You can use the questionnaire below as a starting point. You may already know the answers to some of these but, if you are unsure, do not be afraid to ask. You can’t have control over your loans if you don’t understand them!
Questions to ask your lender:
•What repayment plan am I on? Are there other repayment plans available to me?
•What is my interest rate? Is it fixed or variable?
•Is it possible to switch to a fixed interest rate? What is the process?
•Does my loan offer any sort of forbearance or deferment? If so, what are the details?
•If I lose my job or income and can’t make payments, what happens? Note: this should be explained in the answer to the previous question, but phrasing the question in explicit terms can be helpful if your lender’s answer isn’t clear.
•Is there a prepayment penalty if I pay off my loans early?
Getting the basic information around your private student loans is a key first step. You may be happy about what you find out, or your repayment terms and options may leave a lot to be desired.
Find out what the terms of your private loans are, as well as whether there are alternative payment plans.
The good news is that there is little risk in refinancing private student loans. We’ll go over that next.
Refinancing Student Loans
If you have student loans, you likely have been inundated with offers (I have) from private companies that want you to refinance your student loans. They promise lower interest rates and potentially thousands of dollars in savings.
When you’re in debt and someone offers to save you thousands of dollars, you listen.
Let’s use Rebekah as an example. Below are some of the details of her situation:
Loan Balance: $40,000
Type of Loans: Federal
Interest Rate (weighted average): 8.0 percent
Given these details, on a standard ten-year repayment plan, she will pay $485 a month. If she stays with this plan, she will pay approximately $18,200 in interest over the course of ten years.
If she refinanced all $40,000 of her loans at an interest rate of 6.0 percent, her monthly loans would drop to $444. After ten years she would pay approximately $13,290 in interest. That’s a savings of $4,947, or 27 percent.
To lock in a lower interest rate and save nearly $5,000 on interest, Rebekah may be willing to give up her rights to forbearance, deferment, income-driven repayment, and loan forgiveness.
Let’s take this a step further. If Rebekah was willing to sacrifice and pay $750 a month toward her refinanced loans instead of $444, she could pay them off in approximately five years instead of ten and pay just $6,640 toward interest. That’s an additional $6,650 in savings on interest for a total of $11,597, or 64 percent, on interest.
If she didn’t refinance to 6.0 percent and stuck with an 8.0 percent average interest rate but still made the higher payments, she would pay off her loans in approximately five and a half years and would still save significantly on interest, approximately $8,600, or 47 percent.
One thing to note is that if Rebekah stuck with the ten-year minimum monthly payment plan after refinancing to 6.0 percent and did not contribute anything beyond the required minimum monthly payment, she would still be paying approximately $41 less a month. $41 a month may not seem like much, but that translates to nearly $500 in savings a year. If she were to invest that in a retirement account, she would benefit from her investments gaining value, as well as potentially lower her taxable income (if the retirement account was a 401(k) or standard Individual Retirement Account (IRA)).
Interest rates matter!
This example illustrates exactly why refinancing has become so popular. The banks benefit because they can take the lower interest rate and still profit on other products they sell, while the borrower benefits because they can save hundreds or even thousands of dollars on interest payments.
Refinancing private student loans is becoming a no-brainer for those with good credit. As long as the new lender offers similar benefits to your current lender in terms of deferment, forbearance, hardship, and other factors, it usually makes sense to refinance to a lower interest rate.
With federal student loans, it becomes a more difficult decision. When you refinance with a private lender, you are eliminating your current federal student loans. The new lender is paying them off and, in turn, creating a new loan that is 100 percent private. That means the following benefits that come with federal student loans are gone:
•Opportunities for loan forgiveness: Public Service Loan Forgiveness (PSLF) and other forms of loan forgiveness are no longer available to you.
•Forbearance and deferment: You will no longer have the standard rights to forbearance and deferment that come with federal student loans. Make sure you understand how the new lender treats hardship situations such as a loss of income.
•Income-driven repayment: Income-driven repayment options help make otherwise unaffordable student loans affordable. They cap your payment at 10–20 percent of your discretionary income. These are only available for federal loans.
For some borrowers, refinancing may still make sense. For example, if you run the numbers and project you can reasonably pay off your student loans in three to five years without stretching your budget too far, you may want to refinance if it means saving thousands of dollars on interest.
At a minimum, I would encourage people to build a healthy emergency fund, eliminate credit card debt, and factor in retirement savings before they refinance federal student loans. Until these actions have been taken, it’s best to keep the protections of federal student loans in place.
Again, refinancing can’t hurt if you have private student loans, but proceed with caution if you have federal loans. You can always refinance later if it makes sense, but you cannot “undo” refinancing and go back to your federal loans.
This book spends a significant amount of time covering things like loan forgiveness and income-driven repayment, and I think those topics are important. But there are still many borrowers out there who will stick with the standard ten-year repayment plan and may benefit from aggressively paying off their student loans. Refinancing could be a part of their plan.
I am all for saving money on student loans through refinancing, but only if you fully understand what you are giving up by doing so.
Forbearance and Deferment
Before we look at federal student loan repayment options, it would be beneficial to spend some time going over deferment and forbearance in more detail. I’ve mentioned forbearance and deferment a few times already, and you are probably wondering what they are and how they work.
Deferment
In some situations, you are able to temporarily stop making payments on your loans by putting them in deferment. In fact, there’s a good chance you’ve taken advantage of at least one type of deferment (in-school).
Some common scenarios where you can apply for deferment are:
•In-school—You can take advantage of in-school deferment when you are enrolled at least half-time at an eligible college or career school, including graduate school. If you are a college grad, you almost certainly took advantage of in-school deferment while you were finishing your degree.
•Unemployment—You can defer your loans for up to three years during times of unemployment or when you are unable to find full-time employment.
•Economic Hardship—You