What to know when the time comes to refinance your student loans
You’ve found four roommates for your two-bedroom apartment in the cheapest part of town, pillaged the grocery store shelves of their special items, and rode your bike everywhere. Yet, after all of this, you are still struggling to make your minimum student loan payments. You are only able to cut costs so much before your bottom line drops out, creating a situation where you’re literally scraping for money. It’s a situation that is becoming increasingly common, as more and more college graduates find themselves unable to carry the financial burden of four years of college while entering the toughest job market in years.
What if you were able to lower your interest rate or extend your payment period? This is something that refinancing student loans can give you. However, there are many factors to take into consideration before signing on the dotted line to refinance student loans.
What’s involved in refinancing student loans? A refinance is, simply put, a loan that pays off another loan, either through a consolidated student loan, a personal loan, or a mortgage. Refinancing student loans allows you the option to either take advantage of a better interest rate, to reduce the monthly payment or to switch from a variable interest rate to a fixed interest rate – all depending on when, and with whom, you are refinancing student loans. You can also refinance student loans that have higher interest and a higher balance (which most borrowers do when refinancing student loans), whereas a consolidation combines all of your loans into a single, monolithic beast.
Before you refinance student loans, review your credit report. Since your credit score is how lenders evaluate the risk they will take by providing the funds for your loan, it will be used to ascertain your interest rate. The better the report, the lower the interest and the more money you will save. Go through it repeatedly, check for potentially harmful mistakes and get them corrected.
After your credit report is up-to-date, start researching various lenders and what they offer for refinancing student loans.
“Read all of the fine print,” recommends Dan Kadlec of Bank of Dad, a finance blog geared towards the college age population as well as parents. “What happens to your monthly cost? What is your new balance? What is your new interest rate?”
For some, refinancing student loans is a way to quickly reduce monthly payments that are simply too much for them to afford, and they will opt for an extended repayment period. While this might be a stop gap for the short-term, the consequences will bare themselves over the years.
“Just like any loan, you want to look at the amount of interest you are going to pay over the life of the loan,” says Kadlec. “It’s not that you’re going to be able to do much about that, but it’s really a lot and it should encourage you to pay the loan sooner rather than later.”
One of the major ways to save money when refinancing student loans is to navigate the various interest rates that are offered by different lenders. A good refinancing package will offer a fixed-interest rate which, as a rule, is reduced by about two points. The new interest rate, whether it’s fixed or variable, and the new repayment period will allow you to calculate whether refinancing student loans will be advantageous for you.
For example, if you are a graduate with $30,000 in debt at an 8 percent interest rate (the average for private loans is 12 percent and 6 percent for federal loans) with a repayment period of 10 years, over the life of the loan you will pay a grand total of $43,678.11 at $363.98 per month. At an interest rate of 8 percent, you might want to consider refinancing student loans.
If, however, you are refinancing student loans at an interest rate of 5 percent over a 15-year repayment period, then you will be paying a total of $42,702.69 at $237.24 a month. Not only will your monthly payments be slightly more manageable, but you will be paying less in the long run – and that’s with an extra five years tacked on to the repayment period. Calculating your yearly salary, monthly payments, and total amount paid, decide whether it is financially beneficial for you to be refinancing student loans.
Refinancing student loans can be a research-intensive process, but not knowing your options can inflict major long-term financial damage. Do you want a 20-year repayment period? Your monthly payment will be lower but do you want to be sending off checks for your student loans when your children are asking you for college money, or when that money could be put away for retirement?
Student loans are not dischargeable in bankruptcy. You will be stuck with this loan no matter what, so educate yourself about refinancing student loans so that you are aware of your options. After all, this is a relationship that will last decades.
“You have to be aware that when you take out a loan, you’ll never be able to shed this debt. You are taking on a liability and the only way to get rid of it is to pay it off.,” says Kadlec. “I’ve interviewed people now in their 50s who filed for bankruptcy but they’re still paying off their college debt.”