Which Refinancing Strategy is Right for You?

In recent years, the demand for student loan refinancing options continues to rise.
Student loans are designed to be readily accessible to young borrowers who may not have any credit history or income. As a result, they tend to carry higher interest rates than other types of debt. However, after graduating and finding employment, many borrowers are able to improve their credit and possibly qualify for better rates. This means that you may be able to obtain better terms on these loans while repaying them.

The choices are abundant when it comes to refinancing student loans. You could try to decrease your interest rate, extend your term, and lower your monthly payment.

Learn about the most common strategies for student loan refinancing and what you should consider when choosing your path.

What Are Your Goals?

Personal finance is just that—personal—which means there’s not usually a one-size-fits-all solution when it comes to tackling one’s student loans. Before you begin, spend some time thinking about your goals and how your repayment options should reflect them. Below are just a few examples of how your goals and plans can impact your loan repayment path.

Before you refinance, remember that federal loans have some benefits that can be lost if refinanced through a private lender. For example, if you plan to obtain a higher-paying job in the future but aren’t earning much now, you might benefit from a graduated loan repayment plan or an income-based repayment plan. A graduated plan begins with a small payment that increases over time, allowing you to pay off more principal as your income increases. An income-based repayment plan uses your adjusted gross income or another income measure to calculate a payment you should be able to reasonably afford.

If your student loans are preventing you from buying a house or purchasing a car, you may want to try to lower your monthly payments. If you can already easily afford your payment, refinancing to increase your monthly payment may be a good idea. This will reduce the term of the loan and interest accrual, accelerate your payoff, and quickly eliminate this monthly obligation.
Keeping these scenarios in mind, let’s review some of the most popular refinancing options available.

Option #1: Refinance to a Longer Term

Student loan repayment terms can vary in length. Shorter repayment terms may appeal to borrowers who want to pay their loans off quickly and begin saving for a financial milestone like a house or a car (or their own child’s education).

However, refinancing to a loan with a longer term can be a palatable option for many borrowers, as well.

Benefits of Extending the Loan Term

Extending your current loan term from 10 years to 15 or 20 can dramatically reduce your monthly payment. This could provide you with some extra budget breathing room and the opportunity to save more.
This lower payment can also give you flexibility; while it might be tough to continue making your original payment during periods of unemployment, reducing this payment can make it far easier to handle under any circumstances. Meanwhile, you can choose to make extra payments to pay down your loan balance.

Drawbacks to Extending the Loan Term

Depending on the rates and terms of your original student loan, extending the loan term could increase your interest rate. Additionally, a longer loan term will generally increase the total interest you’ll pay over the life of the loan.
There are also people who went back to college later in life or who took out Parent PLUS loans to help fund a child’s education. For them, especially, it’s a good idea to consider the loan payoff date and where they hope to be financially at that point. Some prefer to pay off their student loans before their kids go to college (or, for parent loan holders, before they retire); others may not mind the monthly payment as long as they know they’ll have adequate income to cover it.

Option #2: Refinance to a Shorter Term

In some cases, it may make sense to refinance to a shorter loan term to pay the loans off sooner.

Benefits of Reducing the Loan Term

One of the main benefits of a shorter loan term is a potentially much lower interest rate. In some cases, shortening your loan term could mean that your payment won’t increase by much, if at all. In addition to enjoying a lower interest rate, paying your loan off sooner will reduce the total amount of interest that accrues over the term of the loan.

Drawbacks to Reducing the Loan Term

Not all shorter loan terms come with similar-sized payments; in some cases, shortening the term may place your monthly loan obligation at an uncomfortable percentage of your net income. This can leave you vulnerable if you don’t have much of an emergency fund.

Option #3: Refinance to a Lower Interest Rate

A third option doesn’t involve a change in the loan term at all—only the interest rate. Over the last couple of decades, federal student loan interest rates on undergraduate loans have ranged from a low of 3.37 percent in 2004 and 2005 to a high of 8.25 percent from 1995 to 1998. Meanwhile, those who took out PLUS loans for graduate school between 2006 and 2010 paid a top rate of 8.5 percent.

Benefits of Reducing the Interest Rate

While interest rates have risen in recent years, they’re still well below the rates many students paid ten years ago. Refinancing to reduce the interest rate can lower one’s payment and the total interest paid; this might enable you to pay off the loan sooner or just free up some extra spending money.

Drawbacks to Reducing the Interest Rate

On the face of it, there aren’t many potential drawbacks to lowering your interest rate. However, it’s always important to investigate your specific loan terms before refinancing. This will help ensure that you’re not waiving any options you might like to use in the future.
For example, if you work in a public service job and are interested in taking advantage of the Public Service Loan Forgiveness (PSLF) program in the future, refinancing your federal loans to a lower interest rate may exempt them from PSLF eligibility, essentially restarting the payment clock.

Other Factors to Consider

Yet another wrinkle in the decision to refinance one’s student loans involves consolidation. It’s not uncommon to have half a dozen or more student loans in active repayment mode. This may especially apply if you have both federal and private student loans or attended college during different time periods.

Consolidating these loans as part of the refinancing process can streamline your monthly payment obligations.
However, consolidation isn’t necessarily a no-brainer. As discussed above, each loan product has its own benefits. Therefore, consolidating low-interest or low-balance loans into other loans at a higher interest rate may not always make sense. Review your loan terms carefully before choosing to consolidate. Once you consolidate your loans, this process generally can’t be undone.