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Student loan refinancing isn't for everyone—here's how to decide if it's right for you

Refinancing student loans can score you a lower interest rate, but you lose federal loan benefits.

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Refinancing your student loans might sound like a no-brainer. In essence, it means swapping existing loans (either federal or private) for a new consolidated personal loan, ideally with a lower interest rate. But the reality's a little more complex.

To begin, you (or a co-signer) must have good credit, a reliable income and a low debt-to-income (DTI) ratio in order to be approved for a refinancing, or "refi," loan.

And just because you qualify doesn't necessarily mean you should always refinance. Borrowers refinance their student loans mostly when they can get substantially lower interest rates, allowing them to pay off their debt faster, or get a smaller monthly payment that's easier on the budget.

Refinancing can make sense in some situations, such as if you've landed a stable job with higher income, and/or improved your credit score enough to snag interest rates you just can't pass up.

Yet, refinancing federal student loans to a private lender is irreversible. You sacrifice important federal loan protections such as income-driven repayment and public service loan forgiveness by agreeing to refinance privately.

We therefore don't currently recommend refinancing your federal student loans given the payment and interest freeze that is in effect through September 2021 and with potential student loan forgiveness still on the table.

Below, CNBC Select outlines four questions to ask yourself when shopping around for a refi loan. These should help guide you to know when student loan refinancing is a good idea and when you should reconsider.

Will I actually get a much lower interest rate?

A lower interest rate is not guaranteed, so it's important that you shop around and prequalify first.

Submitting your preliminary information, either to a peer-to-peer platform like SoFi or a private lender, gives you a chance to view personalized rates before choosing the best loan option.

Generally, the better your credit score and overall finances, the lower rate you'll likely qualify for.

Will refinancing save me enough money?

To see what you could be saving through student loan refinancing, there's an easy mathematical experiment: Plug your current balance into a student loan refinancing calculator like this one from Student Loan Hero or this one from SoFi. Then adjust the interest rates to compare your current APR and the one you qualified for.

This should help you see how much you would actually save in interest compared to what you pay now.

How much of my student loans do I have left to pay?

Refinancing may stretch out the amount of time it takes to pay off your loans, depending on what kind of term you qualify for.

With a shorter term, you could make more aggressive monthly payments but save in interest over time. A longer repayment term would lower your monthly payment, but overall save you less since you're incurring interest for longer.

If you are already halfway through paying your student loans off and you have the means to pay the remaining portion quicker, choose a short repayment term to get the most out of refinancing.

Will I need federal loan protections in the future?

This is the most important question for federal student loan borrowers to ask themselves.

Federal student loan borrowers who don't need the governmental protections might benefit from refinancing when the Covid forbearance period on their loans is over. Know the protections before making this decision.

Through the government, federal student loan borrowers have unique protections that are a good form of security should anything go wrong down the line. Such protections include:

  1. Deferment and forbearance for up to three years (and with subsidized federal loans, you aren't charged interest during deferment)
  2. Access to income-driven repayment plans that recalculate your monthly bill based on any changes in income
  3. Forgiveness programs for certain jobs through Public Service Loan Forgiveness (PSLF) and Teacher Loan Forgiveness

Many private lenders also have their own protections, though they aren't as extensive as you would receive with federal loans. Some private lenders offer deferment in the case of unemployment or economic hardship, as well as the option to make interest-only payments before your repayment term begins. Be sure to inquire about these protections before you refinance with a private lender.

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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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