Should You Refinance Your Federal Student Loans?

Sarah Reese
Mar 17, 2021

For millions of graduates across the US, college has left them with a substantial debt burden. According to the Federal Reserve, 42.9 million people owe money in student loans, with the debt exceeding a colossal $1.5 trillion in total (see portfolio summary.)


With so much debt hanging over their collective heads, student loan borrowers make an attractive market for refinancing companies, who promise to deliver a lower interest rate, lower monthly repayments, and a smoother path through financial life.


But there's just one problem with this picture. According to figures from academic data firm MeasureOne, around 92% of the loans still outstanding were taken out under the Federal Student Loan scheme. And federal student loans have some unique features and protections which can make the decision to refinance more complicated.


For private loan borrowers, refinancing can make perfect sense so long as the new terms improve their finances. 

But in the current pandemic, losing federal protections could be a major risk given the widespread financial uncertainty many people are going through. 

By refinancing a federal loan, borrowers will likely forgo the option of reduced repayments if their loans become unaffordable in the future, along with the current government-mandated payment pauses at 0% interest and the halt on default collections. 

Even if federal loan refinancing may be a good option in more normal times, right now it pays to be extra cautious. 

You may not be in a position to refinance your student loans just yet, but understanding the protections of your federal student loans can help you make educated decisions regardless of the financial climate. 


What's special about federal student loans? 

The terms of federal student loans can't be changed after the loan is arranged, and for many borrowers this can cause problems.


Details such as the interest rate are set in the year the loan is disbursed, and they're fixed for the life of the loan. And while federal loans can be consolidated to provide a single repayment, the underlying rate will remain the same.


Keep reading: Student loan interest rates for 2021 and how they work

If you want to refinance to a lower rate, you need to transfer the debt to a private lender, and this means losing out on some valuable protections and features attached to the federal loan scheme.

Some of the most important of these benefits include:

  • Federal loans offer various forms of income-based repayment (IBR), where the amount you repay each month can vary according to your financial circumstances. For example, with the Repaye option, your monthly bills are capped at a maximum of 10% of your disposable income. Such a level of flexibility is very rare in private refinance lenders.
  • Federal loan repayments can in some circumstances be paused through deferment, where interest is also paused, or through forbearance, where interest continues to build up. This might be done in times of exceptional personal financial difficulty, or in wider crises like the COVID-19 pandemic where federal student loans across the board were temporarily paused.
  • Any debt remaining after 20-25 years of repayments is eligible for student loan debt forgiveness under the federal loan scheme.
  • Loan forgiveness may also be available to workers in some key areas, including teachers, non-profit workers, and those in public service.
  • A federal student loan can be discharged upon your death or permanent disablement, leaving nothing to pay. This is a particularly important point for those with co-signed loans, as it relieves the responsibility of the co-signer if the worst happens to you.
  • If you default on your student loan in the future but then resume repayments, the default notice can be wiped from your credit file. This process is known as default rehabilitation, and it will reduce the damage to your credit rating considerably.


It's important to note that all these benefits are set down in federal law, and aren't just details in a private contract. As such, they offer extremely strong protections that shouldn't be discarded without considering all the potential consequences. And once you refinance into the private sphere, there's no way to regain the federal benefits you've lost.


How much can refinancing a federal loan save?

Before deciding whether refinancing is worth sacrificing the federal benefits, it's helpful to know how much it could potentially save you.


For specific savings based on your financial situation, use our refinancing calculator, but here's an example set of figures so you can understand how it works. 


If your existing loan debt is for $100,000, and is repayable over ten years at a rate of 8%, your monthly repayments will be $1,213 and the total amount of interest charged will be around $45,600. Refinancing the loan with a private lender could see the rate reduced to 5%, which over the same ten years would reduce the total interest to a little over $27,200.


This interest saving of around $18,400 over ten years works out to roughly $150 less on each monthly payment you make.


However, it's important to note that other expenses may be involved. Most private lenders charge an application or arrangement fee, while if you're refinancing existing private loans as well as federal ones, there may be early repayment penalties too.


As with any financial decision, make sure you see a detailed and final set of figures before signing up to a deal.


When shouldn't you refinance federal loans?

No matter how attractive the potential savings may seem, there are several circumstances which should make you think twice before refinancing your federal student loans, and so losing their benefits.


  • If you think your job may be at risk over the next few months or years, or if you may be planning on a career change with an uncertain financial outcome.
  • If you'd have major trouble making your existing debt repayments if your financial circumstances worsened even slightly.
  • If you think you may one day take advantage of federal loan forgiveness programs, such as those available to teachers, non-profit workers, and public servants.
  • If there's a chance you may not have cleared your loans after 20-25 years of repayments, when you may be able to have the debt forgiven.


The importance of debt-to-income ratio for student loans

Lastly, you should work out your debt-to-income ratio before considering refinancing. This ratio is the size of your monthly debt repayments as a proportion of your gross monthly income. Your student loans count towards debt-to-income ratio just like any other debt.


If your repayments take up more than half of your income, you have a ratio of over 50%, and this has a strong negative impact on the interest rate you may be offered for refinancing.


You'll likely find it very difficult to get a low enough rate to make it worth giving up the benefits of a federal loan if you try to refinance with a high debt to income ratio.


When you SHOULD consider refinancing a federal student loan

However, the benefits refinancing can bring to your monthly budget means it's well worth considering so long as a few important conditions are met.


  1. If you're confident in your current financial situation, and can be reasonably certain that it'll not change drastically over the next few years.
  2. If you have a good credit rating, with a FICO score in the high 600s range or better.
  3. If your debt-to-income ratio is lower than 50%, preferably by a healthy margin.


Also, refinancing can be attractive for other reasons, including:


  • If you want to lengthen the repayment term to lower your monthly payments, although this will be at the expense of more interest charged over the life of the loan.
  • Alternatively, if you want to reduce the payment term to clear the debt more quickly, and also pay less interest overall.
  • If you're unhappy with your current loan servicer for any reason, and would like to switch. This alone isn't enough to justify refinancing (switching can also be done through a federal Direct Consolidation Loan), but it's an extra potential benefit to consider.
  • If you’re thinking of refinancing graduate student loans, for example a Grad PLUS loans, these typically have less competitive rates than undergraduate loans. In this scenario, refinancing  Grad PLUS loans may be a more attractive option.


How to refinance effectively for the best results

If you decide that the financial benefits of refinancing your federal loans outweigh the loss of the protections, to get the best results it's important to go about the process in the right way. Here's what to do in five simple steps.


1. Research potential lenders

There are many companies offering student loan refinancing, but not all offer the same services.


For example, if you have a loan with a cosigner , then not all private lenders will consider taking you on. Or, if you have student debt but didn't complete your degree, your options may be more limited.


Start by putting together a list of all the potential lenders you can find who offer the right features for your own situation.

Keep reading: How to compare student loan lenders


2. Get several quotes

Once you've compiled your list of lenders, get a rate estimate from each. You may be able to do this in bulk through a comparison service, or you may need to visit each lender's website individually.


When getting a quote, it's important to check whether it's a firm offer or a pre-qualification. A firm offer will need you to give your in-depth personal details. It will also leave a credit check entry on your file, which can temporarily lower your score by a few points.


A pre-qualification quote requires less personal detail and leaves no credit file trace, but doesn't guarantee you'll receive the rate that's offered.


3. Choose the specific loan terms

Once you've found the lender offering the best rate, decide on the rest of the loan terms you prefer. Do you want a fixed rate which gives certainty over how much you'll repay each month, or a variable rate which may be lower at first but could rise later on?


Would you prefer a longer repayment term for lower monthly repayments, or a shorter one to clear the debt more quickly with less overall interest? Think carefully about these options, as they'll affect your finances for several years to come.


4. Complete the application

To receive an iron-clad offer, you'll need to complete a full application supplying documents such as proof of employment, proof of graduation, and so on.


To avoid delays, ensure you submit everything required.


5. Finalize the loan

Once your application is approved, sign and return the loan documents, and wait for the loan payoff to be completed.


It's important to continue with your current repayments until you receive confirmation that the application is completed and that your old loan has been settled. You can then switch your payments to your new provider.


Refinancing federal student loans: Key takeaways

If you have one or more federal student loans you can likely reduce your monthly repayments by refinancing them with a private lender. But in the process, you'll permanently lose some valuable protections.


If you're confident you won't need these protections, and also that the amount you'll save by refinancing makes the risks worthwhile, then refinancing could reduce the burden of your college debt by a welcome amount.

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