If you have a student loan I’m sure you have seen them recently. The offers that come either in the mail or online, to refinance that loan into one loan through one provider to get an ideal rate. But is it a good idea? Hopefully these two examples will give you a way to think through whether or not it is a good idea to refinance that student loan…
- Undergraduate loan (Direct unsubsidized loan) $25,000 @4.29%
- Undergraduate loan (Direct subsidized loan) $15,000 @4.29%
- Jill is single and recently graduated last May 2015, with a Bachelors degree in Communications.
- She found a job that pays her $50,000 a year.
- She has to begin payback this month of January 2016.
She has multiple options to pay back her loan, but here are what I consider the main two.
The standard payback period is 10 years. Leaving Jill with a
If she does Pay as You Earn Revised over 11.5 years (the time it takes because of lower payments) it would be
- $270/mo, initially.
Now what happens if she were to Refi this loan through a company I’ve seen and heard from lately called Sofi (or insert other student loan consolidators here)?
Firstly, she would lose all the income based repayment options. This means Jill’s payment would not fluctuate with her income anymore. She would be locked in to the offer she takes.
Say she does the 10 year payoff.
They currently offer a 4.62% interest rate with the best credit, so best case scenario would be a
- $416/month payment.
Obviously not much better than the income based repayments. BUT: If Jill gets a higher paying job at $75,000 in a couple of years she would owe
- $411 a month – the max is capped at the standard payback method
For this example it doesn’t appear to be a better deal when you lose the flexibility of the income based payment. Although you may pay extra months, since the initial payment is so much lower because of her income it might be worth it for her to not refi. Also, her interest on her loans is low compared to what the offer was.
John & Ashley Free’s situation:
- John undergraduate loan (Direct Subsidized loan) $30,000 @4.29%
- John undergraduate loan (Direct Unsubsidized loan) $35,000 @4.29%
- John Graduate loan (Grad Direct Plus loan) $100,000 @6.84%
- John graduated with his Masters in business last May 2015. His payments start January 2016.
- He got a job making $100,000
- They are married
The Standard repayment plan 10 year payoff, would be
A Pay as You Earn Revised program which would take 14 years and would be
Considerably less than the standard repayment plan, because the couples income level is considered low compared to the outstanding student debt.
So what does it look like if they refinance?
At a fixed rate for a 10 year payoff @4.62% fixed it would be
Although with a 15 year payoff @5.22% would be
There are obviously a lot of variables that affect whether you should refinance or not.
Think about if John & Ashley anticipate making more money rather quickly. It would then be better for them to refinance, because it would be a lower payment compared to the Standard payback. Another question would be, is it better for them to file their tax return as married filed separately so that John can qualify for a lower monthly payment that only uses his income?
As with most things finance, it depends. Every situation is different. Everyone has different goals and therefore you need to incorporate different assumptions. With that in mind Jill should probably keep her income based repayment plan. John and Ashley might want to consider refinancing if their income will increase rapidly. The other variables I didn’t get into were the initial interest rates on their student loans. The rates will vary by the type of loan you have and when you took it out. So comparing interest rates can have a big impact on your decision. Time frame can be very important as well. Depending on how quick you are trying to pay off your loans it might make your decision easier.
Lastly, tax implications. If you stick to an income based repayment plan, any amount forgiven after 25 years counts as taxable income to you. Depending on the size of loan that gets forgiven, this could be a big consequence to deal with.
Knowing all your options is only half the battle, but choosing the right option is important for you to be able to live the life you desire.
With so many variables, and trying to figure out what to do, why not schedule a free 30 minute strategy session to figure out which strategy would be best for you.
For all assumptions I used the following website: https://studentloans.gov
For interest rates: https://studentaid.ed.gov
I assumed that the borrowers qualified for the best interest rates at Sofi
All examples are hypothetical and are for illustrative purposes only. Actual Results will vary. Past Performance does not guarantee future results. Commonwealth does not provide legal or tax advice. Please consult with a legal or tax professional regarding your individual situation.