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Should I Refinance My Federal Student Loans?

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I often get this question when I talk to people about refinancing student loans. The answer is a thunderous "maybe." A lot has changed in the student loan landscape over the last 10 years (and even in the last year). Conventional wisdom used to hold that federal student loans are categorically better than private student loans. And while that's never been true for everyone, it has been a useful mental shortcut because federal loans are a better option for many borrowers. However, private lenders are increasingly offering lower rates than the federal government for high credit-quality graduate students. So if you're in that position, should you take advantage of it?

The most important thing to understand in order to answer that question is what you're giving up by refinancing federal or federally backed loans through a private lender. Federal loans afford borrowers certain options that many private loans do not. These include: term extension, Income-Based Repayment (IBR), loan forgiveness programs, and the Federal Direct Consolidation Program.

1. Term Extension. Federal loan repayment plans allow you to extend your repayment period from the standard 10-year rate to a longer repayment period. While this will lower your monthly payment, the extension of your term will also increase the amount of interest you pay over the life of the loan. You can view the various federal repayment options here (http://studentaid.ed.gov/repay-loans/understand/plans). While mileage may vary based on your specific situation, I will say that it is generally better to pay off your loan as soon as possible. That way, you've minimized the amount of interest that accrues on your loan and you have more money to save or spend as you please in the long run.

2. Income-Based Repayment and Pay As You Earn (PAYE). You are also able to take advantage of various repayment plans that are tied to your income. These programs were enacted to allow borrowers to get on their feet just out of college. It is definitely worth taking a look at your budget, calculating your potential monthly payments, and finding the repayment plan that is right for you. You can calculate your estimated payments under various plans here.

3. Loan Forgiveness Programs. Federal student loans also feature various loan forgiveness programs. There are options for both teachers and those in public service. Chances are, if you're eligible for either of these programs, then you likely don't want to refinance your federal loans with a private lender.

4. Federal Direct Consolidation Program. I've seen some confusion about the Federal Direct Loan Consolidation program and private refinancing. People will say, "I can't refinance my loans privately because I've already consolidated them." Whether you've consolidated loans through the Federal Direct Consolidation program has no impact on whether you can refinance those loans through a private lender. Consolidation through the Federal Direct program is a great option for borrowers with disparate student loans and can, in some scenarios, reduce monthly payments. But I want to stress that Federal Direct Loan Consolidation is different from refinancing through a private lender, and you can privately refinance a Direct Consolidation loan.

Why refinance federal student loans with a private lender?

If federal loans have all these great features, then why should someone refinance them? Aren't more options always better?

Not if you're not going to use them and you can save money if you refinance. If you've been working for a few years and have been making monthly payments on a standard 10-year term on federal loans, refinancing through a private lender amounts to a basic tradeoff. You're giving up downside protection (the ability to minimize your monthly payments through alternative repayment plans) for upside gain (a lower interest rate that decreases what you pay over the life of the loan).

If you're not sure whether you're better off refinancing with a private lender, then I propose a quick guideline: if your annual income exceeds the amount of student loan debt you have, then you should research private refinancing. Other factors, such as your credit history and other monthly expenses, should be taken into account, but comparing your income to your debt load is a good start.

As private lenders re-enter the student loan refinancing market, there are more and more options to refinance. In evaluating options that may lower your rate, ask yourself, "Is it worth it to give up federal repayment options to lower my interest rate?" For many young professionals with good credit and a steady income, that answer is likely "yes." But you should familiarize yourself with your federal student loans options before making that decision.

Nate Howard is Corporate Counsel at CommonBond, a student lending platform that provides a better student loan experience through lower rates, superior service, and a strong commitment to community. CommonBond is also the first company to bring the 1-for-1 model to education.

States With Highest Average Student Debt - TICAS - Class Of 2012
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