When most kids enter college, they never imagined they would be leaving school four or five years later carrying a mountain of debt. They certainly couldn’t know how it would impact their lives, with many struggling, paying down student debt, while living paycheck to paycheck. The average student loan debt for today’s college graduates is $37,000, which will cost them more than $27,000 in interest costs over the life of the loan. That’s $27,000 that won’t be going towards buying a house or starting a family or retirement. You go to college to expand your opportunities, only to have them stunted by ongoing debt payments.The High Cost of Student Loans
The problem with carrying student loan debt is that the interest costs mount up over the length of the loan, which can run 20 or 25 years depending on the type of loan. Making the minimum payment on loan allows the interest to continue to grow on the balance, much like compounding interest in reverse. If you can lower the interest rate to reduce the monthly interest cost, you could accelerate the principal payments which will reduce your interest costs, allowing you to pay the loan off sooner.
For example, if original balance on your student loans was $37,000 with an average interest rate of 5.5 percent, your monthly payment would be $227 of which $169 is your initial interest cost. Five years into your loan, your balance is $33,000 and your interest cost is around $151 out of your $227 payment and you have 20 years left on the loan.Slashing Your Interest Costs
If you took your loans to a private lender and refinanced them at a rate of 3.5 percent for 15 years, your monthly payment would increase to $235 but your interest costs are reduced by almost 40 percent. Most of your money would be going towards principal. If you were able to increase your monthly payment to $260 a month, you would pay the loan off almost two years earlier.
The bottom line is you save nearly $18,000 in total interest costs and you have your life back.How Does Student Loan Refinancing Work?
Refinancing student loans can only be done through private lenders. Borrowers with very good credit can qualify for low rates currently around 3 percent. If you don’t have great credit, you can apply for a loan with a cosigner who does. You will still be the primary borrower responsible for making the payments, but, the cosigner will be on the hook if you don’t. Some lenders offer a cosigner release once the primary borrower makes 12 to 24 months of on time payments.
Loan terms vary from lender to lender but most offer terms of 10 to 15 years. Most lenders offer variable loan rates, which means your rate can start out really low, but, if interest rates rise, your loan rate can increase. However, an increasing number of lenders are starting to offer fixed rate loans.
Shopping around at banks that offer student loan refinancing as well as alternative, online lenders, is critical for comparing loan rates and finding loans with the lowest costs. The more competitive lenders don’t charge origination or application fees.What You Need to Know Before Refinancing Your Federal Loans
Before taking the plunge into refinancing your federal loans, there is a downside you should consider. Once you convert your federal student loans into a private student loan, you no longer have access to certain protections. For instance, if you run into a financial hardship and are unable to afford the full payment on your private loan, you won’t be able to turn to one of the income-based repayment options that are available with your federal student loans. Income-based repayment options are great when you run into financial trouble; but, they will also increase your interest costs over the life of the loan. Most private lenders don’t offer any repayment options, though a few offer a temporary, graduated-payment option.
Along with the loss of repayment options, you will also lose the loan forgiveness opportunity that comes with them. Also, most private lenders don’t offer deferment or forbearance in the event of a significant financial hardship.Should You or Shouldn’t You Refinance Your Student Loans
The thing to consider is, if you think you might need any of those protections sometime in the future, you may not be a candidate for accelerating your loan payoff anyway. If your primary objective is to lower your monthly payment to make it more affordable, you should consider one of the income-based repayment plans. However, if your objective is to lower your interest costs so you could pay down your loan more quickly, you would need to be able to commit to paying the full monthly payment and more if you can afford it.
If you have the certainty of steady employment with regular salary increases, you can and should consider refinancing your student loans. It would be important to make it a part of a long-term strategy to become totally debt free. If you can commit the resources, there is nothing stopping you from paying down student debt in less than 10 years.
By Patty Moore, blogger @WorkMomLife on Twitter!