When is Refinancing Your Student Loans a Bad Idea?

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Brian O'Connell

By Brian O'Connell

January 21, 2019

Is refinancing your student loan a good idea?

In some cases, yes, there are good reasons for refinancing your student loan, with a lower interest rate at the top of that list.

In others, refinancing your student loan doesn’t add up financially, and won’t save you much money. Worse, some refinancing scenarios could lead to higher fees and higher payments, and take some much-needed leverage out of the equation.

This is the second in a three-part series on refinancing a student loan. This series takes a closer look at why and when refinancing a college loan is a good idea – and when it’s not.

This story reviews scenarios where it isn’t a smart move to refinance your student loans.

The Disadvantages of Refinancing Your Student Loan

Sure, you can benefit from refinancing your student loan debt, especially if you’re in a downward financial spiral and can’t afford basic living expenses, like rent, food and utilities.

Refinancing can buy you some time and still protect yourself, financially.

But in myriad other cases, refinancing your student loan can easily fall into the “bad decision” category.

The key in evaluating a student loan refinancing plan is to weigh needs versus wants. If you’re making decisions based on needs, like the need for food and shelter, do your due diligence and keep working on a refinancing plan.

If you’re prioritizing wants – like a new big screen television or trip to Key West – over your next few student loan payments, you’re only setting yourself up for failure. That could mean a future filled with late fees and penalties, and an early start on a sub-prime credit score.

That’s why it’s equally important to know when a student loan refinancing move is a bad idea. That’s certainly the case under the following scenarios:

When It’s a Bad Idea to Refinance a Student Loan

Avoid refinancing a student loan if . . . .

You lose the benefits of borrowing from Uncle Sam. Let’s face facts, most student loans are backed by the U.S. government, and that has a big ripple effect when you refinance your student loan.

That’s because when you refinance a student loan, you’re leaving the federal government student loan cocoon and entering into a student loan with the private sector, where your ongoing options can be limited, depending on your loan needs.

For example, you may have been able to reduce your student loan payments via one of the federal government’s best college loan ideas – income-driven repayment plans. Under these plans, your monthly loan payments are capped at 10% to 20% of your discretionary income, making the loans much easier to manage until you earn more income, and can be more aggressive about paying down student loan debts.

Yet, when you leave your federal student loans behind to refinance into a private student loan, you’ll lose access to income-driven repayment plans, thus taking a potentially valuable loan option off the table.

You’ll also lose the opportunity for any federal forgiveness programs, generous deferment options, a death and disability discharge option, and more.

You pay more interest with a private student loan. Federal student loans offer low fixed interest rates. Most of the savings from refinancing a student loan comes from a shorter repayment term, not a lower interest rate. You can reduce your repayment term on a federal student loan by making extra payments and by targeting the loan with the highest interest rate for quicker repayment.

You lose your ability to earn Federal Student Loan Forgiveness. Call this “part two” of the federal government student loan departure risk – besides the income-driven repayment option.

If you refinance into a private student loan, you’ll also lose the right to apply for federal student loan forgiveness program (known more formally as Public Service Loan Forgiveness, or PSLF.)

This is a pretty big deal given what the PSLF offers, including total student loan forgiveness after 10 years of qualified public service. If you are a teacher, you also lose teacher loan forgiveness of up to $17,500.

Unlike Uncle Sam and certain state programs, private lenders aren’t in the loan forgiveness business. Know that you will lose loan forgiveness if you refinance federal student loans into private student loans.

You have bad credit. This is a tricky, but ultimately common scenario for student loan borrowers down on their financial fortunes who want to refinance into a less-expensive loan payment.

If you have bad credit, you’re much less likely to be approved for a refinanced student loan by a private lender. In fact, the hurdle is fairly high for student loan refinancing deals – at least a 700 credit score is often required just to be considered for a refinance and 780 or more to be given the green light.

If you can’t qualify for a refinanced loan from a reputable lender (and most reputable lenders expect borrowers to have stellar credit), you might be tempted to take a loan from a company that engages in “red flag” practices, like demanding a big fee payment up front. Requiring an up-front fee is often a sign of a student loan scam.

Don’t go this route, especially if you have weak credit. You probably won’t qualify for a much lower loan interest rate with toxic credit and the prospect of paying added fees and penalties make this idea a “no go.”

You’re well on the way to paying off your student loans. Sometimes, student loan borrowers run into severe financial difficulties, like a serious illness, the loss of a job or bank account-draining divorce. To save money, they look at their student loan and conclude they can refinance it into lower payments.

Generally, that’s not a bad idea – if you have a long way to go before you finish paying your student loans. But if you’re struggling financially, and you’re close to paying off your entire loan debt – less than five years left is a good rule of thumb – stay the course, and work with your student loan servicer on different repayment options.

By refinancing when you’re almost done paying your student loans, you likely won’t save too much money with a lower interest rate and you run the risk of adding years to your repayment schedule, which could drive up your total loan costs in the process.

Certainly, even the moderate risk of that outcome makes a refinancing deal not worth the hassle.

Talk to a Financial Professional

If you’re undecided about refinancing your student loans and aren’t sure you’ll gain any benefits, confirm that suspicion and talk to a trusted financial advisor to see if a student loan refinancing deal makes sense for you.

A second set of eyes and ears can study your unique financial situation and provide a personalized recommendation that comes from years of financial planning experience.

A good place to start:

See the best 529 plans, personalized for you