You are getting ready to refinance your student loans with a private lender because you can save thousands with a lower interest rate. Before you make the final decision, there are a few things to consider as federal loans lose some key benefits when you use a private lender instead of applying for a Direct Consolidation Loan through the federal government.
If you are currently struggling to afford your monthly federal student loan payment because you make a relatively low-income you might qualify for one of several income-based repayment plans such as the PAYE or REPAYE programs that limit your monthly payment to 10% of your disposable income. This benefit is still available when consolidating through the federal government. And, for some repayment programs, you need a direct consolidation loan to qualify for a particular repayment plan.
Private lenders do not offer similar repayment benefits. Yes, refinancing your loans for 20 or 30 years will reduce the monthly payment to potentially reflect 10% of your income, but, the federal programs forgive the remaining balance after 20 or 25 years of repayment.
Loan Forgiveness Benefits
The fastest growing loan forgiveness option at the moment is the Public Service Loan Forgiveness (PSLF) program. It allows many government and non-profit employees with high student loan balances and low salaries to have their remaining federal loan balance forgiven after 10 years of payment. As the standard repayment rate for all federal student loans is 10 years, this can save graduates a lot of money in loan payments.
In addition to the PSLF, the PAYE and REPAYE forgiveness options that forgive the balance after 20 or 25 years are also forfeited when going with a private lender. If you do not qualify for these plans, then the loss of these benefits might not be an issue.
As private student loans do not have forgiveness options, federal loans lose their benefits when they are combined with other private loans or refinanced through a private lender even when they are left separate from any private loans you might have.
Deferment and Forbearance
Sometimes life has a few rough patches that make it difficult or impossible for you to make your student loan payments. Some examples might include a medical emergency, disability, or temporary unemployment. A select few private lenders do offer loan protection options like job loss protection or deferring to launch an entrepreneurial startup, but, the Department of Education is still more flexible.
Although you cannot predict your financial future, it might be a good idea to compare the federal deferment and forbearance options to those offered by the prospective private lender.
One of the most compelling reasons to refinance with a private lender is to secure a lower interest that can save you hundreds or even thousands of dollars in interest charges over the life of your loan. If you can pay you loan off within a few years and have good credit or a co-signor with good credit, you will qualify for the lowest fixed or variable interest rate.
Private loan rates increase as the repayment period is extended. With federal consolidation loans, the interest rate is the same regardless of the loan length.
This is because the Department of Education uses a weighted average of all the federal loans you plan to consolidate. Your new interest rate will be slightly higher than your current federal loan interest rates because the average interest rate is rounded up to the nearest one-eighth percentage point (0.125%), you essentially “break even” regarding your new federal interest rate.
No matter how you consolidate you consolidate a federal loan through the federal government, your rate will not go below what it actually is now. Simply because they use the weighted average for all consolidation loans.
This will not save you money if you are on track to repay your loan early or already have low-interest rates, but, it can be the cheaper option than refinancing with a private lender if you need more than 10 years to repay the balance and can also qualify for an income-based repayment plan. As the highest fixed interest rates from private lenders can be as a high as 8% and your federal loans might have a weighted average of 6.8%, consolidating with a federal lender is the better option in this instance.
Is the Loss of Federal Benefits Worth It?
The key difference between refinancing with a private lender and applying for a federal Direct Consolidation Loan is the loss of income-based repayment and forgiveness options. Borrowers that are pursuing refinancing to get the lowest interest rate possible and do not plan on using these benefits might benefit more from private refinancing. Although, those wanting “peace of mind” of having those options available will be able to have a similar interest rate using the federal consolidation program as they currently pay on their existing federal loans.