An important challenge for anyone who used federal student loans to finance their education is to manage the debt. Refinancing your loans with a private lender is one option, which simply means replacing your student loans with a new private loan.
The debt doesn’t go away, but your new loan should provide you with some benefits, such as reduced interest rates or monthly payments that improve your cash flow. Before you make the leap and refinance, however, find out what benefits are lost when you refinance federal student loans.
Should I Refinance My Student Loans?
With refinancing, you can lower your APR, change the length of your loan term, choose between a variable rate or fixed rate, or release a cosigner on your federal student loan. Of course, this depends on your ability to qualify for refinancing based on the lender’s criteria for creditworthiness and ability to repay. Here are six things to know before refinancing your federal student loans:
1. Refinancing Turns a Federal Student Loan Into a Private Loan
The federal government offers several programs for managing your government student loans, but refinancing is not one of them. Refinancing must take place through a private lender. Your new lender will pay off your government student loans and replace them with its own promissory note with new terms, and federal government student loan rules will no longer apply.
2. A Grace Period Exists for Direct Student Loans
For recent undergraduates or students who have reduced student status to less than half-time or dropped out of school, there is no urgency to refinance federal student loans directly received from the government. A grace period begins the day after any of the previous events occurs and lasts between six and nine months.
For example, loans made under the Direct Loan or Federal Family Education Loan programs have a six-month grace period. For a Perkins loan, the grace period is nine months. In most situations, you do not have to make any payments during the grace period.
Sometimes, however — as with a Direct Subsidized Loan made between July 1, 2012 and July 1, 2014 — you’re responsible for interest payments during the grace period. Interest payments that you opt out of will be added to your loan’s principal balance.
Unfortunately, for postgraduate students who used Direct PLUS loans to finance their student debt, a grace period does not apply. As an alternative, postgraduates are eligible to delay payments for up to six months through deferment.
3. You Have Deferment and Forbearance Options
Although the lure of refinancing with a private lender will be a new promissory note with a better interest rate and repayment terms, you’re assuming a greater risk if you run into difficulties repaying the note due to the loss of a job or a life-altering event.
A federal student loan gives you protection in these situations that are unlikely to be offered by a private lender. For example, you might be able to temporarily stop making payments on your federal student loan by requesting a deferment or forbearance of the loan. A temporary break from payments can give you breathing space to find a new job or otherwise get back on your feet without defaulting on your financial obligation.
In some circumstances, you might not have to repay your federal student loan. Federal student loan forgiveness programs are available to teachers and employees of government or not-for-profit organizations that can result in certain loans being entirely or partially forgiven or canceled.
Regardless of your profession, government student loan rules might also provide for a complete discharge of your federal student loan via borrower defense to repayment, which takes effect if the school you attended misled you or violated certain laws in connection with your student loan. Refinancing your federal student loan will cause you to lose your eligibility for any of these benefits.
5. Income-Driven Repayment Plans Are an Alternative
Refinancing seems like an attractive alternative when what you pay monthly for your federal student loan takes up a disproportionate share of your income. Lowering your monthly payment is one benefit of refinancing; however, this same benefit is already available for many federal student loans.
You can apply for a reduced monthly payment using an applicable federal income-driven repayment plan. Four different plans are available depending on the type of student loan you have. These plans give you the refinancing benefit of a reduced monthly payment without sacrificing the other benefits that apply to your federal student loan.
6. Refinancing and Direct Student Loan Consolidation Are Different
You’ve probably heard about student loan debt consolidation — which is different from refinancing — if you have multiple student loans. Although consolidation might appear the same as refinancing because you’re swapping your old loans for a new one, a direct consolidation loan is not designed to lower your federal student loan interest rate or otherwise give you better repayment terms.
The primary benefit of a direct consolidation loan is to simplify the repayment process by combining several federal student loans into one loan. The annual percentage rate for your direct consolidation loan will generally be the same as your prior loans, and you might, in fact, be paying more in interest and total payments over the life of the loan. A direct consolidation loan might also negatively impact some federal student loan forgiveness program benefits the same way refinancing does.
Check Out: 15 Ways to Pay Off Student Loans
When evaluating whether refinancing of your student loans is right for you, keep in mind that the best use of refinancing is to get a new loan that lowers your federal student loan interest rate and provides favorable repayment terms. Getting a better loan is most easily accomplished when you’ve established a good credit score and have a stable employment record — something more likely to occur several working years after you’re done with school. Before then, consider utilizing the benefits provided for federal student loans that will assist you in meeting your repayment obligations.