict the future.
Also, now it is a bad time to refinance federal student loans because the government has suspended payments and interest until 31 January 2022 due to the pandemic COVID-19 course .
If you refinance your loans now, you must start paying interest and making payments. The only exception is if you find your best deal with SoFi , who has promised 0% interest until December 20, 2021 and suspension of payments until February 2022.
However, if you have private student loans, there is nothing wrong with refinancing, especially if you can secure a better rate than your current loans.
Although the interest rate is the main factor in saving money, it is not the only thing that matters. When comparing private student loan offers, look for flexible repayment options, borrower protections, deferral and tolerance terms, and special discounts and benefits.