When to Refinance Student Loans—and When Not To

When President Biden announced targeted student loan debt forgiveness on August 24, 2022, millions of federal borrowers heaved a sigh of relief. Assuming every eligible person takes advantage of the forgiveness, roughly 20 million people will have their federal student loans discharged. That’s great news! But, there will still be millions of borrowers left with a remaining balance. If you fall in this category, it is important to think about what comes next, because there is still work to do. That’s why we reached out to personal finance company SoFi, asking for a CFP’s take on when to refinance your student loans.

“Refinancing is a common approach to make paying back your federal or private student loans more efficient,” explains Brian Walsh, Senior Manager of Financial Planning and Certified Financial Planner at SoFi. “Over the years, millions of borrowers—including my wife and me—have refinanced their student loans to save money on interest, pay off their loans sooner, or lower their current monthly payments. These benefits are amazing, but that doesn’t mean that refinancing is a magic solution or the best choice for everyone.” As a certified financial planner at SoFi, Walsh’s goal is to help its members reach financial independence and create a financial game plan that they feel good about. 

In this article, Walsh walks us through the basics of refinancing student loans, when it makes sense, and more importantly, when it doesn't. 

What Is Student Loan Refinancing?

When you refinance a student loan, whether it's federal or private, you are taking out a new student loan with a private lender that is used to pay off some or all of your existing student loan debt. Essentially, the loans that you refinance are gone and replaced with your new student loan. Ideally, your new loan aligns with your goals by having a lower interest rate or monthly payment. 

"It is important to keep in mind that this is a private student loan,” says Walsh. "This means that it does not come with federal benefits such as income driven repayment options, public service loan forgiveness, or future forgiveness.”

Making the Decision to Refinance Your Student Loan

On the surface, this is a simple decision. If the benefits of refinancing outweigh the costs, then it makes sense. The challenge, according to Walsh, is that it can be tough to understand the costs and benefits of this decision. “I generally use a simple framework and answer three questions to decide if student loan refinancing makes sense or not," he says.

1. What is my goal?
2. What type of loan is it?
3. How does each option align with my goal?”

1. Goals

A great first step is thinking about your goals. Do you want lower payments for extra room in your budget for everything else? Do you want to pay off your student loans as quickly as possible to save money on interest or be debt free sooner? Do you want to keep payments the same and just make sure you are getting the best deal on your interest rate?

There is no right or wrong answer, explains Walsh. “This is your goal, but there are trade-offs between these goals.” Generally, if you pay less now, you will pay more over the long term and vice versa. If you prioritize a lower payment now, it will make your current budget more comfortable but will typically result in paying more interest for a longer period of time. If you prioritize a shorter payoff, it will typically mean paying less interest for a shorter time, but will come with higher payments right now. Start by thinking about what matters most to you so you know what to look for when making a decision.

2. Type of Loan

Next, you should understand whether your existing loan is a federal or private student loan. 

• Federal student loans are made by the federal government. The interest rate is set by the government based on the year you took out the loan, so your income, credit score, and other financial characteristics do not influence your interest rate. This could be a bad thing if you are a well qualified borrower because it means you aren’t getting as low of a rate as you could in the private market. Federal student loans also come with federal benefits, such as the COVID-19 temporary emergency payment pause, income driven repayment, and potential forgiveness for those who qualify. Sometimes these federal benefits are extremely valuable, whereas other times, they might not be worth much to people.
• Private student loans are made by private lenders. The interest rate is based on your financial situation when you took out the loan, which could be good or bad, depending on the circumstances. They do not come with federal benefits, which makes them easier to evaluate in the context of refinancing.

3. Comparison

The last step of Walsh’s framework is comparing your existing loan with a new loan, while keeping your goal in mind. 

• If your goal is to minimize current payments: the main focus would be the current monthly payments, but it is also important to keep the total amount paid in the back of your mind as a potential tie-breaker. If your existing loan is a federal student loan, you may also want to review income driven repayment plans, including the new option announced by President Biden. Income driven repayment plans can be a powerful way to keep payments low for certain borrowers, since payments would be limited to a certain percentage of your income. If your existing loan is a private student loan, the comparison is pretty simple considering you do not need to worry about federal benefits.
• If your goal is to minimize the amount you pay back: the main focus would be the total interest paid, but it is also important to keep the current payment in mind, so you are confident you can fit it into your budget. If your existing loan is a federal student loan, you may want to review potential loan forgiveness, especially if you work for the government or a non-profit that could qualify you for public service loan forgiveness. As mentioned above, if your loan is a private student loan the decision is simpler.

Next Steps

As you consider all of these factors to develop the best plan for your student loans, it is important to understand some next steps and best practices. 

First, if you are eligible for federal student loan forgiveness announced in August 2022, take advantage of it and be sure to keep an eye out for the online application that is expected to be released in the coming weeks. 

Second, keep an open mind and explore your options. If you receive forgiveness and still have a balance left over, refinancing the rest could align with your long-term financial goals. Many people underestimate the savings from small changes especially for larger balances. For example, someone with $50,000 in student loans would save nearly $1,500 over ten years with a 0.50 percent lower interest rate. 

Third, it is fairly easy to shop around and check your rates without experiencing a hard credit inquiry that would ding your credit score. As you think through next steps, you hopefully now have a better understanding of how the refinancing process works. 

“Now it’s time for you to put this into practice and create a financial game plan to pay off your student loans that works best for you,” says Walsh.