On a perfect Montauk summer night, me and three old college friends were catching up and taking in the sunset when a conversation about graduate school got ugly and someone asked, “Hey, have you refinanced your student loans?”
It took approximately 10 seconds before the mood was ruined. Even on a lovely August evening, nothing destroys a good time faster than the words, “refinance your loans.” One might as well ask you to recount your favorite root canal story.
The truth is, “refinancing your loans” is not only a terribly daunting phrase, but it also leaves a paralyzing feeling of anxiety in its victims.
Despite my desire to simply delete the phrase from my memory the next morning, I knew that ignoring refinancing my loans could be a bit like ignoring a small leak in the ceiling: At the moment it doesn’t feel urgent, but it just might end up costing you thousands of dollars if you don’t get on top of it.
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Thus, I decided to take the responsible path and research my options. Here’s what I learned about refinancing student loans:
Refinancing Vs. Consolidating
Refinancing a loan is not to be confused with consolidating a loan. Consolidating a loan is for those with several loans and means you're paying a weighted average interest on the sum of those loans. Basically, it means you pay the same interest rate for all of your loans.
It doesn’t necessarily save you money because you may have to pay for a longer period of time, and it doesn’t mean you are switching to a lower interest rate.
Your new interest rate is often generated from a variety of factors, including your credit score and other financial information.
The Gist On Refinancing
Let’s move on to refinancing a loan, shall we? Refinancing a loan is essentially selling your loan to a new private lender. They take on your debt; they offer you (hopefully) a lower interest rate and now you pay them back instead of your old lender.
If buying debt sounds weird to you, think of it like this: You owe Sally $20 and she charges you $2 interest every week for that loan.
I pay Sally the $20 instead and now you owe me $20. If I charge you only $1 interest, I’m now making money -- not more than Sally, but hey, I was making nothing before.
That’s a pretty basic way to look at it. It can obviously get a bit more intricate than this, but thinking of it like that has always helped me.
Now, you might be wondering, where does that new rate come from? Lenders often calculate your new interest rate based on your credit profile (read: pay your bills on time because this may greatly affect your credit score).
So, are there any risks to refinancing? But of course! It couldn’t be that easy, could it? You should consider a few things before refinancing.
First, you’ll want to check with your new lender to see what federal benefits you may be forgoing by switching to the new lender.
These benefits on your federal loan may range from loan forgiveness, to income-based repayments, to certain tax deductions that you may no longer qualify for if you switch to a private lender.
Next, if you are switching to a variable rate and interest rates end up rising, your interest rates could theoretically become higher than your original rate. Finally, you’ll also want to take a look at the APR.
Lower monthly payments don’t translate to overall savings if you’re extending the life of the loan; on the contrary, the cost of your loan actually rises.
Now that you’ve weighed the pros and cons, let’s say you decide refinancing is for you. The next step is to find out if your current lender offers a refinancing option.
Once you decide if one of these is right for you, follow the application process on the company website and pat yourself on the back; you’ve officially earned the right to kick back and relax at your next college catch up.
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