Should you Refinance Your Student Loan?
When you sign your student loan agreements, the lender offers you 10-years to pay back to money. Statistics show that most students don’t adhere to the original term, with the actual average repayment period being 21-years. That’s two decades of your adult life spent paying the Federal government for the privilege of going to college.
Current outstanding student debt is nearing $1.6-trillion, and we can expect that figure to continue to increase into the future. Unlike most other personal loans available from lenders, the US government insures the loans. As a result, the taxpayer is going to be responsible for bailing out the US government if default rates escalate.
This situation would follow a similar trend as the 2008 financial crisis, where the government stepped in to bail out the banks. This time, instead of a $700-billion banking problem, Americans have a student loan bubble that’s more than twice as large.
Student Loans and Debt
After reading the debt figures for outstanding loans, you may think it’s a good thing. After all, it means that more students are in college, and the country is developing more skilled professionals. However, reality tells a different story. There are three primary issues with student loans and college education that people aren’t taking into account when assessing the extent of the problem.
The first is that less American students are entering the STEM fields. Instead, the behavioral sciences are taking the lion’s share of new freshmen students. Areas of study such as science, technology, engineering medicine, and math are taking a backseat to psychology, philosophy, and political sciences.
Unfortunately, while getting your bachelor’s degree is commendable, it does not translate into a guaranteed job after graduation. Many of the students in the behavioral sciences struggle to find employment due to rising competition for jobs. As a result, most of these students end up entering the workforce in jobs that do not utilize their university training.
The second primary issue with student loans is the rising cost of education at colleges across the country. Tuition, housing, books, and lifestyle expenses all costs a significant amount of money for students, and the average cost of tuition skyrocketed over the last two decades. Campuses saw an opportunity to raise fees with the introduction of federally insured student loans.
As a result, the cost of tuition alone is nearly three times what it was some 20-years ago. The average student loan debt currently sits at $36,000 per student, with some graduating with four times that debt load.
The Economic Landscape for Students with Debt
The third primary factor responsible for graduates defaulting or refinancing student loans is the US economy. The economic landscaped experienced changes alongside the recovery from the Great Financial Crisis of 2008.
As banks collapsed and global credit markets started to freeze up, the US government intervened alongside the Federal Reserve, to stop the financial landslide causing the crisis. The money printing programs known as TARP and QE flooded US markets with cheap money, allowing the government to step into the credit markets and create programs like student loans.
Unfortunately, the effect on the broader US economy did not coincide with the credit expansion. Wealth inequality continues to increase, and real consumer inflation on food and other household staples continues to rise.
Research shows that the American economy is amid a slowdown, teetering on the point of a recession. As a result of the impending contraction, many companies are scaling back hiring, and there are fewer jobs available in both the professional and informal employment sectors.
Why You Might Need to Refinance Your Student Loans
Students that graduate with a diploma in a field that has high competition are struggling. They have to compete with millions of other candidates in a shrinking job market. However, they also have to contend with paying off their student loans as well. Therefore, it’s not surprising that many qualified professionals are working minimum wage jobs to make ends meet.
When your creditors start calling, you need to provide them with the money they need, or they can damage your credit score. Failing to pay, or not paying your debts, results in a lower FICO score set by the credit bureaus. The loan lenders report your payment history to the bureaus, and they adjust your credit score accordingly.
Graduates that can’t afford to pay may find themselves wedged into a tight spot. With a bad credit score, employers won’t want to take a risk on you, even if you qualify. The employer views you as a financial risk and thinks you are more likely to do something risky while working at the company.
You’ll also find it challenging to get a lease on an apartment or condo, as the landlord sees you as a risk for defaulting. You can forget about applying for other forms of credit, like a mortgage or an auto loan, and no bank will issue you an unsecured credit card.
Therefore, many millennials graduating college go to work as baristas, bartenders, or fast food servers to pay the bills. The rising cost of living coupled with minimum wage and thousands of dollars in student loans is a recipe for financial disaster. Some graduates never manage to escape from under the thumb of their debt.
If you’re up to your eyeballs in debt and struggling to pay your bills, then considering refinancing your student loans is an attractive option. By refinancing, you get a lower monthly payment and more breathing room in your budget.
In a nutshell, refinancing involves taking your existing loan and extending the loan term. Instead of repaying the money to the lender in the prescribed 10-years, you can double that to 20-years. As a result, your payment comes down significantly.
However, it’s important to note that extending your loan term means that you’ll be paying interest on the money for another 10-years. As a result, you get a lower monthly payment, but you have to pay more in the long run due to the additional interest charges.
In some cases, the lender may also let you refinance at a lower interest rate as well. The current tightening cycle of the Federal reserve resulted in the Federal Funds Rate, hitting a peak of 2.5-percent at the end of 2018.
The Fed states that they are interested in cutting rates into the future. This situation is good news for students, as they might be able to secure a more favorable interest rate on the refinancing deal. By adjusting, you save thousands of dollars in interest payments over the loan term.
Reasons Why You Shouldn’t Refinance Your Student Loans
Refinancing your loan has plenty of financial benefits. However, refinancing can also cost you access to other federal programs associated with student loans as well. If you want to qualify for a government debt forgiveness program, then you have the opportunity of escaping your debt. However, if you refinance, then you lose this benefit, and you’ll have to repay the loan.
Considering that very few students ever qualify for debt forgiveness, this should not deter you from refinancing. The government only grants debt forgiveness to graduates that are destitute. Unless you are close to living on the street, the chances are that the government won’t grant debt forgiveness over your loans.
Refinancing also leaves you unable to access the federal repayment opportunity if you work in the public sector. Government employees may receive partial or complete debt forgiveness if they commit to working in a government department for their career.
However, if you have no intention of going to work for the government, then this program will not apply to you.
If you have a bad credit score, then avoid refinancing your student loans. The credit bureaus collect payment data on your credit history and use it to calculate your credit score. Borrowers with a credit score of more than 800 will receive the best lending terms on any credit facilities.
People who have a credit score in the 700s are average borrowers, and lenders may offer them a slightly higher APR than prime customers. People who have a credit score below 680 are subprime borrowers, and lenders will charge a high APR on any credit facilities.
Therefore, when you go to refinance your loan, the lender could hit you with a higher annual interest rate. With a higher interest rate, you won’t get much relief in your monthly cash flow. The situation does not benefit you; it benefits the lender.
When is Refinancing a Good Idea?
The best time to refinance your student loans is when you have a stable job and a good credit score. If you are one of the few graduates that managed to secure a good position with a firm after graduation, then you are in the best position.
Keep your loan commitments, and you’ll experience steady growth in your credit range toward the 800-mark. The credit bureaus allow you to check your credit score once a year for free. Visit the Experian, Equestrian, and TransUnion websites once every few months and stagger out your credit reports.
This strategy allows you to keep an eye on your credit score, and lets you know when you achieve a good enough score to refinance. We recommend you try and hold on until you reach an 800+ score.
However, the best time to refinance your student loans is as soon as possible. If you manage to secure a new loan with favorable rates lower than your previous APR, it will save you thousands of dollars.
Most students don’t go into a high-paying job after college and plenty that remain unemployed. If you are struggling financially, and your credit score is low, wait until it improves before refinancing your loan.
Graduates that have more than one loan, which is the majority of students, should refinance as soon as they get an opportunity. All federal student loans come with a six-month grace period after graduation. The government offers this grace period to help graduates get on their feet financially, and find a job before the loan payments start.
If you are struggling to find work, and the grace period is about to expire, then its best to enquire about refinancing right away. By refinancing, you drop your monthly payment but extend the payment period. While this may cost you more over the term of the loan, it helps you find room in your budget, and avoid default.
What Happens if You Default on Student Loans?
Some students succumb to the financial pressure and start to default on their student loan agreements. It’s important to distinguish the difference between debt held with private lenders, and that held with the US government.
If you default on private debt, the creditor lodges a collection notice against your credit report. The creditor may also choose to file a judgment for the debt against your name in court. If you receive a judgment, and can’t pay the debt, you have the right to file for bankruptcy. Bankruptcy absolves you of your previous debts and allows you to start with a clean slate.
However, federally backed loans are different from private credit facilities. If you enter bankruptcy, then your student loan debt does not go away. You are still liable for the monthly payments, and it remains as a permanent blemish on your credit report.
Wrapping Up – Key Takeaways
Refinancing your student loans will help you if you are struggling financially. By refinanci9ng, you get the opportunity to reduce your monthly payment by extending the loan term.
If you have a good credit score, then refinance directly after the grace period ends, six months after graduation. By refinancing early, you save yourself thousands of dollars in interest payments over the loan term.
When refinancing, check your credit score with the credit bureaus. If you have a lousy credit FICO score, make arrangements to improve it before refinancing. Applying for refinancing with bad credit will result in the lender offering you unfavorable terms that don’t help your financial situation.
If you plan on applying for debt forgiveness, or you want to work for the US government, then avoid refinancing.