NerdWallet's Smart Money Podcast - Should I refinance my student loans?

Episode Date: August 19, 2019

Refinancing student loans might save you money — if you’re a good candidate. But that’s not the only way to help manage your student debt. In this episode Dayana and Sean get to the bottom of when student loan refinancing is a good idea, so you can see if it’s right for you.

Hello, and welcome to NerdWallet's Smart Money Podcast, where we answer your real-world money questions in 15 minutes or less. I'm your host, Dayana Yochum. And I'm Dayana's charming and indispensable co-host, Sean Piles. All right, my charming, indispensable, and unavoidable co-host, Sean, what is today's money question? The question comes from Valerie, who says, I'm paying down $40,000 in student loans. The monthly payments are doable, but definitely squeeze my budget. And I've been wondering if it makes sense to refinance the loans and if I'll even qualify.

All right. This is a tricky one. Yeah. As you probably know, Valerie, higher education costs have skyrocketed over the years, leaving Americans with roughly $1.6 trillion in outstanding student loan debt. The average household owes nearly $50,000 in student loans. And Sean, I know you're one of those households, right? Yeah, I don't owe quite that much, fortunately, although it's not too far off.

I'm very grateful for the education I got from my tiny liberal arts college. Thank you, Marlborough College. But it did come with a hefty price tag. My current monthly student loan payments are just a little over $400 a month. And every time that big chunk of dollars comes out of my account, I do wish it could be less. Have you ever looked into refinancing? So I have in the sense that I know I shouldn't do it. All of my loans are federal. And so I don't want to lose the protections that I have with them by refinancing and going

private. Nor do I want to jump the gun on all the insider tips we have for you, dear listener, on this episode of NerdWallet's Smart Money Podcast. Very smooth transition into today's episode where we're joined by NerdWallet education writer, Ryan Lane. He'll be schooling us on student loan refinancing. Do you see what I did there? Good joke, Dayana. Yeah. All right. Ryan has been reporting, writing, and blogging about college financial aid and repayment plans for more than a decade. He's here to help field Valerie's question and offer tips for everyone on the ins and outs of refinancing, figuring out how much you might be able to save, and how to spot a good refi deal. Hi, Ryan. Thanks for joining us.

Hey, guys. Thanks for joining us. Hey, guys. Happy to be here. Right out of the gate, let's clear something up. I often see student loan refinancing and student loan consolidation used interchangeably, but are they the same thing? Enlighten us. What is the difference between the two? Yeah, it can definitely be confusing because refinancing and consolidation both kind of

do the same thing and that they're replacing your existing student loans with a new loan with new terms. But the biggest difference is that consolidation is for federal loans only, and it won't really change your loans interest rate. Refinancing is for federal or private loans, and it can ideally decrease your interest rate so you pay less over time. The federal government offers consolidation loans while private lenders offer refinancing, even though some refer to their products as consolidation loans. So the bottom line really is if it's through the government, it's a consolidation. If it's through a private lender, it's a refi.

All right, that makes sense. Okay, so now that we know what we're working with here, can you tell us what makes someone a good candidate for student loan refinancing? For me, I think it really all starts with whether you have private or federal loans. Private loans are easier. So if you already have those, have a good credit score, probably in the high 600s and a solid debt to income ratio, you're a good refi candidate. There's pretty much no downside to refinancing your private student loans. Federal student loan borrowers, and most borrowers have federal loans like you, Sean, they need to be aware of a few other key things.

When you refi a federal student loan, you give up all the protections that federal borrowers are entitled to and most lenders don't typically offer. That includes making payments based on your income, other repayment plans, postponements, loan forgiveness, and discharge options, just to name a few differences. Most importantly, I'd say if you're struggling to afford your payments or are aiming for a loan forgiveness program, do not refinance a federal student loan. Because once you do, you can't get it back into the federal program to regain those options. So if you go that route, you'll want to make sure your money saving is really worth it to you. So we know about the criteria for when someone should or should not refi their loans. Now I want some numbers here, Ryan. How much can someone

expect to save if they do refi their loans? Yeah, that's kind of the unsaid thing so far, which I think is kind of impressive because I feel like I've already said a lot. So pretty much a good refi candidate is going to be someone who stands to save some money. So let's take Valerie, for example. We know she owes $40,000 and let's say her interest rate is 6%. If she's on the standard 10-year repayment plan, she would pay about $440 each month and a little bit over $53,000 overall. So if she qualified to refinance at a 4% interest rate and kept that same 10-year loan term, she would decrease her payments by about $40 each month and save more than $4,600

overall. Now, of course, those numbers are highly personal. The more you owe, the higher your interest rate, and the more time you have left on your repayment term, the more you could save, obviously, depending on your new loans terms. And I guess if it's not too early in the podcast to start shilling stuff, I'd recommend definitely checking out the student loan refi calculator that we have on nerdwallet.com to get an idea of what you might actually be able to save. I'll say it's never too early to start shilling. And we have a link to that at our show notes page. You can check that out at nerdwallet.com slash podcast. Awesome. So, Ryan, what does a good student loan refinancing deal look like? And is Valerieers who get that lowest advertised rate, it's going to vary by lender, but it's typically around 10% or 30%.

It's never 100%. But having said that, even if you don't necessarily get the lowest possible rate, that doesn't necessarily mean it's a bad deal for you because ultimately a good deal is the one that's going to save you money. But definitely shop around to find that lowest rate possible if you're interested in refi. What about loan terms here for student loan refinancing? Here I'm talking about the amount of time you have to pay off the loan. Is it like a mortgage where you can choose between a 15-year or a 30-year loan? Yeah, typically you're going to have a choice in the loan term that you want. Some terms can be as short as five years or as long as 20 years.

And obviously there's a little bit of a trade-off there. So if you go for that shorter term, you're probably going to get a better interest rate, but you're going to be paying more each month overall. If you go for a longer term, you'll probably get a higher rate, but your payments will be lower and you're going to pay more overall. Yeah. And this is the same kind of tricky math that's at work when you go into a car dealership and the salesman asks you, how much would you like your monthly payments to be? It's a dangerous question. People should be careful here because it's really tempting to finance into a lower monthly payment to alleviate

cash flow issues. But the trade-off can be really costly because like you said, you're extending the payoff time, ergo the number of years you're paying interest and the amount of interest you're paying on the loan. Okay. So you've refinanced, you got your lower payment and all is hunky-dory, but then life throws you a curve ball and you suddenly can't afford your payment anymore. What options do those who have private loans have here? It's going to depend on the lender you go with. So that's definitely something to look into when you're shopping around. Most, but not all, are going to offer programs that will let you pause payments, typically

for up to 12 months total. And some may offer other options as well, like temporary reducing your interest rate or payments, or have unique career assistance programs to help you get back on track. But really, if you run into trouble, the first thing you should do is contact your lender and do it immediately to discuss your options before you even miss any payment. And that's also because, and this is something else to keep in mind if you give up federal student loans and refinance them into a private loan, the pathway to default is much quicker for private loans. Federal student loans default after 270 days of missed payments, whereas the length for private student loans is typically not even half that or even less. And we're talking about a major ding to your credit score

if you've default. Yeah, absolutely. It's really bad to have on your credit score, and you're going to face other potential penalties as well. Your lender could take you to court. The court could issue wage garnishment against you. So definitely nothing good comes of it. Right. Pay your bills on time if you can, if not, call. All right. Let's say Valerie's determined that refi isn't really an option for her. What are other ways that she can save money? Yeah, there's definitely a number of things that she can do. One of the simplest is to just sign up to have her servicer auto debit her payments from her bank. If you have federal student loans, enrolling in auto pay is going to

automatically reduce your interest rate by 0.25%. Obviously, the downside of that is, you know, if you owe a lot each month, you'll just want to make sure you have enough in your bank account to cover it because you don't want to have an overdraft fee that sort of offsets any savings that you might get otherwise. Right. That's a super simple thing to do. Good to know. All right. Absolutely. Another thing that you can do, very straightforward, you can simply prepay or overpay your loans. There's never any penalty for prepaying a student loan. I actually, I prepaid my student loans. I saved a couple thousand dollars in interest along the way by doing that. The trick with prepaying student loans is you just want to make sure the extra money goes towards

your principal balance and not your next payment. That's actually a mistake that I made when I started prepaying my loans, but that's probably a story for a different podcast. Mistakes nerds made. Yeah, that would be more than 15 minutes, maybe. And finally, if you want to prepay, a trick that you can do is to switch to paying half your bill twice a month instead of one monthly payment in full. And what that's going to do is you're going to end up making 26 half payments over the course of the year, which will actually equal 13 full payments. So you will have an extra monthly payment that you've made over the course of the year

without really feeling like you're paying a lot more toward your loans. Right. And nerd tip here, this is the same advice that we offer if you want to pay down your mortgage faster. Very true. You guys are so nerdy. Thank you for those excellent tips, Ryan. I think that about covers it. Valerie, I hope this has helped. Let's get to our takeaway tips. Kick it off, Dayana. I will. Thank you, Sean. To figure out if refinancing your student loan is a good move, ask yourself two questions. First, will I save money? Here, a tip is you want to choose the term length that your loans currently have or a shorter one to

ensure that you save money both monthly and long term. Second question, does it even make sense to refinance the type of student loan you have? So if you have a federal loan plan, be particularly careful about making this decision. You can lose a lot of protections and options with no way to regain them. That said, if you have private loans, there's really minimal to no downside to refinancing if you're going to save money. Next up, be honest with yourself about your student loan situation. Refi isn't a get-out-of-debt-free card. You'll still have to pay the new loan.

If you're struggling with your current payments, look into options to make them more affordable, like income-driven repayment if you have a federal loan, and if you have private loans, talk with your lender about your options. And that's all we have for this episode. Do you have a money question of your own? Turn to the Nerds and text us your money questions at 901-730-6373. That's 901-730-NERD. You can also email us at podcast at nerdwallet.com. Visit nerdwallet.com slash podcast for more on this episode. And remember to subscribe, rate, and review us wherever you're getting this podcast. And here's our brief disclaimer lovingly crafted by NerdWallet's legal team. Your questions are answered by knowledgeable and talented, very, very talented finance writers,

but we are not financial investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances. Thank you, Dayana. And with that said, until next time, keep it nerdy!