With college years left behind, and the real world beginning to settle over your life, it's time to think about what to do about your student loans. Obviously, you want to pay them off as quickly as possible, but should you refinance them, and if so, how should you? That question may not be quite as easy as you think. Not all student loans can or should be refinanced, and here's why.
Tax Benefits- Simply put, the interest you pay on a student loan is tax-deductible every year. The same can't be said, though, for a personal loan or credit card debt, common ways of refinancing. For instance, let's say you have a $20,000 student loan that is federally promised. If you pay 5% interest per year, you'll pay about $1,000 in interest. Refinancing may reduce your interest to a 4% rate, and you'll pay $800 in interest, but your taxable income will be raised by $1,000. If this kicks you into a higher tax bracket, that $200 savings could easily be nullified.
Institution track record- Regardless of your personal credit history, if you have privately-issued student loans that aren't backed by the federal government, private refinancing banks may want nothing to do with them. This may be because the students' repayment history is available to the refinance banks, and if a great enough number of those students ended up defaulting on their loans, the company won't want to take a chance on you. Keep in mind, though, that that only applies to privately-issued loans. They're usually more than happy to refinance federally-funded loans because if you default on the loan, they can ask the government to cover their losses.
Interest Rate- Generally speaking, the interest rates for student loans are quite a bit lower than the rates you might be able to find for personal loans. The reason for this is that while credit cards and other personal credit lines are typically unsecured, and technically speaking, most student loans are unsecured, student loan interest rates subsidized through the government are set by congress. They might rise and fall occasionally, but since most policymakers see the inherent positives in a well-educated workforce, they want to make certain that such educational opportunities are readily available and affordable. In order to remain competitive in the field, many private student loan issuers keep their loan rates within a few points of the federal rate to entice borrowers.
Income-based Repayment- Income based repayment is a means of ensuring that regardless of how much a student borrows for their education, the amount they repay won't go above a set percentage of their current income. For instance, let's say that you have $100,000 in student loan debt, and have a hard time finding work for the first four years out of school. You end up working as a barrista pulling in about $20,000 per year. While your debt might call for you to pay a specified amount per year, income-based repayment holds your payments at 10% of what you make. That means you'll pay just $2,000 on your student loans until you find work in your field. The bonus is that there are two provisions to the plan that could relieve you of much of your student loan debt. If your work is in the public sector, then paying on the income-based repayment plan for 10 years will allow you to apply for loan forgiveness. If you work in the private sector, the plan provides forgiveness after 25 years.
Clearly, refinancing might make sense for certain students, but when you consider doing so, consider first the benefits you just might be throwing away.
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