Most refinancing involves replacing an existing loan with one with either a lower rate or a shorter term. Employees may question why they shouldn’t refinance right away given those two options. The answer is many of them should, if they can meet a few conditions.
Student loans are universally bemoaned as oppressive, burdensome and nightmarish. One recent grad even called them inhumane. The urge to get rid of them faster or find some way to make them hurt less can’t be ignored. It’s not unlike the itch you have on the bottom of your foot in the middle of the meeting: constant, distracting, and probably a little sweaty. But just as all rational employees know to keep their oxfords on the middle of the quarterly SWOT analysis, so too should employees look and listen before refinancing their student loans.
While conventional wisdom advises that employees should refinance as soon as they have stabilized their income and have achieved a solid credit score, there are a host of reasons to question that advice.
Most refinancing involves replacing an existing loan with one with either a lower rate or a shorter term. A lower rate saves money over the course of the loan, freeing up more for the employee to use later on (for children’s education, retirement or a house purchase). A shorter term may temporarily increase the amount of loan payments but shorten the duration of the loan, allowing for savings over the long term and reducing debt to income ratios for those employees looking to possibly purchase a larger house or qualify for some other loans (for those looking to start a business of their own in a decade or two).
Since each of those scenarios sounds anything other than sweaty or itchy, employees may question why they shouldn’t refinance right away. The answer is, many of them should, if they can obtain a better interest rate than they currently have and can meet a few other conditions.
The other conditions are the key. The key condition is a stable job in a stable industry. Refinanced federal loans aren’t eligible for certain flexible programs, like loan forgiveness or a change in payment plans based on income. That means employees that are downsized through a change in the market and obtain a new job at a lower rate of pay may not be eligible for more flexible or income-based payment plans on their federal loans (private loans are another matter entirely).
Another condition to refinancing student loans is the key one: the terms should change to be more favorable. If the new term makes the monthly payment lower without impacting the life of the loan, then it is more favorable. Changing from a $500 a month payment to a $400 a month payment only makes sense when it doesn’t require that you make an additional decades’ worth of payments at $400 a month to make up for it.
Other reasons to keep your shoes on, so to speak, in refinancing student loans is the potential negative impact a new loan might have on a credit report. This may be especially important for those employees looking to buy a home. Some refinanced loans may have a temporary depressing impact on a credit report or score and therefore negatively impact mortgage options for an employee. Usually, those impacts to credit scores are relatively short-lived. Importantly, if the refinancing alters your monthly student loan payment it could have a positive impact on mortgage possibilities, as it would lower an employee’s debt-to-income ratio. The key then is timing, no matter how badly the itch to lower the debt payments are, getting the refinancing completed at the right time may have a significant impact.
Another odd impact on credit from refinancing student loans may come through consolidation. For most students who borrow to attend college, they may have multiple loans per year, resulting in what appears on a credit report as multiple individual loans. Refinancing can involve consolidating those multiple individual loans into one payment. However, for those with little (or bad) credit, having multiple credit payments reporting as on time paid in full for a period of time can enhance credit (especially if there are other aspects of an employee’s credit that might have been late or not paid in full). Employees with credit concerns should seek advice from consumer counselors before opting to consolidate loans into one monthly payment.
Employees who have interest rates that are reasonably low, but locked in, may also want to rethink whether they wish to refinance if it means accepting a lower, though variable rate. While paying 1.5% less per month at the variable rate could produce long0term savings, those savings will vanish if the rate varies to a 1.5% higher rate than before the refinancing occurred.
Finally, employees with less than $15,000 in loans may not see much of a benefit from refinancing and the new loan hit to their credit score could do more harm (even if tit is only temporary) than good.
Whatever the reason employees want to refinance their loans, ensuring that they’ve considered all the possible implications could keep them from ending up losing their shoes.
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