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Should I refinance my student loan?

Last week, we published a report on student loan affordability, which discussed the low levels of activity in the student loan refinance market. Since that time, we’ve received a lot of questions from consumers about what to consider if they find a refinance option. We’ve uploaded these questions to Ask CFPB. Take a look.

Should I refinance my private student loan into one with a lower rate?
Private student loans generally feature variable interest rates based on a borrower’s credit history. When borrowers first take out private student loans, many have a limited credit profile and are treated as higher credit risks by lenders. This means that, for many borrowers, private student loan interest rates can be quite high.

Some borrowers who have graduated, obtained a job, and have excellent credit may be able to qualify to refinance their existing private student loans with a new private loan at a lower rate.

Unfortunately for many borrowers in this situation, there aren’t very many financial institutions that offer this financial product, but if you are able to find one, here are some things to consider:

  • Look closely at the APR. The monthly payment on your new loan might be lower, but the interest rate could be higher. This can occur because the loan term might be spread out over more years. Active-duty servicemembers should remember that they might also lose rate benefits on pre-service obligations if they refinance.
  • Consider the tax consequences. Your new refinanced loan may not be considered a student loan for the purposes of the student loan interest tax deduction. If you regularly claim this deduction, be sure to consider whether the new loan will allow you to continue to do so.

Should I refinance my federal student loan into a private student loan with a lower rate?
It depends. While today’s interest rate environment is at historical lows, federal student loan interest rates set by Congress have not gone down on the most common type of loan, the Unsubsidized Stafford Loan. Some borrowers in repayment with excellent credit may be able to qualify to refinance their existing federal student loans with a new loan at a lower rate. Borrowers considering this option should also be aware of the risks:

  • Look closely if you’re switching from a fixed to a variable rate loan. Interest rates for most outstanding federal loans have fixed rates, which means that you never have to worry about your monthly payment going up when interest rates rise in the future. If you switch to a variable rate loan, know that your interest rate could rise higher than the original fixed rate loan over time.
  • You’ll probably sign away certain benefits if you refinance. Federal student loans feature a number of options for borrowers that run into trouble, including Income-Based Repayment (IBR). Borrowers working in certain professions—like those employed in public service or asteachers may be eligible for loan forgiveness for certain federal loans. If you refinance a federal loan with a new private student loan, you will no longer be eligible to participate in these federal loan forgiveness programs. There are also loan discharge benefits in the case of death or permanent disability on certain federal student loans. Active-duty servicemembers might also lose benefits on pre-service obligations if they refinance.

If you are considering refinancing your federal student loans with a new private student loan, be sure you understand what you’re giving up before making this choice. In general, honest lenders will warn you about the benefits you are giving up when refinancing out of a federal student loan. If you have a secure job, emergency savings, strong credit, and are unlikely to benefit from forgiveness options, it may be a choice worth considering if you’re looking to lower your payments.

Refinancing your student loan could help you take advantage of your improved credit profile, as well as today’s historically low interest rates. It can be a useful way to lower your monthly payments and build your savings, but be sure to consider the risks and benefits before signing on the dotted line.

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