College students are graduating today with more college debt than at any time in history.
With the average debt for the 2015 graduating class estimated at more than $35,000, it's only natural that new grads, along with those who borrowed more than $1 trillion dollars before them, are often eager to find ways to lower that load.
Many borrowers naturally wonder if refinancing or consolidating their student loans will provide relief. The answer is: Making this move can be a smart idea for some graduates, but not for others.
Here are four things that you need to know about restructuring your student loans.
1. Student debt is different than other kinds of debt.
You can refinance your house and capture a lower interest rate. And you can move your balance from a credit card with a high interest rate to one with a lower rate to save money. But strangely enough, federal law prohibits borrowers from refinancing their federal student loan debt to capture today's lower interest rates. For example, it's impossible for a borrower who has older student debt charging 7 percent interest to refinance it into the current federal direct loan that charges an interest rate of 4.29 percent.
Individuals can consolidate their federal loans with the federal government, but the new interest rate generated with the combined loans will be calculated using the weighted average of the rates of a borrower's loans, and the interest rate will be rounded up by 1/8th of a percent.
This inability to capture lower rates is a moneymaker for the federal government, but extremely disappointing for borrowers. U.S. Senator Elizabeth Warren (D-Massachusetts) has so far unsuccessfully sponsored legislation to allow borrowers to benefit from lower federal rates when consolidating.
2. You may want to consolidate to stay organized.
Students can easily graduate from college with a dozen federal student loans or more. It can be challenging to keep on top of all of them and making sure all the payments are made on time. You may want to consolidate just to simplify your life with a single monthly payment.
3. Refinancing federal debt into a private loan is risky.
If you have excellent credit, you may be tempted to refinance your federal debt with a private lender at a lower rate. This, however, poses significant risks.
Private student loans do not offer the safety features that federal loans have, such as hardship options like forbearance and deferment and more repayment methods. For instance, the federal government offers the Pay As You Earn plan for borrowers that essentially allows them to repay their federal loans based on what they're making rather than what they owe. This can be an especially attractive offer for borrowers with large amounts of debt from graduate and professional schools.
There's no turning back if you move federal debt into a private loan. You can't later transfer the debt back into a federal loan.
It's almost always better to avoid combining federal and private debt.
4. You can refinance private loans.
Unlike federal debt, however, it is possible to lower your payments by refinancing your private loans with a private lender such as a bank or credit union. Whether you qualify for a lower interest rate will depend in part on your credit profile. If you're a recent grad, it could be difficult to get an attractive rate without a co-signer.
If you have excellent credit and are eligible for a lower rate, you could save money. You can speed up the repayment process by using your savings to pay down the principal faster.