NEW YORK (MainStreet) — Student loan debt is up to a whopping $1.2 trillion for the country. But defaults are down, and the economy is stronger. This has led to a flurry of offers for student loan refinances. However, if you get into a student loan refinance deal that only looks good on the surface, you could end up paying a lot more in fees with fewer protections than you have for your current loans. So how do you know if student loan refinancing is the right choice for you?
Why Is There a Refinancing Bonanza Right Now?
Mike Sullivan, the director of education with nonprofit credit counseling agency Take Charge America, believes there are a couple of reasons for the current refinance frenzy. One is the oft-stated fact that student loans cannot be discharged in bankruptcy. "Student loan lending is a very low-risk form of lending," he says. "Federal law makes them so collectible that they're easier to collect even than secured loans." What's more, with interest rates so low across the board, student loans can look like a competitive investment for banks.
John Heath, managing attorney with LexingtonLaw agrees. "We're in a much better economic climate than we were six years ago," he says. And because of this better climate, banks are much more willing to refinance a number of loan products, including student loans. So if you're dying inside every time you look at your student loan interest charges, it's time to at least start thinking about whether or not now is the right time to refinance.
Interest Rates Reign Supreme
While there are other factors involved, the first issue of importance you need to look at is the interest rate. "Common sense says that no one is going to lend money for less than 3% for any purpose," says Sullivan. This is because the paperwork and processing costs quickly wipe out any yield that might be gained from a refinanced loan. Sullivan says that a 3.5% interest rate would be very competitive, with 4% to 5% interest rates being far more common. If you're paying much more than that, start looking into what your refinance options are. But don't have interest rates be the only factor in your decision making process.
Considerations Besides Interest Rates
Interest rates aren't the only factor you need to consider when you're looking into refinancing your student loans. Heath says that if you're near the end of your repayment, you probably won't save much no matter how much your interest is getting lowered. What's more, because refinancing might take a government loan and convert it to a private loan, you'll be sacrificing some of the protections you currently enjoy under federal law.
"The first thing to do is make sure you're comparing apples to apples," says Sullivan. "If you have private loans about the only thing that matters is the interest rate or the length of the loan." The issue comes into play when you get a private refinance of your government student loan. "You have additional forbearance and repayment options with a government loan. You have to ask yourself if you're willing to give up those protections for a lower interest rate."
"I would look at your finance charges, convenience charges for online payments and what happens if you're late on your payments," says Heath. Other questions to ask yourself are if there are any grace periods for late payments, as these are common with student loans. If you're being offered a deal without a grace period, keep looking. You'll probably find one somewhere else. Finally, Heath urges people to look at what happens if you go into default. "Most places are going to have pretty severe penalties for defaulting, but some are worse than others," he says.
Evaluating a Lender
Finally, before you take the plunge, make sure you're using a reputable lender. Sullivan says the easiest way to find a reputable lender is to simply go with a larger bank that's a known quantity. Further, Heath suggests that you use the Better Business Bureau to ensure that your lender has a good track record when it comes to student loan refinancing.
Refinancing your student loans can save you a lot of money over the life of the loan. With just a little bit of due diligence and legwork, you can take advantage of those savings.
--Written by Nicholas Pell for MainStreet