Pros and Cons to Refinancing Student Loans

According to a recent survey of 1,001 students with student loans, 38% said they were unfamiliar with refinancing student loans. Given the opportunities out there that can help us build wealth, that is shockingly high.

Not surprisingly, for those who did choose to refinance (about 30%), it appears a lower interest rate was the highest motivating factor next to having a lower monthly payment.

Then again, many student borrowers are looking at loan repayments with low interest thanks to federally subsidized loans. If that’s the case, then refinancing means losing many federal benefits, and that might not be worth the benefit of reducing an interest rate by 0.1%.

As a couple who holds 117k in student loan debt, both federally subsidized and private, we’ve been researching our options heavily over the last few years.

That’s not to say we know everything there is to know about refinancing student loans, because, as we found out, the process can be confusing.

The majority of my knowledge comes from speaking to friends who have gone through the process. I ask them how easy it was to refinance, if they would do it again, what would they do differently, etc. Luckily, millennials appear to be much more open about discussing these types of personal finance issues, so I have gathered some feedback.

So why haven’t we refinanced such a large amount of debt yet?

The short answer is that we’ve elected to take a different approach. We’ve focused on tax efficient investing before tackling our tax efficient debt.

We’ve placed maximizing our wealth as a higher priority than reducing our debt.

If you’re curious how the math works out, check out this classic article explaining our approach.

Now that we’re becoming more established in our careers, we are continuing to live a frugal lifestyle, maxing out our 401K’s, and are still left with a bit of extra cash when all is said and done. That being the case, our motivation to move forward on refinancing student loans has recently increased.

Why recently? Because this opportunity was not available a few years ago due to both of us having entry level positions and significantly lower annual income.

Lately, I’ve been using a site called LendEDU to review my options. If you Google, “student loan refinancing,” you’ll see it is the 3rd or 4th hit.

In the past, I used to visit individual lending company sites after hearing about them through friends or family. The process was tedious since I was required to fill out separate applications for each site before seeing what rates were available.

I like LendEDU because I only had to fill out the application once and view multiple offers at the same time without doing a hard check on my credit score.

Find out what your refinancing rates are by taking this 3 minute questionaire.

I worked hard recently to restore my credit score, so I prefer to keep it as high as possible when entering a refinancing negotiation.

So, now that I see what options are available to me, I’m going to step back and weigh the pros and cons to student loan refinancing.

Pros to Refinancing Student Loan Debt

Lower interest rate. This one is easily the stronger pro to refinancing. If the amount of interest you pay each year goes down, then you are paying less for your student loans. This means more cash back into your pocket to be used on useful supplies such as groceries and rent.

Changing the Payment Terms. This is another common reason to refinance student loans.

In some cases, the term of the loan may be extended from 10 years to 20 years, allowing a longer runway to get out of debt. The downside is you’ll be facing a stronger headwind because you’ll be paying more interest over the full life of the loan. The upside is your monthly payments will become much more manageable and you can always increase your payments as you develop your finances.

In other cases, you might shorten the term of the loan from 10 years to 5 years. When coupled with the first pro of lowering your interest rate, you can effectively cut the amount of interest paid by more than half.

Release a Cosigner. If you’re like me, and wish to be financially independent, then you want to stand on your own two feet more than anything. This might mean releasing a cosigner so that you are the sole party responsible for the loan. It is a scary thought, but it might motivate you to stick with your budget, or create one.

Change Providers. If you don’t like the company that handles your current student loans, you can switch. We have had a comfortable time with our providers, but I thought I’d mention this as a pro for anyone who doesn’t like theirs.

Cons to Refinancing Student Loans

Losing Your Federal Benefits. I won’t go into detail here (as this post is already becoming lengthy), but there are many benefits associated with having student loans. These include the ability to renegotiate the payment schedule and even quality for loan forgiveness over time.

Lower interest rate. Wait, how is this a pro and a con? I’m so glad you asked — paying student loan interest is subject to certain tax breaks. The interest paid on student loans can reduce your modified adjusted gross income (MAGI) on your tax return by up to $2,500. (Source)

In my case, my MAGI is starting to approach the phase out limit where this silver lining will no longer be available to me.

There is one last thing to consider when refinancing student loans…

The Difference Between Fixed Rate and Variable Rate Interest Rates

The traditional option is to opt for a fixed rate, which is a set interest rate throughout the life of the loan. Variable rates might appear lower at first, but can adjust higher over time. For an excellent summary reviewing the pros and cons to variable rate loans, check out this post by another great personal finance blogger, Sam from Financial Samurai.

Our Final Decision

Based on the pros and cons, I’ve been weighing my decision to refinance against my opportunity cost. If you’re unfamiliar with opportunity cost, it’s the number one factor Warren Buffett uses when making any financial decision. Simply put, opportunity cost is what you are giving up by making the decision.

In our case, we are deciding whether to accelerate the rate at which we pay down our student loan debt, OR funnel that same cash into a downpayment on our first home. The full details on what we settle on doing can be hashed out another day.

For now, I trust you’ll say you’re no longer in the 38% of those who are not familiar with refinancing.

If you’re still lost on whether refinancing will benefit you, check out the same online resource I’m using to compare quotes without impacting your credit score.

Have you refinanced any debt in the past few years? Have you refinanced student loans or a mortgage? Which provider did you use? Would you do it again?

Master Distiller

16 comments… add one
  • Thias @It Pays Dividends Jul 22, 2016, 6:16 am

    Fantastic summary of the refinancing options! We had most of our loans paid off by the time I first started seeing companies aggressively get into this space. Looking back, I would have tried to refinance to a lower rate.

    • Distilled Dollar Jul 22, 2016, 5:01 pm

      I’m jealous! Although, I’ll forever be grateful for the lessons I learned from having all this student loan debt.

      It is amazing to see how many companies are now in the refinancing. I heard Amazon just announced they’re looking to move into it. I guess that shows how ridiculous the default rates are and how much opportunity there is to refinance to a lower rate.

  • The Green Swan Jul 22, 2016, 6:49 am

    Pretty surprising stat of how many are unaware of the option to refinance, but it does sound a bit complicated. My wife and I were fortunate to come out with no student debt, but it’s good to know there are better and better options out there for folks.

    Regarding rate type, I’d be more apt to go for a variable rate option. The Fed had been so cautious in raising rates and the economy hasn’t been going gang busters so I’d expect rates you stay low for a while. I’m not an economist, that’s just my feel.

    • Distilled Dollar Jul 22, 2016, 5:02 pm

      I’m in agreement on the variable rate option. I’m sure I’ll write up another post soon once we refinance to discuss my decision process there.

      Nice job on coming out with no debt!

  • Apathy Ends Jul 22, 2016, 7:10 am

    Refinanced last year – variable rate (about 44 k worth).

    Interest rate dropped significantly- so it made the decision for me. Also consolidated 2 payments down to 1.

    I was ok dropping the tax savings, $1000 a month is to much of a liability and that money can start being invested as soon as they are gone

    • Distilled Dollar Jul 22, 2016, 5:04 pm

      I like that approach with the variable rate. Do you mind me asking who you refinanced with? It looks like refinancing is like car insurance where different places might give you a different rate, depending on the individual…so not everyone gets the best rate from the same company.

  • [email protected] Jul 22, 2016, 8:30 am

    It doesn’t surprise me that people aren’t aware of refinancing options. It takes a lot of work to do what you have done – and even more work to actually do all of the applications and associate math related to opportunity costs. This will be a very helpful resource for many! We would love to refinance a property we own – but it is very difficult without “real” jobs! Many of you read Financial Samurai – and if Sam has trouble refinancing, many of us without earned income will too. Interesting discussion here as always!

    • Distilled Dollar Jul 22, 2016, 5:09 pm

      Refinancing would sound like a struggle especially in your case, without the standard full-time “earned income”.

      I’m sure I’ll have a follow up post soon on what we ended up going through to refinance our loans. Stay tuned! 🙂

  • Pamela Jul 22, 2016, 4:41 pm

    These are all good points. Federally issued Canadian student loans work the same way. You lose the interest expense you can claim on your taxes each year if you refinance and the banks buy the loans. I think that is the minor loss because like you mentioned in your post, with effective tax planning, the loss is minimal and if you are investing the money that is not going towards the debt, then you will win out in the long run.
    The real loss is that in Canada, if your bank pays off your federally issued student loans then it become a private loan that no longer qualifies for ‘repayment assistance’ which occurs when your income is too low to make the payments, the government will either make the interest payments for you, or freeze your loan for 6 months where you don’t have to pay anything until your income goes up. With the private banks, you pay up whether you have the money or not.
    In Canada, repayment assistance is the #1 reason I am against refinancing student loans, but I think the States works a bit differently

    • Distilled Dollar Jul 22, 2016, 5:13 pm

      What you explained appears to parallel the US system. From my understanding, once you refinance from federal to private, you lose out on the same type of loan assistance programs. This is definitely the largest risk I can think of when refinancing, so it is critical to weigh it against all the potential scenarios. Sometimes saving a few dollars each month on interest is not worth removing a safety net.

      In our case, I’m confident in our ability to maintain our current level of income. I’m factoring in any raises and bonuses as additional savings or money that could be used to assist with paying down the debt quicker. All that said, I would still want to have our cash buffer extended a few months just in case we find ourselves looking for jobs overnight.

  • FinanceSuperhero Jul 23, 2016, 11:00 am

    I’m glad you chose to write about this topic, Matt, as I find more and more that many young people have just given up when it comes to researching their options on their student loans.

    As you know, I no longer carry student loan debt, but if I did, I would definitely look into refinancing options in order to lower interest rates. For anyone who is planning to carry student loan debt in favor or maximizing retirement contributions, this seems like the most sensible approach, IMHO. Certainly, there are many options available for refinancing today. So-Fi and Purefy are two good companies which come to mind.

    I’m definitely looking forward to reading about your experience and final decision. It sounds like that story has the potential to be a very popular post.

    • Distilled Dollar Jul 25, 2016, 6:09 am

      I’m glad you liked it Dave. Funny enough, this post doesn’t appear to have received the initial readership numbers I was expecting, but I have been blown away by the number of individuals commenting on my site or by sending me emails. It seems like one of those topics that hits close to home for a few people. For others, it doesn’t apply as much. Either way, I’ll be sure to share my experience as I go through the process and I’m curious to see the response.

  • Angela Madera Jul 29, 2016, 9:26 am

    I do feel more knowledgeable about refinancing student loans, however I remain cynical through the process. On my end, I have avoided refinancing student loans, instead taking the automatic debit benefit which reduces my interest rate to 6.55%. Now, I just make massive monthly payments to kill the loan because I feel like this is an all or nothing game. Refinancing to me unfortunately still means calling up providers who are supposed to provide a service and help me, but I don’t think they are there to help me. These contracts are filled with jargon that is difficult to understand. If you ask a question to the person on the phone and they tell you the wrong answer, you are still responsible for what is in the contract that you sign. All in all, the process feels out of control and manipulating. If you refinance your student loans, I imagine you are looking to lower the interest rate, which subsequently will increase the life of the loan. My question to that is, are there penalties for additional payments to the student loan?

    Great post,

    • Distilled Dollar Jul 29, 2016, 9:50 am

      Hi Angela – I can see the concern, especially since refinancing often means eliminating the federal benefits available.

      If you make additional payments, my only concern is in case you are unable to make future payments. For example, if you make an extra payment of 10k on a 20k loan, your monthly payment will stay exactly the same. If you’re unable to make the next months payment, then it won’t matter if you paid that extra 10k as you will be delinquit on payments.

      My approach in that scenario would be to keep the 10k saved as an emergency fund. Once you are able to eliminate the monthly cash flow altogether, and pay off the entire balance, then I think it makes a lot more sense to elinibate the debt.

      Again, this is coming from knowing a little about your situation so I wouldn’t suggest anything without knowing a few more details, such as the reliability and source of your income, the amount of free cash flow you have each month and the balance on the loan.

      I saw you mentioned changing the interest rate would increase the life of the loan. This isn’t always the case. In my case, I’m looking at lowering my rate from ~5% to 3-4% while decreasing the term of my loan. I’ll be able to pay off the loan quicker AND pay less in interest.

      I hope that answers your question. You can always email me if you have follow up questions or respond back here in the comments.

  • Mr. PTM Aug 14, 2016, 12:22 am

    Hi Matt. Awesome post. I refinanced my student loans 6 months after graduating (when the grace period ended) and it was so worth it. I went from GradPLUS loans at 7.9% fixed at a 10-year term to 2.79% variable (at the time) at a 15-year term. The rate is attached to the 3-month LIBOR and resets quarterly. Although a 15-year term would imply more interest, I still plan on having this paid off in less than 10 and it’s a huge relief knowing how much smaller of a required monthly payment I have if I lost my job or encountered some other type of financial emergency.

    The biggest benefit to a variable rate loan is that it reamoritizes every quarter (in my case), which means that all the extra principal payments I’ve made will lower my required monthly payment (barring a major uptick in the interest rate).

    • Distilled Dollar Aug 15, 2016, 5:57 am

      Awesome! I might be in the same boat very soon – although I’m considering a ten or five year term. Like you, I plan on paying these loans off in an accelerated fashion either way.

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