Student loan refinance has been a very hot topic over the last year. It makes sense. Student loans are an enormous problem in the United States, and many borrowers are looking for solutions to help improve their cash flow. Moreover, our current low interest rate environment has enabled student loan refinance lenders to offer mouth wateringly low interest rate options.
If you aren’t familiar with the topic of student loan refinance. Student loan refinance is the process of refinancing old student loans with a new private student loan lender. Both federal and private student loans are eligible for student loan refinance. In most cases, there are usually no origination or pre-payment fees either. Over the last couple years the number of student loan refinance lenders has soared. At LendEDU, we work with a number of lenders who offer rates as low as 1.92%.
But with all the media hype surrounding the positives of student loan refinance, the negatives are sometimes lost along the way. At LendEDU we work to add transparency to the student loan markets. I want to address two big risks associated with student loan refinance.
1) You will lose certain federal student loan benefits.
If you have a student loans, you probably have a federal student loans. According to the Consumer Financial Protection Bureau, federal student loans account for about $1 trillion out of the $1.2 trillion in outstanding student loan debt. It is unanimously recommended that you should use federal student loans over private student loans. Federal student loans usually have lower interest rates and come with many great benefits.
If you elect to refinance your federal student loans you will lose a number of important federal student loan benefits. Why? Well when you refinance a federal student loan it is no longer guaranteed or held by the federal government.
Federal student loans are eligible for Income-driven repayment. Income-driven repayment plans are designed to make your student loan debt more manageable by reducing your monthly payment amount. In short, you can choose to make your monthly payment a factor of your monthly income. If you refinance your federal student loan you will no longer be eligible for income-driven repayment.
Federal student loans are eligible for Public Service Loan Forgiveness Program. Borrowers working in certain public professions (ex. teachers) are eligible for loan forgiveness. According to the Department of Education, qualifying employment is any employment with a federal, state, or local government agency, entity, or organization or a not-for-profit organization that has been designated as tax-exempt by the Internal Revenue Service (IRS) under Section 501(c)(3) of the Internal Revenue Code (IRC). If you refinance your federal student loan you will no longer be eligible for Public Service Loan Forgiveness.
Lastly, federal student loans are eligible for loan discharge benefits in the case of death or permanent disability. If you refinance your federal student loan you will no longer be eligible for loan discharge benefits. Many student loan refinance lenders offer this benefit, but not all.
All of these benefits are designed to protect borrowers in case of financial turbulence. Refinancing could be risky if you run into a tough or unlucky situation.
2) You might be find yourself exposed to interest rate risk.
Low interest rates have started to feel like the new normal. The vast majority of student loan borrowers currently have fixed rate student loans. Federal student loans such as Stafford loans, Perkins loans, and PLUS loans all have fixed rates. Fixed rates are also extremely popular with private student loan borrowers. Fixed interest rates, as you might expect, do not adjust with changing market interest rates.
As I mentioned above, a number of popular student loan refinance lenders offer rates as low as 1.92%. These sub-two percent rates are all variable rates. Locking into a variable rate at this period of time might be risky business. Sure, a variable rate might offer significant short term savings, but eventually interest rates will rise again. Variable student loans usually adjust on a monthly or quarterly basis alongside LIBOR. Meaning, if you refinance to a variable rate, know that the rate you pay could rise higher than the original fixed rate loan over time. Don’t be so quick to let that fixed rate go, especially if the rate savings aren’t substantial.
Student loan refinance can be an awesome tool for creditworthy borrowers. But before you consider refinancing your old student loans, you needed to understand the risks. If you have a secure job, good income, great credit, and student loan forgiveness doesn’t sound like and option, student loan refinance is a great path. At LendEDU we put together a guide to help you navigate all the student loan refinancing options. Check it out!
Nate Matherson is the Co-Founder and CEO of LendEDU. LendEDU is a marketplace for student loans and student loan refinance.