People often think that the only, and possibly best, way to refinance their student loans is by using a private lender. But, depending on the type of student loans you have, it might be better to pursue renegotiating your student loans through a different avenue. If you have federal student loans, these alternatives to traditional student loan refinancing are more likely to be the better option depending on your circumstances.
Federal Consolidation Loans
If you have federal loans that you want to consolidate, it is possible to pursue this option through the U.S. Department of Education. Also, all federal consolidation loans have fixed interest rates just like the various Direct & Parents PLUS student loans.
Pros of Federal Consolidation
There are several benefits to having your federal loans consolidated with the Department of Education instead of with a private refinancing lender.
Monthly Payments Can Be Capped At 10%
Depending on your income, you might qualify to enroll in an income-based repayment plan that caps your monthly student loan payments to 10% of your income. With private refinancing, the only way to reduce your monthly payment is to extend the repayment term to 15 or 20 years. Even then, your monthly payment still might be higher than 10% of your monthly take-home pay.
Qualify for Loan Forgiveness
One benefit that federal student loans have that private loans do not is the ability to have them forgiven after 20 years for most repayment options or 10 years with the Public Service Loan Forgiveness option. When refinancing with a private lender, you forfeit these forgiveness benefits which can save you thousands or tens of thousands of dollar in student loan payments.
Cons of Federal Consolidation
The forgiveness & monthly payment cap benefits are the two primary reasons to pursue federal consolidation, but, there are some tradeoffs as well.
Slightly Higher Interest Rate
If the primary reason you want to refinance your loans is to qualify for a lower interest rate, that won’t happen with federal consolidation. In fact, your interest rate will probably increase slightly because they federal lenders use the weighted average of your current loan interest rates and round it up to the nearest one-eighth of one percent (0.0125%). The rate increase isn’t enough to significantly raise your monthly but, although, you won’t save any money either.
Private Student Loans Can’t Be Bundled
Since private student loans do not have similar benefits such as income-based repayment plans or loan forgiveness options, they cannot be federally consolidated. If you have a mixture of federal and private student loans, you will have to refinance each type of loan separately.
A second private option is to transfer your current student loans balance to a personal loan. This is an unconventional option to traditional private refinancing, but, it’s a possibility that this is a better alternative.
Pros of Personal Loans
These are some reasons you might want a personal loan instead of the other federal or private alternatives.
Potentially Lower Interest Rate with HELOC Loan
So a Home Equity Line of Credit (HELOC) isn’t the most common personal loan, but, it can have a smaller interest rate than a variable refinanced student loan does. The only catch is that you need to own a house with equity. If you are a 22-year-old just entering the workforce, this means your parents would essentially “pay” your student loan by transferring the balance to their HELOC balance and you write them a monthly payment.
Of course, if they originally borrowed the money in the form of a parent student loan, this can have the cheaper interest rate.
Cons of Personal Loans
Personal loans are ideal for aselect subset of borrowers, but, the reasons below will probably help show why they might not be the best option for your situation.
Relatively High-Interest Rates
As the lowest interest rates normally start at 5% for a personal loan, these are normally not the cheapest option compared to private refinancing interest rates that are currently as low as 2.21%. The reason most people use personal loans is to transfer more expensive debt like credit card balances with a 15% interest rate to save a large sum of money. Student loans are already some of the cheapest loans on the market and personal loans are more expensive in most instances.
Short Repayment Period
In addition to the potentially higher interest rates, personal loans often have shorter repayment terms such as 3, 5, or 7 years. If you are pursuing refinancing to extend your repayment period to 15 or 20 years, a personal loan will most likely not be a possibility.
Cannot Deduct Interest Paid
Unlike regular student loans or balances that have been consolidated, federally or privately, with tax-deductible interest, that isn’t the case with personal loans and adds to the total borrowing cost.
Refinancing your student loans with a private lender is an attractive option, but, sometimes it’s not the best option. You have the most flexibility if you have federal loans. If your primary motive for refinancing is to qualify for a lower interest rate or you intend to use the federal loan forgiveness benefits, it’s better to pursue federal consolidation. Otherwise, federal and private lenders will both extend your repayment terms to 15 or 20 years if you simply need more time.