There are a lot of ads these days, as well as articles on the web, that tout refinancing of your student loans as a solution to unaffordable monthly payments. They say that you can get a better interest rate by doing so! But what they don't tell you is that if you do that with a federal student loan it could make things worse!
For Payments, It Isn't Just the Interest Rate!
The trap lies in thinking of it just in terms of the interest rate. Currently, federal student loans under the Stafford program for undergraduates is 4.45%, and for graduate students it is 6%. Loans taken out by parents are at 7%, as well as for those students taking out Graduate PLUS loans. Can a private bank beat that by enough to make a difference?
The monthly payment is also not solely determined by the interest rate. The standard repayment plan for a federal loan is 10 years. However, this can be extended to up to 25 years if you owe, overall, more than $30,000. Although you will be paying it for longer, and pay more overall because of interest over time, it can make payments more affordable.
For a more detailed discussion of this topic: Check out Episode 51 of my Financial Freedom Podcast!
You can also enter into a graduated plan in which the payments start out much lower, then increase every 2 years (for a 10-25 year period). If you opt for the 10 years, and the increased payments track with increases in your income over time, you can get an affordable payment without paying forever!
You Can Lose the Programs and Benefits of Federal Loans!
Deferments & Forbearances. There are many programs through the federal system that may well not be available in a private loan. One of these is deferments and forbearances. These can come in handy, should you need them, to allow you to stop making payments for a time without going into default. Although they are limited in the times you can get them, they are available for:
- Periods of Unemployment
- Periods of Economic Hardship
- Periods of Military Service
- Short Periods of Post Active Duty
In addition, a deferment of a subsidized federal loan accrues no interest during that period that can capitalize and increase your loan balance when it is over. This is because the federal government pays the interest. Will a private bank do that?
All federal loans have these options, but not all private loans do. If you are looking at a private loan refinance, be sure that the new loan has deferment and forbearance programs that match the federal ones (or come as close as possible).
Loan Discharge Options. Federal loans can be discharged administratively under certain circumstances. If the student dies, the loan dies with him or her. If there is a co-signer, that person is off the hook. With Parent PLUS loans, the parent(s) are off the hook if the student dies, but if both parents cosign, and one parent dies, the other parent is still responsible. Permanent total disability will also end the loan.
Plus, certain employment can trigger early discharge of a federal loan. If you work full time for a public entity, charity, or qualified non-profit, you can get the loan balance discharged after 120 payments! No private loan, that I am aware of, offers that!
Federal Loan Consolidation. If you want the convenience of one payment, there is no need to get a private loan. You can always refinance federal loans within the federal system and keep all of these benefits! It is called “consolidation,” and does require more than one loan, but it is something to look into. The interest rate would be a weighted average of the rates on all of the loans.
The Ability to Get Out of Default. If you default on a federal student loan, there are ways to get out of default and get the loan back on track. There is even a way to do this and help your credit! No private loan that I know of allows you to do that!
Be Sure You Know What You Are Giving Up!
The bottom line is that in looking at the refinancing of a federal loan with a private bank, you need to be sure that the bank has the equivalents of as many of the federal programs as possible, or that the features and benefits of the private loan outweigh the lack of these equivalents.
I'd Be Happy to Help!
If you live in the Gloucester County, New Jersey area and are looking for a more affordable repayment plan, please feel free to call my office at 856-432-4113 or contact me through this site to schedule an appointment in my Woodbury office to discuss your situation. We can talk about the refinancing loan you are considering and whether it is the right step for you.
If you would like more information about federal student loans, their benefits and options, you can dowload my free book, I Graduated; Now What? A Guide to Dealing with Your Student Loans.