A Quick Guide to Whether You Should Refinance Your Student Loans

College graduates with a history of earnings and good credit may be able to save a significant amount of money by refinancing their student loans at lower interest rates, but less than half of Millennials are taking advantage of refinancing, consolidation, or other options to get a better deal.

Granted, refinancing is not for everyone. It’s best suited to people with good credit that are currently paying a high-interest rate on their student debts. Beyond that, there are also some potential drawbacks borrowers should take into consideration before they move to refinance. But it’s worth your consideration. Here we lay out the pros and cons of refinancing student loans so you can make the best decision for you.

When Refinancing Can Be Right for You

If you’ve been making your regular monthly student loan payments, but it’s still going to take many years to pay them off, your interest rates might be to blame. This is especially true if you took out your loans between 2006 and 2013, when interest rates on unsubsidized loans were higher than they are currently.

Refinancing could help you lower the rates on your loans, so more of your money can go toward paying off your principal balance. Refinancing is the process by which a borrower pays off their student loan debt by taking out a new loan with a private lender. This process can also combine all the loans you refinance into one payment.

Refinancing doesn’t guarantee lower monthly payments, but, depending on the repayment plan you choose, you could pay off your debt faster and save money.

The Drawbacks to Refinancing

Unlike federal student loans, which guarantee every borrower a fixed, low interest rate, private student loans come with fixed or variable rates and require credit checks — so, if you don’t have good credit, you could end up with a higher rate.

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You also generally have fewer borrower protections if you refinance your federal student loans into private loans. For instance, private student lenders are not required to offer forbearance or deferment options. Those that do may charge a fee for the option. (You can learn more about private student loans here.)

Assessing All Your Options

If you have government loans, you’re probably aware that federal loans offer certain borrower benefits. A debt consolidation loan from the U.S. Department of Education, for instance, allows you to consolidate multiple federal student loans into a single loan so you’ll have one payment each month. A Direct Consolidation Loan also may lower your monthly payments by giving you as long as 30 years to repay.

Income-driven repayment (IDR) plans can also help you lower your monthly payments by limiting your monthly payments to a percentage of your disposable income, and by extending your loan term by up to 25 years. Under an IDR plan, your monthly payment will be capped at 10, 15 or 20% of your income, depending on the plan.

The Drawbacks to Direct Consolidation & IDR Plans

For those borrowers looking to lower the amount devoted to student loan payments each month, these plans can be the way to go. But, here, too, there are some trade-offs to keep in mind.

Consolidation loans, for instance, won’t lower you interest rate. In fact, while that lower monthly payment can provide some much-needed relief, by increasing your loan repayment period, you’ll have more payments to make and, therefore, pay more interest. (Note: There are no prepayment penalties with a Direct Consolidation Loan, so you can pay ahead.)

Here are a few things to note if you’re thinking about an IDR plan.

IDR plans help you lower your monthly payments by stretching out your repayment term. Again, while this means you pay less each month, stretching out your loan term may mean you’ll end up paying more in interest overall.
If, for whatever reason, you need to leave an IDR plan halfway through (or you’re no longer eligible because your income exceeds the income cap), you’ll still be responsible for paying back some or all of the unpaid interest that’s piled up (this is called “interest capitalization”).
Under an IDR plan, you could qualify for loan forgiveness after 20 or 25 years of qualified repayments. However, if you do, remember the amount that’s forgiven is considered taxable income, and you’ll have to pay interest on it. If you work for the government or a nonprofit, and qualify for Public Service Loan Forgiveness after 10 years, that amount will not be taxed.

Student Loan Refinancing 101

If you do decide to explore refinancing, it’s important to comparison shop. You’ll want to find out what interest rate range is being offered, whether there are any origination fees and if forbearance of deferment is an option when vetting lenders, among other things. You’ll also want to check your credit so you have an idea of what offers you may qualify for. (You can do so by viewing two of your credit scores, updated every 14 days, for free on Credit.com.) If your credit is in rough shape, you may want to take steps to improve it before applying.

Not everyone will qualify to refinance their student loans — it helps to have good credit and a low debt-to-income ratio. But while refinancing isn’t for everybody, everybody should at least consider it.

Image: Petar Chernaev