Restructuring Education Debt

August 8, 2015

With interest rates down for several years, many homeowners have refinanced their home mortgages. Why keep paying, say, 6% on your old home loan when you can save money by replacing it with a new loan charging less than 4%?

Does that same reasoning apply to student loans? Can you take advantage of today’s low interest rates by trading in existing education debt bearing higher rates? It’s possible, but you should proceed with care.

Choosing consolidation

Federal education loans can’t be refinanced. The government offers Direct Consolidation Loans, but that’s not really an opportunity to refinance. Instead, you can combine all federal education loans into one outstanding loan. There’s no fee for consolidating but there’s also no saving on interest because your new rate will be a mix of all the existing rates.

Example: Ellen Benson has $10,000 of outstanding student debt with a 5.6% interest rate and $10,000 of outstanding debt with a 6.8% rate. When Ellen consolidates into one $20,000 outstanding loan, those rates will be combined to 6.2%. (Technically 6.25%, because consolidated federal loans are rounded up to the nearest one-eighth of 1%.)

Although federal loan consolidation won’t save on interest rates, it can simplify your life. Going forward, borrowers will have only one monthly bill to remember to pay, rather than multiple existing loans with different payment amounts and different deadlines. In addition, consolidating federal student loans allows you to extend repayment to as long as 30 years.

Various repayment options are offered. A longer repayment period will reduce your monthly obligation, if cash flow is an issue. Extending the loan term may not be a drawback because you always can prepay a federal student loan, in part or in full, with no fee. However, there may be some drawbacks to federal loan consolidation, including the loss of borrower benefits such as possible loan cancellation.

Going private

Although federal student loans can’t be refinanced via the federal government, many private lenders offer the opportunity to do so. In essence, you borrow enough money to pay off your existing federal loans—as mentioned, federal loans can be prepaid without penalty. Then you are left with one private loan to pay down. (Refinancing might cover private student loans as well.)

You typically must pass a credit check to refinance with a private lender. The higher the interest rates on your existing education loans and the higher your credit score, the more it may make sense for you to refinance with a private lender.

If you’re deemed creditworthy, you probably can save money by lowering the amount of interest you pay. That’s especially true if you hold existing PLUS loans, which have relatively high interest rates.

Nevertheless, refinancing with a private lender is not always a good idea. Interest rates usually are variable, so you’ll pay more if rates move higher. What’s more, private loans can come with fees, reducing the financial advantage of the lower posted rate. As is usually the case when you get a loan, you should read the fine print carefully. Our office can help you determine the true cost of a private loan.

You may lose some valuable federal loan benefits if you move to a private lender; you can’t change your mind afterwards and revive a paid-off federal student loan. Therefore, you should crunch all the numbers and weigh all the consequences before refinancing federal education debt.