How to Refinance Student Loans
Borrowers who feel challenged by their monthly student loan repayments can pursue relief via several different strategies. In this article, we’ll discuss two popular methods – consolidation and refinancing.
What Is Federal Student Loan Consolidation?
The Department of Education (DOE) administers several federal student loan programs, including Direct Consolidation Loans. Consolidation can simplify your monthly payments when you have two or more federal student loans, but you might have to give up some benefits along the way. Direct Consolidation Loans charge a fixed interest rate that is the weighted average of the rates on the loans being consolidated. The interest rate is uncapped and rounded up to the nearest 0.125 percent. Private student loans cannot participate in a federal consolidation.
How It Works
When you take out a Direct Consolidation Loan, you replace multiple federal student loans with one, requiring only one payment per month. To qualify for loan consolidation, you must have one or more federal loans (Direct or FFEL) that are in repayment or in a grace period. These are the types of federal student loans that can be consolidated:
- Direct PLUS Loans
- Direct Subsidized Loans
- Direct Unsubsidized Loans
- Federal Nursing Loans
- Federal Perkins Loans
- Health Education Assistance Loans
- PLUS loans from the Federal Family Education Loan (FFEL) Program
- Subsidized Federal Stafford Loans
- Supplemental Loans for Students (SLS)
- Unsubsidized Federal Stafford Loans
In addition, some existing consolidation loans can be reconsolidated if you include an additional Direct or FFEL loan, although you may be able to reconsolidate an FFEL loan without including other loans.
Not only does loan consolidation simplify your monthly repayment schedule, but it can also reduce your monthly payments by extending your loan repayment period to 30 years. You also might gain access to alternative repayment plans and/or replace variable-rate loans with a fixed-rate loan. These repayment plans include options to pay less now and more later, to base payments on earnings, or to cap payments as a percentage of discretionary income or annual income:
- Standard: You have up to 30 years to repay a standard consolidation loan. All federal borrowers are eligible for this type of loan.
- Graduated: Payments start off low and increase over time, usually in steps every two years.
- Pay as you earn: The limit on monthly payments is 10 percent of discretionary income. Your loan payments are recalculated annually based on your family size and income. Family income is included if you file a joint return. You receive forgiveness on any loan balance remaining after 20 years (beware that forgiven debt may be taxable). This plan is available to loans made after September 30, 2007, and you must have a high debt-to-income ratio.
- Revised pay as you earn: Family income and loan debt are considered, independent of how you file your tax returns. Also, loan forgiveness starts after 20 or 25 years.
- Income-based: Payments will be only 10 or 15 percent of discretionary income. Otherwise, this loan resembles revised pay as you earn.
- Income-contingent: Available for student and parent loans. You pay the lesser of
- What you would pay on a 12-year, income-based plan
- 20 percent of your discretionary income
- Income-sensitive: Annual income determines your monthly payments. These loans can have terms up to 15 years.
The flip side of extending a loan is that you’ll make more payments and pay more interest. In addition, you have to be wary of possibly losing benefits that came with the original loans, including partial cancellation, principal rebates, and interest rate discounts. If you are concerned about losing these benefits, you should also explore options for receiving loan forbearance or deferment.
You can apply for a Direct Consolidation Loan after you leave school, drop below half-time enrollment, or graduate. However, you cannot consolidate a defaulted loan unless you first make arrangements with the current loan servicer, or you agree to repay the consolidated loan under one of the income-related plans. There are no application or prepayment fees for a consolidation loan.
The Federal Student Loan website allows you to apply for a Direct Consolidation Loan electronically or with paper forms. You can apply online by first choosing the existing loans, then picking one of the repayment plans. You then sign the application after you review all the terms and conditions. The servicer will arrange to pay off your existing loans and set up your consolidated loan repayments.
Normally, repayment of a Direct Consolidation Loan commences within 60 days of disbursement. If your existing loan is still in its grace period, you may be able to delay repayment until your grace-period end date. Your repayment period will be 10 to 30 years, depending on several factors.
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Pros and Cons of Refinancing Student Loans
- Simplifies and centralizes your student loan repayment schedule
- Offers the opportunity to reduce your monthly payments
- Offers the opportunity to adopt an income-related repayment plan
- Converts variable-rate loans to a fixed-rate one
- May increase the number of payments and interest paid
- Does not include private and parental student loans
- May cause forfeiture of certain existing benefits
- Interest rate is not lowered
RELATED: Refinancing a Personal Loan
Avoiding Student Loan Refinancing Scams
Consolidating multiple federal student loans is a good idea after you graduate. However, you must be vigilant when it comes to consolidation scams. The most popular scam involves companies charging you a fee, sometimes as high as $1,000, to consolidate your loans. Remember, loan consolidation is free, and you can accomplish it at the Federal Student Aid website. Another scam is one in which a company offers you “immediate debt relief,” implying a cut in your principal balance or interest rates. Instead, the company charges a hefty fee and, at best, puts in the paperwork to consolidate your loan. At worst, they take your money and do nothing. As an example, the Consumer Financial Protection Bureau shut down College Education Services in 2014 because it was running illegal debt relief services.
Look for these red flags before considering the use of a private company for student loan consolidation:
- Pressure tactics: It is illegal to demand upfront fees for loan consolidation assistance. Beware if they ask you to sign some sort of contract or to reveal your credit card number or bank account number.
- Immediate relief: No company can truthfully promise to immediately reduce or cancel your debt. If a company tells you it can work out a special deal with the DOE, consider reporting it to the authorities. Debt relief is only possible via the approved federal student loan programs.
- Third party authorization: Any company asking you to sign a third-party-authorization or power-of-attorney document is probably crooked. There is no reason to grant these companies any of your rights, nor should you make your loan repayments through them.
- Stealing your PIN: Your Federal Student Aid PIN uniquely and secretly identifies you to the DOE for matters relating to federal student loans. If a company asks for your PIN, it’s equivalent to stealing your signature. Honest companies will never ask for your PIN.
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If you wish to submit a complaint about a company offering student debt relief services, contact the Consumer Financial Protection Bureau (CFPB).
Did You Know That Parents Cannot Transfer PLUS Loan Debt to Their Child Directly with the Department of Education?
Parents who took out a Direct PLUS student loan on behalf of one or more of their children might be tempted to transfer the loan to their offspring after the latter have graduated and are working. The sentiment is certainly understandable, but the truth is that a PLUS loan cannot be transferred from a parent to a student through a consolidation loan. Therefore, a student borrower must exclude any PLUS loans taken out by parents when applying for a consolidation loan. As we’ll soon see, the appropriate vehicle for moving a loan from parent to child is private refinancing.
What Is Private Student Loan Refinancing?
Direct Consolidation Loans only operate with federal student loans. If you wish to consolidate private student loans, or a mix of private and federal loans, you can apply for private student loan refinancing. You may be able to refinance at your loans at a lower interest rate if:
- Your credit rating has improved since the time you took out the original loans, and/or
- Interest rates are now lower than they were when you took out the original loans
While you can privately refinance federal student loans, you might lose certain benefits, such as income-based repayment plans or forgiveness for public service. If you don’t need the special benefits provided by federal student loans, private refinancing is a viable alternative.
RELATED: Closing Out a Tuition Bill With a Personal “Gap” Loan
One major difference between federal loan consolidation and private loan refinancing is that the latter requires underwriting. This means you need to pass a credit check, and the interest you pay depends on your creditworthiness. Co-signers are allowed and can help reduce the cost of, or improve access to, refinancing. Here are some LendEDU survey results to consider when seeking to refinance your student loans:
- The average FICO score of approved applicants is 757. The lowest approved score was 560.
- About 43 percent of applicants are denied student loan refinancing, and 33 percent of approved applicants actually complete the refinancing process
- At the time of the survey, the average interest rate received was 4.82 percent, the average amount refinanced was $53,892 and average term length of the refinanced loan was 10.4 years
- Approval required about 28 days on average
- Co-signers were used for about 32 percent of the loans, and co-signing reduced interest rates an average of 0.15 percent
Pros and Cons
- Can refinance private, federal or a mix of student loans
- May lower your interest rate and save you money
- Can transfer parent’s loans to the child (see below)
- Can choose between fixed-rate, variable-rate and hybrid loans
- Generally higher interest rates than those for federal loan consolidation
- May lose federal benefits
- Requires a credit check
You Can Transfer Parent PLUS Loans to the Child via Private Refinancing
Parents of dependent undergraduate students can receive a federal Direct PLUS Loan if parent and child both meet the general eligibility requirements. The obligation to repay the loan rests solely with the parents, and the DOE doesn’t permit the direct transfer of the loan from parent to child. However, there is a work-around: The child can apply to a participating private bank or loan company to refinance the loan in the child’s name.
Several student loan refinancing companies offer this option to children whose parents took out a Direct PLUS Loan. Generally, the child must have graduated with at least a Bachelor’s degree and be professionally employed.
Each refinance company evaluates the child’s loan application using its own criteria, but generally, the lenders want to be sure that the child can repay the loan. Typically, this requires the child to provide information about financial history, career experience, the school attended, the kind of degree received, and current income and expense.
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Eric Bank is a business and personal finance writer who has been featured in Credible, Wisebread, CardRates, Zacks and many other outlets. He holds an M.B.A. from New York University and an M.S. in Finance from DePaul