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.
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?