Posted by Elliot Kravitz, ATP

Refinancing Federal Student Loans

Refinancing Federal Student Loans

If you are overwhelmed with student loan debt, there may come a time when it will be difficult for you to move forward. You make payments as at when due, but you are not even close to the principal. Who is to blame? Interest rates. Federal student loans have a fixed interest rate that doesn't change over time, and that means that you are stuck with the rate, and if you have PLUS loans, that rate could exceed 5%.

One possible solution is to refinance student loans. But while it can help student borrowers save money on interest, it's especially risky for federal student borrowers.

What is student loan refinancing?

You've presumably heard that you can save money by refinancing your car loan or mortgage. Well, you can also refinance and consolidate your student loans, save interest, and make it easier to manage payments. And by reducing it by a few percentage points, you can save thousands of dollars and get out of debt faster. Sounds attractive, doesn't it?

While there are economic benefits, this can be a risky decision, especially for federal student loan buyers.

Consequences of refinancing federal student loans

The United States Department of Education administers your federal student loans. Federal student lenders have certain rights through the Department of Education.

For example, federal student lenders have access to various repayment plans, including an income-based plan, which bases monthly payments on your discretionary income. People between the ages of 20 and 25 may be eligible for student loan repayment. Federal student loans also have access to deferral and forgiveness options. These options can put your student loan payments on hold if you can't make monthly payments.

Integrated benefits

Federal student loans have many built-in protections for consumers, such as death or disability write-offs, generous deferral and leniency options, and the right to remedy a default. These programs are provided by contract and federal law, which makes them incredibly robust. And these perks can be useful if you work in a low-paying field or are struggling in tough times.

What are you at risk of losing?

But federal student loan lenders forgo some benefits if they refinance. When you refinance your student loans, it means you are working with a private corporation. As such, you are on their playing field, fighting their rules. While refinancing your student loan can save you money, it might not be of any help if you lose your job and can't make payments. You will not get the generous federal loan benefits offered by the United States Department of Education.

And after refinancing, there is no turning back. Refinancing federal loans into private loans is a one-way street outside of the federal lending system. There is no way to turn a private loan into a federal loan.

As a federal student loan borrower, you may lose the following benefits through refinancing:

  • Death and disability

  • Default rehabilitation 

  • Deferment

  • Eligibility for an income-driven plan

  • Forbearance 

  • Payment assistance programs (such as public service loans forgiveness and other programs)

  • Possibility of cancellation of student loans

While lenders in student loan refinancing may offer some benefits, such as referral, the benefits are still limited compared to what the US Department of Education offers. Also, private creditors can change their offers at any time.

Private student loans are contracts.

The consumer protections offered to a private buyer of a student loan are contractual and often discretionary, which means that the lender or the credit manager can decide whether or not to apply them.

There are also many unknowns about the student loan consolidation industry. Since many participants in the private student loan refinancing arena are relatively new, we just don't know how they will handle issues or defaults. We don't know how tolerant and flexible they will be, how freely they will implement aid programs in their contracts, or how aggressively they will pursue people.

Is refinancing a good idea?

If you consider refinancing federal student loans, it is important to weigh the pros and cons carefully. The cost savings may be beneficial for some borrowers, but it may not be a good idea for most federal government student loans. There is a lot to lose in terms of benefits and protections.

However, refinancing federal student credit can be a good idea in certain circumstances. For example, if you have a stable job, large cash reserves, and intend to pay off your debt quickly, refinancing may be a good idea to lower interest rates and pay off debt faster. But there's no fast rule about who should and shouldn't refinance federal student loans.

I think borrowers need to understand what they're getting and giving up and need to assess their risk tolerance. For some borrowers, this risk can be very high, while for others, it can be a short-term risk that helps them pay off their debts faster.

So if you have a federal student loan and want to save interest on refinancing, consider your current financial situation first. Understand the benefits and protections you can lose and make sure they're worth it.

How Does Student Loan Refinance Affect Your Taxes?

Those who are considering refinancing a student loan will be happy to know that it is very likely that it will have little or no effect on their Taxes. Here are a few reasons:

  • IDR (Income-Driven Repayment plan) tax liability on forgiven debt: If you have an IDR plan, refinancing can reduce your potential student loan tax debt: states that the IRS may consider canceling the IDR student loan as taxable income. Depending on the amount forgiven, it can lead to a big surprise in the tax account. Therefore, by refinancing student loans, you can not only lower your interest rate, but you can also avoid a potential student loan tax bomb in the future.

  • Income limits: You can only claim a student loan interest deduction if your income is below the levels described above. But borrowers usually refinance this because they have high income and no longer benefit from IDR (income-driven repayment plan). And in this case, the concern about taxes may not be relevant, as you may not have the right to deduct the interest on the student loan in any way.

  • Refinancing can generate more savings in general: Even if you qualify for a student loan interest deduction, refinancing can still make financial sense. For example, if you save $2,500 a year in interest and lose $925 in interest deductions on student loans, you will still come out ahead by $1,575.



Elliot Kravitz, ATP
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