If you’re saddled with student loan debt, there may come a point where it feels tough to get ahead. You’re making payments, but a good portion of it isn’t even touching the principal. The culprit? Your interest rates. Federal student loans have fixed interest rates that don’t change over time, so you’re stuck with your rate—and if you have any PLUS loans, that could be over 5%.
One potential solution is student loan refinancing. But while that can help student loan borrowers save money on interest, it’s especially risky for federal student loan borrowers.
What Is Student Loan Refinancing?
You’ve probably heard that you can save money by refinancing your auto loan or your mortgage. Well, you can refinance and consolidate your student loans, too, allowing you to save money on interest and make payments more manageable. And by shaving off a few percentage points, you can save thousands of dollars and get out of debt faster. Sounds appealing, right?
While there are cost-saving benefits, it can be a risky move for federal student loan borrowers in particular.
Consequences of Refinancing Federal Student Loans
Your federal student loans are administered by the U.S. Department of Education. Through the Department of Education, federal student loan borrowers have certain rights.
For example, federal student loan borrowers have access to a variety of repayment plans—including an income-driven plan, which bases your monthly payments on your discretionary income. Federal student loan borrowers on an income-driven plan that make consistent payments for 20 to 25 years may be eligible for student loan forgiveness. Federal student loan borrowers also have access to deferment and forbearance options. These options can put student loan payments on pause if you are unable to make your monthly payments.
Student loan debt forgiven between 2021 and 2025 is tax-free, according to the American Rescue Plan of 2021.
“Federal student loans have many built-in consumer protections such as death and disability discharge, generous deferment and forbearance options, and the right to cure a default,” says student loan lawyer Adam S. Minsky. “These programs are not just provided by contract—they are provided by federal law, which makes them incredibly strong.” And these perks can come in handy if you’re working in a low-paying field or if you are hit with hard times.
What You Risk Losing
But federal student loan borrowers give up these benefits if they refinance. When you refinance your student loans, you are working with a private company. As such, you are on their playing field, dealing with their rules. While student loan refinancing can save you money, it might not help if you end up losing your job and can’t make payments. You won’t have the generous federal student loan benefits offered through the U.S. Department of Education.
And once you refinance, there’s no going back. “Refinancing federal loans into a private loan is a one-way street out of the federal loan system. There's no way to re-convert a private loan back into a federal loan,” explains Minsky.
As a federal student loan borrower, you stand to lose the following benefits through refinancing:
- Eligibility for an income-driven plan
- Potential student loan forgiveness
- Repayment assistance programs (like Public Service Loan Forgiveness and other programs)
- Death and disability discharge
- Default rehabilitation
Though lenders in the student loan refinancing space may offer some benefits like deferment, the benefits still come up short compared to what the U.S. Department of Education offers. Not only that, but private lenders can change their offerings at any time.
Private Student Loans are Contracts
“The consumer protections afforded to a private student loan borrower are contractual and are often discretionary as well—that means the lender or loan servicer gets to decide whether or not to enforce them,” notes Minsky.
There’s also a lot of unknowns about the student-loan-consolidation industry, which is still in its infancy.
“Because many of the players in the private student loan refinancing field are relatively new, we simply do not know how they will treat struggling borrowers or borrowers who have defaulted,” says Minsky. “We don’t know how lenient and flexible they will be, how liberally they will implement the relief programs in their contracts, or how aggressively they will pursue people.”
Is Refinancing a Good Idea?
If you’re considering refinancing your federal student loans, it’s important to weigh the pros and cons carefully. The cost savings can be worth it for certain borrowers, but for the majority of federal student loan borrowers, it may not be a good idea. There’s too much to lose in regards to benefits and protections.
However, refinancing your federal student loans may be a good idea under certain circumstances. For example, if you have a steady job, hefty cash reserves, and plan to pay off your debt in a short time, refinancing can make sense as a way to lower your interest payments and pay off the debt faster. But there’s no hard and fast rule about who should refinance their federal student loans and who should not.
“I think borrowers need to fully understand what they are getting and what they are giving up, and they need to assess their risk tolerance,” says Minsky. For some borrowers, that risk might be too much—while for others, it could be a short-term risk that helps them pay off debt faster.
So if you have federal student loans and are looking to save money on interest through refinancing, first assess your current financial situation. Understand what benefits and protections you stand to lose, and make sure the benefits you are getting are worth it.