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Don’t rush to refinance your federal student loans

For an overwhelming number of young professionals, the topic of student debt is a sensitive one. With some federal loan rates as high as 7.9 percent, it does not take much to entice my fellow millennials, especially the older ones, into an emotional discourse on the subject.

In fact, student loans are such a hot topic right now that they are a frequent, if not focal, point of discussion in the 2016 presidential primary debates.

Interns from around the city protest near the Senate steps to urge the Senate to act on a House passed bill, Smarter Solutions for Students Act, which would prevent student loan interest rates from doubling.
Tom Williams | CQ Roll Call | Getty Images
Interns from around the city protest near the Senate steps to urge the Senate to act on a House passed bill, Smarter Solutions for Students Act, which would prevent student loan interest rates from doubling.

Politicians aren't the only ones listening, either. Due to the notoriety and overwhelming amount of outstanding student debt, financial technology start-ups looking to address the issue have emerged. A number of existing large financial institutions have also been joining the conversation, with "attractive" refinancing opportunities, which could give student loan borrowers a much needed financial break.

When it comes to privately refinancing federal student loans (e.g., any lending organization other than the government), the overarching strategy is to obtain an interest rate that is lower than the rate of your current loan(s).

As a result, refinancing at a lower rate is often a financially positive one because reducing the rate on your federal student loans could:

  1. Reduce the amount of interest you pay over the life of your loan(s).
  2. Reduce your monthly loan payments.
  3. Be a combination of the two, depending on the details of the loan.

Before we get overly excited and say that privately refinancing your federal student loans is a "no-brainer," it's extremely important to understand what you are keeping and losing should you choose to stick with those government loans or privately refinance them.

The biggest advantage to keeping your student loans with the federal government is repayment-plan flexibility. Federal loans offer their borrowers a myriad of repayment plans to choose from and the ability to switch between plans at any time.

The main categories of plans are standard, graduated, extended and income-driven plans. Each plan has its own advantages and disadvantages, depending on what your financial needs are.

"The ability to adjust your repayment plan could be a reason for keeping your loans with the federal government, even if it is at a higher interest rate than what you could get privately."

For example, if you find yourself in a difficult financial situation or should your financial priorities shift due to a significant life event, having the flexibility to move from one payment plan to another could be valuable.

Therefore, the ability to adjust your repayment plan could be a reason for keeping your loans with the federal government, even if it is at a higher interest rate than what you could get privately. Additionally, there are loan-forgiveness options for public servants that are also worth considering before refinancing away from Uncle Sam.

While having repayment flexibility can be a major benefit to keeping your federal loans where they are, there can be some danger involved with frequently switching plans, especially when choosing among the income-driven plans.

By overly relying on these plans and using them as a sort of financial crutch, you could find yourself paying back your loans for far longer than you had hoped. In more extreme cases, you could actually find yourself moving backward, meaning your loan balances can actually grow because those more flexible payments don't cover the interest accruing each month.

However, if repayment flexibility is not needed and you feel secure in your financial situation, refinancing your federal loans with a private lender at a lower rate could turn out to be a no-brainer, after all.

It is important to remember that eligibility for refinancing is based on your financial health and is determined through financial underwriting. After all, financial technology companies and institutions alike will want to understand your financial situation so they can determine what new rate, if any, you are eligible for.

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Therefore, if you are qualified and confident in your ability to make your payments each month, you should strongly consider privately refinancing your loans, potentially saving thousands of dollars in interest through the life of your loan.

Overall, the important lesson here is that the choice between privately refinancing federal loans or keeping them where they are is about more than just your ability to obtain a lower interest rate and better loan terms. Ultimately, the decision requires a closer examination of your overall financial picture to determine whether it is in your best interest financially, because once your federal loans are refinanced, there's no going back.

I would also like to point out that the discussion surrounding student debt is part of a greater discussion surrounding financial education in our country. For those of us who have already finished our college and graduate school educations, refinancing student loan debt is a reaction to costly financial decisions already made.

If anything, the opportunity to take advantage of any student loan refinancing is a reminder of the importance of financial literacy so that, in the future, we are voting on issues other than who can solve a growing $1.2 trillion-dollar problem.

You can learn about all the federal student loan repayment plans at website StudentAid.gov.

— By Douglas A. Boneparth, partner at Longwave Financial