Refinancing can allow a borrower to replace an existing loan with one that has a longer repayment term and lower interest rate. This can make consumer debts like mortgages and auto loans cheaper over time—especially for those with good credit.
Many borrowers would love to have this option for federal student loans, and consumer groups and some lawmakers are interested in giving it to them. However, you cannot refinance a federal loan at a lower interest rate into a new federal loan at this time.
On the other hand, more and more lenders are offering borrowers the option to refinance a federal loan into a private loan. This may be a good deal for you, but before choosing this option, make sure you know what you're giving up.
Refinancing Federal Loans
It's easy to see why refinancing sounds like a good deal. If you can get a lower interest rate on your current federal loans, why wouldn't you do this?
Limiting interest costs is a great way to pay off your student loans faster. You could really save if your debt is mostly PLUS loans, which have slightly higher interest rates, or if you use that extra money to increase your loan payments. But refinancing federal loans into a private loan can be risky.
That's because doing so erases all the protections and benefits that come with federal loans. Few private lenders offer repayment, postponement, and forgiveness options as generous as federal loans, if any. Do you make enough money that you won't need an income-driven repayment plan at any point in the life of your loans? Are you not going to qualify for student loan forgiveness? Are you confident that your job and your health aren't at any risk? And do you have at least a year's worth of expenses saved in an emergency fund?
These questions could help you determine what to do. If you answer "yes" to all of them, are recently out of school, and have a steady income and stellar credit, refinancing may make sense for you.
If you go this route, remember to read the fine print. Advertised interest rates may be lower than what you actually qualify for. And in many cases, the lowest interest rate offers are for shorter term loans, i.e., 5 years as opposed to 10, 15, or 20 years. Be sure that you can afford the monthly payments on a shorter loan period, and shop around for the best option.
Consolidation Vs. Refinancing
Once you refinance your federal loans into a new private loan, you cannot move them back into a federal loan. You cannot reclaim the benefits of federal loans either.
If you're worried about losing these protections but want the convenience of a single monthly payment, consider a federal Consolidation loan instead. Consolidating in the federal program allows you to combine any/all of your federal student loans while retaining all of your federal benefits.
Some borrowers confuse consolidation and refinancing or use the terms interchangeably. This is understandable. After all, both replace your old loans with a new one with new terms. But there's a big difference between the two: Unlike refinancing, consolidating won't lower your interest rate in the federal student loan program—even if it appears that way.
Interest rates on federal Consolidation loans are the weighted average of the rates of the loans consolidated, rounded up to the nearest 1/8th of a percent. So, even if the rate is lower than it was for some of your loans, this all balances out. Consolidation will likely increase your loan's repayment period, potentially costing you more.
Making Your Choice
Consolidation has pros and cons, as does refinancing federal loans or private loans. No matter which option you choose—refinance all your loans, refinance your private loans only, consolidate your federal loans—be sure you know what you're getting into before you sign up. Once the loans are consolidated or refinanced by anyone, there's no going back.