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If you have student loans, you don't need me to tell you that this debt can weigh down your cash flow, slow your progress to your goals, and prevent you from feeling secure in your financial life.
Dealing with student loan debt isn't fun, in other words - which can make the promise of a quick, easy fix to the problem really tempting. Many people look at refinancing as one such solution.
But refinancing isn't always the best move to make. Here's an overview of student loan refinancing that you should understand before making any decisions.
1. Refinancing a student loan means taking out a new loan
When you go through student loan refinancing, the main purpose is securing a lower interest rate (or rates) on your debt. You can refinance both private or federal loans, although refinancing will turn an existing federal loan into a private one going forward.
Depending on your existing interest rate, refinancing to a lower one could save you a significant amount of money. In most cases, student loan refinancing will lower your monthly payment immediately, and that could be a huge benefit.
With more freed-up cash flow, you have more money available each month to put toward other priorities, like your investment accounts, emergency fund, or simply living expenses that are hard to manage right now with your current debt burden.
2. Student loan refinancing could actually cost you more money
If you can significantly lower your interest rate, you might also pay less on your loans in total. But this is where you have to be careful, because refinancing may actually cost you more in the long run.
Paying less in interest is, theoretically, the way to go if you want to save money on your loan - but refinancing isn't free.
When you refinance, you essentially take out a new loan. That comes with origination fees and can also reset the clock on your loan term. If you originally had a 10-year loan that you've been paying off for three years, refinancing could mean starting over with Day 1 on another 10-year loan.
That extension of your loan term could actually negate any cost savings a lower interest rate provided. You'll still have a lower monthly payment, but may end up spending more on your debt over the life of the loan.
3. Refinancing federal loans turns them into private loans
You need to crunch all the numbers before deciding on student loan refinancing, and make sure you understand what scenario puts you in the best financial position. But if you have federal loans, you need to take an extra step to consider what you could give up if you refinance.
Federal loans come with specific borrower protections that private loans may not provide you, including options for discharging your debt. You'll also lose the ability to qualify for federal loan forgiveness programs and repayment plans.
If you refinance a federal loan, you don't have a choice. It's becoming a private loan whether you like it or not. Make sure you acknowledge this trade-off and determine it's worth it to you before you refinance.
Eric Roberge, CFP, is the founder of Beyond Your Hammock.
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