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Should You Refinance Your Student Loans?

Kimberly Rotter

Refinancing student loans can save you money under the right circumstances. It could be helpful to score a lower interest rate, to change from a variable interest rate to a fixed rate, to consolidate your loans for a single monthly payment, or to release a co-signer.

At the same time, you could lose protections and benefits from your original student loan. Before you refinance, make sure you understand your choices, including any trade-offs.

Types of Student Loans You Can Refinance

First, know that federal student loans cannot be refinanced through the U.S. government, only consolidated. You cannot swap your federal student loan for another federal loan with a different interest rate or change your private student loan into a federal loan. Congress, not banks, sets rates yearly.

[Read: Best Student Loan Consolidation and Refinance Companies.]

You can, however, refinance your private or federal student loan into a new private loan. Nevertheless, refinancing a federal student loan into a private loan "doesn't make sense for the vast majority" of borrowers, says Whitney Barkley-Denney, a senior policy counsel specializing in student loan issues at the Center for Responsible Lending.

In doing so, you'll lose eligibility for government assistance programs, including, notably, the ability to enroll in an income-driven repayment plan. All four plans forgive any remaining loan balance if you haven't fully repaid your federal loans at the end of the repayment period. Likewise, certain public service workers repaying their direct federal loans on an income-based repayment plan will no longer qualify for loan forgiveness.

Another important benefit of federal loans that some private lenders do not offer is the ability to temporarily reduce or stop payments but avoid default through deferment or forbearance. Federal student loan borrowers can apply for deferment or forbearance under certain circumstances.

The difference between deferment and forbearance is that you are not responsible for interest that accrues on certain types of federal loans during a deferment, and you are responsible for all interest that accrues on your federal loans during a forbearance.

When It Makes Sense to Refinance Student Loans

Is refinancing your student loans the right choice for you now? Seriously consider it if:

Your credit score is strong enough to qualify for a lower interest rate than your current one. You may qualify for student loan refinancing with a FICO credit score of about 650, but a higher score gets better rates. "If you can get a lower rate that would significantly decrease the amount paid back over time, it's worth looking at that (refinance)," says Barry Coleman, vice president of counseling and education programs for the National Foundation for Credit Counseling and U.S. News contributor.

Your private student loan has a variable interest rate, and you want to refinance to a fixed-rate loan. With a variable-rate loan, at some point, you could see your interest rate go up. If that happens, a new fixed-rate loan might be cheaper.

You want to reduce the number of monthly payments you make. If you have multiple private student loans, you might want to refinance them into a single loan so you can make one monthly payment. If you want this result and your loans are federal, the process is called a loan consolidation, not a refinance. Your new federal direct consolidation loan would have a weighted average interest rate, or an interest rate that is the weighted average of your current loans, rounded up to the nearest one-eighth of 1 percent.

[Read: Best Private Student Loans.]

You want to release a co-signer. If you can refinance a private student loan in your name alone, you could free a co-signer from liability for your debt. However, some lenders offer a co-signer release only after a number of on-time payments, such as two to four years of consecutive timely payments.

You can save money with a private loan and are willing to give up federal benefits. This won't apply to most borrowers, but it is possible.

You will save more in interest than you will pay in closing costs. This is true for any loan. Figure out how much you'll save in interest every month. Although rare and usually less than 5 percent, origination fees may come with some private student loans. If the amount you save in interest over the life of the loan is greater than the origination fee, the refinance could be a good move.

Reasons Not to Refinance Your Student Loans

When the benefits of refinancing are unclear, don't do it. There is no hard and fast rule about how much you need to save to make a refinance worthwhile, but it should be worth the hassle and any potential costs. If you're losing benefits, as with refinancing federal student loans into private loans, be sure you are comfortable with that.

Coleman always cautions borrowers to think about what they could be giving up. Consider your goals. "If you plan to pursue loan forgiveness or discharge, you would not want to (refinance) to a private loan," he says.

Sometimes the benefits and protections of federal student loans may outweigh the gains of refinancing into private loans. If you are struggling to make payments or need a lower payment, staying in a federal program with many payment and emergency options is a better choice than refinancing, Barkley-Denney says.

[Read: Getting Student Loans Without a Co-Signer.]

Also, avoid refinancing when the risk is too high. For example, if you're a parent who has one or more private loans for your child, think carefully before you take out a home equity loan or tap a cash-out mortgage refinance to manage student loan debt. These types of loans use your home as collateral, and if you default, you could lose it.

How to Prepare for Refinancing Your Student Loans

If you've weighed the pros and cons of refinancing and decided to proceed, you can prepare now to take advantage of a lower interest rate, when it becomes available. Here are some steps you can take:

-- Know what type of loans you have and who your servicers are. You can find this information for your federal loans in the National Student Loan Data System database. For private loans, you'll need to contact each lender for information.

-- Know the interest rates on your loans.

-- Know the benefits of each of your loans, including income-based repayment plans available to you.

-- Avoid a forbearance, if possible, because interest will accumulate.

-- Check your credit annually.

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