Saturday , 31 July 2021

Re-Financing Student Loans: Is It Right For You?

The statistics overwhelmingly point to the fact that the average law school student not only graduates with a shiny JD, but often a small mortgage-sized student loan balance. Law School Student Loan Warning discusses the perils of diving into law school or any other graduate degree when a significant portion of your financial backing comes from student loans, but for those who already find themselves on the wrong side of the fence this is water under the bridge. You’ve graduated law school and the monopoly money doesn’t seem like monopoly money anymore. Your grace period is nearing its end, or, your first monthly payment has arrived. The balance seems insurmountable, but you’re determined to rid yourself of this debt as fast as possible. You’ve heard that some are re-financing their student loans to get a better deal. Is re-financing your student loans a smart move? The answer to this question depends on a variety of factors. The below discusses the basics of what you should consider.

The Positive – Lower Interest Rate:

One of the biggest problems with student loans is the interest rate at which they are offered. It’s ironic, actually. The same individuals who developed student loans to provide more people with access to education apparently didn’t think about the other side of the equation: what happens once they are disbursed. It is insufficient to provide someone with a loan to help them with their education when the interest rate ensures that loan will snowball. As they currently exist, Stafford and Grad PLUS loans are disbursed with an interest rate between 5-8%. This means that for every $1,000, they accrue an additional $50-80 a year. Doesn’t sound that terrible until you’re sitting with a $100,000 balance, as many law graduates do. Although it is true that student loans are unsecured and relative to the private market these interest rates are technically generous, if we’re pulling for people to receive an education because we want educated masses it would probably serve us best to provide these student loans at a much lower interest rate. Fortunately, this is where re-financing comes into play. There are certain private lenders out there that have decided to shave the government’s profits off the top. For those most qualified (posing the least default risk), certain private lenders will offer a much lower interest rate by paying down their student loan in full and re-issuing it to them at their own lower rate. Why? Well, these private lenders feel the same way about these usurious federal interest rates and want to step in to give hard working graduates a helping hand. It is possible there are other reasons: they’ve identified a gap between what the government charges and what they could charge while still turning a profit, or the fact that the federal rates are so low these student loans are actually worthy investments in this current environment. But, the intentions are irrelevant. What matters is certain graduates can take advantage of this current climate and cut their interest rates significantly. A lower interest rate will not only mean lower payments, but more of your money hitting principal. This means the loans are paid down faster as there’s less interest accruing and blocking your way. For example, substituting $25-40 for $50-80 on each $1,000 doesn’t sound too bad, does it?

The Negative – Loss of Federal Protections:

Cutting the interest rate on your student loans by re-financing sounds appealing, but it does not come without drawbacks. Private lenders, unlike the federal government, are typically not as gracious about potential hiccups in your life that affect your ability to service your student loans. With the government, there are two important protections that exist: deferment and forbearance. Deferment refers to the ability to temporarily freeze making your monthly student loan payments in certain situations. Most often, this occurs if you re-enroll in school or face unemployment. During deferment, certain types of students loans (ex. subsidized loans) are eligible for a government subsidy where the government pays the interest that accrues during this time period. If you’re coming out of a graduate program, however, the amount of your student loans that will be subsidized will be minimal. Only a portion of Stafford loans are subsidized and Grad PLUS loans are not. However, deferment is a powerful safeguard in an otherwise unpredictable job market.

In addition, federal student loans are also eligible for forbearance. If you can’t make your scheduled loan payments, but don’t qualify for a deferment, your student loan servicer may be able to grant you a forbearance. With forbearance, you may be able to stop making payments or reduce your monthly payments for up to a year. There is a mandatory and discretionary forbearance option available. Discretionary forbearance leaves the decision to your student loan servicer, but often may be granted due to financial hardship or illness. Mandatory forbearance requires a specific event described on the StudentAid website. The problem with forbearance, however, is that the interest will continue to accrue. At the percentages discussed above, this can become a problem when you leave forbearance and that amount capitalizes. This means it gets added to your principal. For example, if you owed $1,000 and accrued $50 in interest in forbearance, once you leave forbearance you may now be accruing interest on $1,050 rather than $1000. This means that’s 5% coming off an additional $50. As a result, these safeguards can be valuable, but they make matters worse if your goal is complete student loan repayment as the interest continues to balloon the balance. Some private lenders who handle student loan re-finance have started to offer versions of these federal safeguards, particularly for those suffering economic hardship, but they are usually shorter-term and in the lender’s discretion. Remember, a private lender wants to get paid. As a result, these safeguards exist on the private side only to the extent necessary to compete with other lenders handling student loan re-finance. The lenders aren’t usually going to compete with the federal government in this category.

Perhaps the biggest problem with re-financing is that it disqualifies you from taking advantage of the various income-based repayment programs (IBR/PAYE). These programs have largely made deferment and forbearance unnecessary, as enrollment ties your monthly payments to a percentage of your discretionary income (income above the federal poverty level).  This way, how much you pay ultimately rests with how much you make. The problem, of course, is that many people on these programs aren’t hitting much of the principal. In many cases, particularly where law school graduate debt levels are involved, these programs merely offer the comfort of avoiding default, not the prospect of actually paying down the student loans. For more information, visit our IBR/PAYE FAQ.

General Factors to Consider:

1. Employment – the legal field has not been kind to law school graduates. Even where jobs are available, the legal field’s bimodal salary scale often makes student loan repayment a problem. Whether re-financing your student loans is a smart decision will almost certainly rest with your particular employment situation. Those in big law making the best salaries out of law school are in a much easier position to deal with their student loans. However, even there the answer is not so simple. Your overall student loan balance still reigns supreme. There are often law school graduates with $200,000 or more in student loans heading into big law to make $160,000 a year. Considering the former is an after-tax amount and the latter is a pre-tax salary, those numbers don’t look as close as they may first appear. With these salaries often limited to high cost of living areas and big law certainly not qualifying for the job stability award, the answer isn’t very simple. Of course, if you’re in a position where you’re on a big law salary and your debt levels are manageable (south of $100,000), depending on your near-term goals re-financing may be obvious. The same can be said for a law school graduate in a smaller law firm making $60,000 with $30,000 in student loans. This brings up the next point.

2. Financial Goals – outside of measuring your employment against your student loan balance, it is important to consider both your short-term and long-term financial objectives. Someone who is planning on buying a house a couple of years after graduation may not want to re-finance and lose the federal protections available with federal student loans. Someone else may not want to tackle student loan repayment and may prefer to simply factor in the monthly payments into their long-term outlook, exchanging faster loan repayment for other necessities. This choice ultimately rests with you. If you want to be student loan free within five years of graduation and your circumstances allow for a planned attack to pay down this debt, the choice to re-finance may be simple compared to the person in the same financial shoes but with other major obligations that preclude making student loans the focus. At the end of the day, this is a financial trade-off. Inherently, the choice is simple: pay more later or pay less now. Deal with student loans far into the future, or eliminate them as fast as possible. Since life variety ultimately dictates, the choice rests with you. With that said, this doesn’t mean that re-financing is foreclosed to those who wish to draw out student loan repayment. If you feel your employment and financial prospects are solid such that you’re willing to give up federal protections for a lower long-term interest rate, re-financing may be beneficial to save money over the long term.

3. Public Interest Work – the decision to re-finance your student loans changes drastically if you’re in a public interest position that qualifies for Public Service Loan Forgiveness (PSLF) and you’re planning on sticking around for 10 years to take advantage of the program. Although the first graduates eligible to successfully qualify for loan forgiveness after 120 payments have not yet triggered PSLF, many believe the rug won’t be pulled from under the program when the first graduates do qualify. If you fall into this area, re-financing shouldn’t be your goal unless your loan amount is manageable and you’re unsure about PSLF.

General Tip:

Whether you are going to re-finance or keep your federal student loans, there is no reason why you shouldn’t immediately enroll in an income-based repayment program. There is no harm in overpaying what you owe under such a program on a monthly basis if your plan is to knock them out as fast as possible, but each month you spend on the program will help you get credit for the unicorn tax-forgiveness “concept” that no one will test for quite some time. Unless your plan is to re-finance immediately after starting your job, enrolling in an income-based repayment program is a smart move.

Student Loan Re-Finance Lenders:

Here are some of the most popular lenders specializing in student loan re-finance, particularly due to their low interest rates. After all, that’s the point of re-financing. They are in alphabetical order:

1) Citizen’s Bank

2) Common Bond

3) Darien Rowayton Bank (DRB)

4) Earnest

5) First Republic

6) LendKey


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