When you face an important expense that is too high to pay out of pocket, you may decide to take out a loan.
Taking out a loan provides you with a sum of money that you need now to pay for your expenses. Your loan comes with monthly payments and an interest rate, which is the amount (expressed as a percentage) charged by your lender, for lending you the money.
While higher education may come with a substantial price tag, loans can be expensive as well. As the cost to attend college keeps rising, so does the need for students to find ways to cover that cost. In certain cases, it may benefit a borrower to take out a new loan after graduation in order to pay off the original one and obtain a lower rate, which is referred to as student loan refinancing.
It may seem counterintuitive to replace one loan with another, but refinancing has its benefits. If you have multiple loans, you can combine them into one brand new loan, making it more convenient to stay on top of your personal finances. Because you have one loan, you only have one interest rate and one monthly payment. When refinancing a loan, you also have an opportunity to potentially get a better interest rate, meaning that you can end up paying less over time or simply reduce your monthly payments to make them more affordable.
How Does Student Loan Refinancing Work?
When you take out a student loan, whether it’s federal or private, you agree to certain terms and conditions, such as your payment schedule and interest rate. You may not have much control over the terms that will apply to you when you first take out student loans for college, as interest rates for federal student loans are determined by the federal government and do not require a credit check. With private lenders, your terms will oftentimes be based on your credit score or that of a cosigner.
However, that doesn’t mean that you can never change the way you pay back your student loans. Student loan refinancing gives you an opportunity to find loan options with different terms or lower interest rates to get a better deal. This also provides you with the option to release your cosigner from the initial loan.
Student Loan Consolidation vs Student Loan Refinancing
While many people use the words “consolidation” and “refinancing” interchangeably, they have unique identifiers and are used in their own respective situations. Student loan consolidation is designed to make your loan payments easier by consolidating all of your student loans into one single loan, with one payment. Student loan consolidation mostly applies to borrowers with federal student loans. The government allows you to consolidate your multiple student loans into one while retaining all the benefits that your federal loans may offer, such as income-based repayment plans and student loan forgiveness.
It’s important to note that consolidation doesn’t typically save you money. By combining the loans, you’re still paying the same total amount and same total interest, but under one umbrella loan. The key benefit of consolidation is the convenience of keeping track of one loan.
Student loan refinancing involves taking out a brand new student loan and using that new loan to pay off your existing loans. The new loan payment and interest rate will commonly be heavily driven by your credit score, credit history, and income, as well as other factors. Therefore, having great credit could mean substantially lower payments, but it varies from lender to lender.
Refinancing must be done through a private student loan lender. If you have private student loans and/or federal student loans, you may be able to refinance them after graduation into a new private loan.
If you have federal student loans and rely on their income-based repayment plans or are planning on qualifying for student loan forgiveness, you may want to stick with your federal loans and consider consolidation. This is because you may lose these benefits if you refinance such loans. If you have multiple private student loans or even a single loan at a high interest rate, student loan refinancing is a great option. You can also look to student loan refinancing if you have a combination of both federal and private loans, and you want a single loan with options for lower payments and improved terms.
Unsure when the right time to consider refinancing your student loan is? Check out our blog post on student loan refinancing as well as our student refi guide and learn about some of the instances you may want to refinance your student loans along with its potential benefits.