Student Loan Refinancing Or Consolidation
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Refinancing is the replacement of an existing debt obligation with another debt obligation under a different term and interest rate. The terms and conditions of refinancing may vary widely by country, province, or state, based on several economic factors such as inherent risk, projected risk, political stability of a nation, currency stability, banking regulations, borrower's credit worthiness, and credit rating of a nation. In many industrialized nations, common forms of refinancing include primary residence mortgages and car loans. If the replacement of debt occurs under financial distress, refinancing might be referred to as debt restructuring. A loan (debt) might be refinanced for various reasons: To take advantage of a better interest rate (a reduced monthly payment or a reduced term) To consolidate other debt into one loan (a potentially longer/shorter term contingent on interest rate differential and fees) To reduce the monthly repayment amount (often for a longer term, contingent on interest rate differential and fees) To reduce or alter risk (for example, switching from a variable-rate to a fixed-rate loan) To free up cash (often for a longer term, contingent on interest rate differential and fees) Refinancing for reasons 2, 3, and 5 are usually undertaken by borrowers who are in financial difficulty in order to reduce their monthly repayment obligations, with the penalty that they will take longer to pay off their debt. In the context of personal (as opposed to corporate) finance, refinancing multiple debts makes management of the debt easier. If high-interest debt, such as credit card debt, is consolidated into the home mortgage, the borrower is able to pay off the remaining debt at mortgage rates over a longer period. For home mortgages in the United States, there may be tax advantages available with refinancing, particularly if one does not pay alternative minimum tax.
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Student Loan Options: What is Refinancing vs. Consolidation?
To consolidate or refinance student loans; that is the question. Which begs three, much more important questions: What is refinancing, what is consolidation, and how do you know which option (if either) is right for you?
This can be a confusing topic, especially since these terms are sometimes used interchangeably. In fact, the definition of consolidation, as well the implications, actually differ depending on whether its a federal or private lender offering the service. Thats why its important to get acquainted with all of your student loan options before deciding whats right for you.
Heres a quick primer:
Federal loan consolidation
As its name suggests, consolidating implies combining multiple student loans into just one loan. Federal loan consolidation is offered by the government and is available for most types of federal loans but no private loans allowed.
This option generally doesnt save you any money, since youre simply charged the weighted average interest rate of the loans being combined. But there are still a few potential benefits, such as:
1. Fewer bills and payments to keep track of each month.
2. The ability to switch out older, variable rate federal loans for one fixed rate loan, which could protect you from having to pay higher rates in the future should interest rates go up.
3. Lower monthly payments. But beware this is usually a result of lengthening your payment term, which means youll actually have to pay more interest over the life of the loan.
Private loan consolidation
Similar to federal consolidation, a private consolidation loan allows a borrower to combine multiple loans into one and can offer the potential benefits listed above. However, the interest rate you receive is not a weighted average of your existing loans rates. Instead, a private lender will typically take a look at your history of dealing with debt and relevant financial information to give you a new interest rate on your consolidation loan, then use that loan to pay off your other loans.
Essentially, if youre consolidating student loans with a private lender, you are also in fact refinancing those loans.
Student loan refinancing
As we just established, refinancing is when you apply for a loan under new terms and use that loan to pay off one or more existing student loans. If your financial situation has improved since you first took out your loans, you may be able to refinance student loans at a lower interest rate, which can potentially allow you to:
1. Lower your monthly payment.
2. Reduce the time it takes to pay off your loan.
3. Spend less money paying back your loan.
4. Choose a variable interest rate loan, which can be a cost-saving option if you plan to pay off your loan relatively quickly.
5. Enjoy the benefits of consolidation (e.g., one simplified monthly bill).
Unlike consolidation, refinancing is only available from private lenders, and a common misconception is that its only available for private student loans. But while most private lenders wont allow you to combine federal loans with your private ones, SoFi allows borrowers to do just that.
As to whether you should combine federal and private loans, the answer depends on your situation. Federal loans offer certain benefits and protections (such as Public Service Loan Forgiveness and income-driven repayment plans) that do not transfer to private lenders. If youre considering refinancing, you should first take a look at your federal loans to see if any of these benefits apply to you.
If you dont anticipate needing or qualifying for federal loan benefits, getting a lower rate can save you a significant sum. For example, the average SoFi borrower saves about $14k1.
So should you consolidate, refinance or neither? Now that you know how these two student loan options compare, youll be better equipped to answer that question.
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