[00:00:00] Speaker A: If you have federal student loans that you plan to pay off in full or private loans at a high interest rate, it's probably occurred to you at some point that it may make sense to refinance those loans. In this episode, we share some of the factors at play to help you determine when it may be that right time and how if it occurs more than once, it can still be a positive for you financially. Let's get started.
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Hello. My name is Brenton Harrison of escape student loan debt and your host for the Escape Student Loan debt podcast. A couple of weeks ago, we did an episode where we talked about how the pay as you earn plan for federal student loan borrowers can kind of serve as this middle ground between people who think there may be the possibility that they have their student loans forgiven under an income driven repayment plan, as compared to those who think that there is also the possibility that because of how high their payments may be, that they would end up having to pay it off in full. In this episode, we're going to shift a little bit, and we're going to talk about two types of borrowers, federal student loan borrowers who almost definitively will have to pay off their loans in full, and also private student loan borrowers who already have private student loans that they're trying to optimize as best as possible. So first, let's talk about federal student loan borrowers. Right now. If you look at interest rates in the economy, it's pretty clear that there's not much benefit in most scenarios to refinance a federal student loan with a private lender based on interest rates. Now, a few years ago, that was not the case at all. You had people out there who had student loans at six and 7%, and there were private student loan lenders. They were offering the option of refinancing with them at three and 4%, and it made all the sense in the world. But when you're in an environment where the interest rates with a private lender and a federal lender are pretty close, you want to make sure you understand what you are giving up by refinancing a federal student loan. With a private lender, the first thing you're giving up is you cannot unscramble that egg. Once you go from federal to private, you are with private. You can't take it back to the federal government. And having a federal student loan, it has a number of caveats, it has a number of adjustments that you can make that you just cannot make with private lenders. As an example, we've talked ad nauseam about income driven repayment plans, where if you understand the rules of these plans, you can have them recalculate your payment multiple times. There's all different ways that you can strategize to lower your minimum required payment. Whereas when you have a private student loan lender, the real only way to have a lower payment is to have a loan that's offered at a lower interest rate than what you currently have. They do not have income driven repayment. You also don't have the option of having your student loans forgiven under private student loans. Whereas with federal student loans, you not only have income driven repayment which offers loan forgiveness depending on the type of plan that you're under, you also have the ability to have it forgiven through things like the teacher loan forgiveness program or public service loan forgiveness when it comes to deferment and forbearance. With federal student loans, you can have your loans in forbearance for up to twelve months consecutively, 36 months cumulatively over the course of the loan. With private student loans, it's typically three months at a time for a maximum of twelve months or 18 months over the course of repayment, depending on the lender. And there's also when it comes to things like death and disability, while there are plenty of lenders who will forgive your student loans when it comes to the death of the borrower or the disability of the borrower, it's not always the case. With federal student loans. The student loans die with you. If you're totally disabled, your student loans are forgiven due to that disability. With a private student loan lender, you have to actually read the fine print to make sure that it's forgiven as to death or disability. And that's also complicated by the fact that student loan lenders in the private space often ask for a cosigner for that debt. And believe it or not, there are plenty of scenarios where if you co sign on someone else's student loan and that student who actually took out the debt becomes disabled, but you are not, you still have to make the payments on that student loan. So for all those reasons, you want to make sure that if you're refinancing a federal student loan with a private lender, that you're doing it because the interest rate difference is monumental. And to me, monumental means at least half a percent. You do not want to go from a federal student loan at 6.55% to a private student loan at 6.3% because you're giving up so much in order to do so. But if you have a federal student loan that's at 6.55% and you find a private loan that's at 6% or 5.5%, now, you're talking about for large amounts over a significant period of time, potentially tens of thousands of dollars, that it could save you over the course of repayment, and it could, in those scenarios, be worth refinancing with a private lender. If you're in the private space and you already have private student loans, then there's less of a concern. And instead of making sure that you have at least a 0.5% interest rate differential, now, if you have a 00:20 5% interest rate differential going from private to private, it still may make sense to refinance that debt. Now, here's something about the structure of these debts that make refinancing a private loan very appealing in terms of not just doing it the first time, but potentially doing it multiple times over and over and over. Private student loans, when it comes to the process of refinancing them, are unique, as compared to almost any other debt in our economy. If you look at something like a car loan, if you look at something like a home loan, most of the time, when you apply for those new types of debt, whether it's the original debt or whether you're refinancing a current debt, the process of applying leads to something called origination fees or closing costs. So let's say that you're refinancing that $200,000 mortgage and it leads to 2% in closing costs, or two points. That would mean that 2% on $200,000 cost you $4,000 in closing fees just to go through this process. Now, you may choose to do that because you found a mortgage that's offered at a lower rate than what you currently have, but because each and every time you refinance, it leads to more closing costs. You're not going to do it for a very small difference in interest rates. You're going to make sure that when you refinance, that you're limiting the times that you do it to when it's actually significantly beneficial to your finances. The other element that comes with applying for most forms of debt is that when you apply to figure out what your interest rate may be, you have to do what's called a hard pull of your credit. And we're going to talk after the break about how a hard pull impacts your credit score. But needless to say, it has a negative impact on your credit score. So it's even difficult to go through the process of researching if you should refinance these debts, because in most cases, every single time that you try to see what your rate may be, you have to deal with having a ding on your credit. So again, you limit it to the times where you know that interest rate may be significantly better, and you try to avoid researching just for researching's sake. Private student loans are different in both regards. First, when it comes to the closing cost, with almost all private student loan lenders, there are no closing costs or origination fees when you refinance a private student debt. And when it comes to the credit impact, thankfully, at least in terms of figuring out your introductory rate, most private student loan lenders will give you the ability to find that rate by doing a soft pull of your credit. And while a hard pull has a negative impact on your score, a soft pull does not register on your score at all. And only after you've decided to move forward and formally apply would they do a hard pull of your credit that actually has that impact. So while that's a benefit or a feather in the cap of private student loans as compared to other forms of debt in our economy, that doesn't mean that you should just automatically refinance your student loans and assume that it has no impact on the rest of your finances. So after the break, we'll tell you what some of those impacts may be, both positive and negative, so that you have a better idea of when it makes sense to pull the trigger on a private student loan refinance. This is the Escape Student Loan Debt.
[00:08:16] Speaker B: Podcast, a show for established professionals whose student loan payments or loan balances are impacting their marriage, their business, their credit, or their dream of achieving home ownership.
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[00:09:09] Speaker A: All right, let's dig into one of the reasons that you need to make sure you have an understanding of the impact of what happens when you refinance a private student loan. If you're looking on screen, we're going to pull up the elements of a FICO credit score. And while a FICO credit score is not the type of score that every single lender will pull when it comes time to determine your interest rate, it is still the prevalent score as compared to like a vantage score, which is something that you see on sites like a credit karma, which is often a source of confusion. People will say, well, why is my credit score so much higher or lower on credit karma than it is when I actually apply for the debt? It may be because your lender is looking at your FICO score and credit karma is looking at your vantage score. If you're looking at these elements, age of accounts is 15% of your score, and age of accounts looks at the date that you took out each of your different lines of credit. And when you have that date that you took out the loan, it is its functional birthday. And the older the average age of your accounts, the better. This is 15% of your score, 10% of your score are credit inquiries. Credit inquiries being the number of times that people are doing a hard pull of your credit. A soft pull does not impact credit inquiries. A hard pull is something that will negatively impact credit increase, and it's not something that you want to do unless you have a good reason to do so. So when you look at this and you think about what happens when you refinance a loan with a private lender, you are establishing a new line of credit. And not only that, you are also closing out an old line of credit. And when you close an old line of credit, it erases the history in terms of how long it exists when it comes to age of accounts. So it is substantially changing and lowering the average age of your accounts. So 15% of your score is immediately negatively impacted. Now, you obviously will also see an impact in the credit inquiry section, credit inquiries being 10% of your score. And because you will eventually have to do a hard pull of your credit to formally apply for that private student loan, it will show as a hard pull which will have a temporary negative impact on your score. I say temporary because age of accounts is a permanent thing. You just have to wait for the passage of time for your age of accounts to get older. But with credit inquiries, you typically see this reflected on your credit score for up to a year. So if you're looking at the short term impact of applying for a new private student loan, up to 25% of your credit score is going to be temporarily negatively impacted. But in terms of the long term impact beyond that first twelve months, it's only the 15% age of account section where you'll see those lasting effects of your new private student loan. And as long as you have that understanding that if you pull the trigger, it could have those temporary and long term effects and you're comfortable with what they may be, you can start the process of seeing an introductory rate with various lenders. I would recommend that you check out at least three you can see on screen. They were at SoFi. SoFi is a very popular lender in the student loan refinancing space, and you can see on this page that it offers the opportunity for you to see your rate in as little as two minutes with no commitment. That's letting you know that you can see your introductory rate with a soft pull of your credit. And only after you've compared and contrast amongst the various lenders and decided that SoFi would be right for you do you have to formally apply and then be faced with the hard pull of your credit. And even before you go through that, you can actually see if you get that introductory rate, the potential benefits of refinancing based on what current rates are with each of these lenders. SoFi actually has a student loan refinancing calculator where you can see certain estimates. For example, if you're following along on screen, we have a student loan borrower who owes $100,000. Are going to assume that that's at an 8.5% interest rate and that they have 300 months remaining on their repayment. We did that amount because that's 25 years, which lines up with the longest period of time that you'd have to pay on your student loans before they'd be forgiven under an income driven repayment plan. So let's say that they have those 300 months left for $100,000 at 8.5% interest. That means that to pay it off in full within that given period of time, it would cost them $805 a month. We can now then go to the student loan refinance calculator and we'll put a link to this in the show notes, and we can compare that to the rates that they would get if they refinance with sofa at different intervals. For example, if they took that 25 year loan at 8.5% interest based on their credit, they could potentially refinance with a private student loan with sofa at a 20 year repayment with a rate, depending on their credit, of anywhere from 6.35% all the way up to 9.59%. Now, of course, it wouldn't make sense to refinance if they don't get a better rate than what they currently have. But you can see that if they got as low as 6.35%, it would save them up to $68 a month. They would be paying it off for five years less, and it would save them over $64,000 over the course of repayment. You can see that if we went down even lower to the 15 year option, it would be even more significant. It may not save them in terms of their monthly payment, but because of the interest rate difference, it would save them over $88,000 over the course of their repayment. And once you've gotten to the point where it's not going to save you on the repayment, and matter of fact, it could cost you significantly more. This brings to mind something that you want to be careful with when it comes to pulling the trigger on a private student loan refinance. And what I often see when people refinance any type of debt, but specifically federal or private student loans, is that they get so aggressive with wanting to pay off that student loan debt that they bite off more than they can chew in terms of the monthly payment. That's why when we talk about having an income driven repayment plan, I recommend that even if you pay extra on your loans, that you negotiate the lowest required payment possible. And as long as you have a lower interest rate on your private student loans, it's the same philosophy there. Even if you could refinance at a significantly lower rate for a ten year or a five year plan, which knocks a decade off of your payments, if it's causing your payments to go up 200 $300 a month, you want to be careful. And I would almost rather you take a higher interest rate with a lower required payment and pay extra so that you can have the budget flexibility of leaning on that lower payment in the case of emergencies. And as that philosophy has extended beyond just my guidance, but general student loan guidance, you've seen people come up with the idea of a student loan refinance ladder. And a student loan refinance ladder involves instead of you signing up for the most aggressive repayment plan at the lowest interest rate possible, paying down that debt aggressively over the course of a few years, and then continuing to refinance at lower and lower interest rates and shorter and shorter repayment periods. For example, if you're following along on screen let's say that we started our loan off with $100,000. It was with our current lender at 8.5, but we're going to refinance from 25 years at 8.5 to 20 years at 6.35. This means that our initial payment will be $737 a month. Now, we may choose to pay extra on that. Maybe we pay $1,000 a month, maybe we pay 850 a month. And you continue to pay extra and pay it down aggressively until the point where you may get to 75,000. And once you get to 75,000, and you might have done it in two or three years when you started at a 20 year plan. Now you can refinance that 75,000 at an even lower interest rate, say 6.1% over 15 years. This knocks your payment from 737 a month down to 637. But you continue to pay the same amount you are paying, almost like a credit card snowball, until you get to the point where you owe $50,000. And you continue to follow that ladder while leaning on the ability to make that lower payment in the case of an emergency, but taking advantage of those extra payments to still shave off the time as compared to what you originally started with, while protecting your ability to save, to invest, to pay down other debts, and to be prepared for emergencies. So for all these reasons, if you're in a scenario where it may benefit you to refinance with a private student loan lender, you should not be worried about potentially doing it more than once. There are people out there who do it a countless number of times. And you also want to understand that you should continuously look at interest rates. Now, some lenders only change their interest rates once a quarter, which is why I typically tell people who are either interested in taking a federal student loan private or those who already have private student loans to just set a calendar reminder so that every three to six months, you're checking on a quarterly or semiannual basis to see if it makes sense to you. And if it does again in the future, you may be able to pull the trigger again. See you in a couple of weeks from escape student loan debt this was the escape Student Loan Debt podcast, a show for established professionals whose student loan payments or loan balances are impacting their marriage, their business, their credit, or their dream of achieving homeownership.
