Student-loan payments resume in October. Is now the time to refinance your federal student loan?

To make their monthly payments more affordable, borrowers can choose from an array of federal repayment programs, including a new approach to income-driven repayment — where payment amounts are based on the borrower’s monthly income — that will fully roll out next summer.

There’s also the option to refinance the debt into a private loan. In this crossroads moment, it’s easy to see why some people might consider a refinance that sends their federal student loan debt to lenders who advertise potentially low interest rates.

Since the Supreme Court decision, one student-loan interest-rate comparison site has already seen more initial consumer curiosity about refinances. So has one lender offering student loan refinances.

Yet refinancing a student loan only makes sense for borrowers who can afford to give up the protections and repayment leeway that come with federal loans, experts say.

“It’s not the same as the warm and fuzzy student loans that you started out with. It’s a bank loan,” said Stacey MacPhetres, senior director of education finance at EdAssist by Bright Horizons. The company contracts with employers, offering services like helping staff understand and repay their student loans.

For a slice of borrowers, refinancing could be “a wonderful tool,” MacPhetres. But “where possible, we really encourage people to work within the federal program,” she said.

“There are some pros and cons people have to evaluate. One answer isn’t the right answer for everyone,” said Thomas Graf, executive director of Massachusetts Educational Financing Authority, a quasi-governmental state agency without shareholders that offers student loans and student loan refinances.

Since the Supreme Court blocked student-loan forgiveness, refinancing applications have been “up slightly,” Graf said, but there hasn’t been an “enormous surge yet.” Graf has talked to other people working in the student-loan refinance sector who’ve also seen more interest from borrowers. “I’d chalk that up to people doing their homework,” he said.

For all the student-loan borrowers doing their research about refinancing, here are some points to remember.

What are the interest rates on federal student loans vs. private student loans?

One big draw in any refinance is the chance to snag a lower interest rate. The opportunity might sound extra appealing at a time when interest rates are marching higher on mortgages, credit card APRs, car loans and other financing.

But federal student loan interest rates are fixed for the lifetime of the loan. That means that a borrower who took on debt a few years ago in a better rate environment may have a rate that appears relatively low compared to what’s available now.

A refinance rate might not seem so enticing now if a borrower cannot qualify for the best offer. In the private market the lowest rates go to applicants with higher credit scores — just how it is for other sorts of financing. There are usually little or no fees in the student-loan refinance market, so the rate is where lenders make their money, Graf explained.

For context, consider the current rates on federal student loans, which are set by Congress every year in a method that’s tied to the yield on the 10-year Treasury note
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3.986%.

The rate on loans for undergraduates is now 5.5% for loans disbursed between July 2023 and before July 2024, according to Federal Student Aid, an office of the U.S. Department of Education. That’s up from 4.99% during the 2022-23 loan cycle.

For graduate- and professional-level students, federal loans now have a 7.05% rate, up from 6.54%. Another type of federal loan for parents and graduate students now has an 8.05% rate, up from 7.54%.

Rates on MEFA’s refinance loans range from 5.5% to 8.45%. To get the 8.45% rate, you’ll need a minimum credit score of 670, Graf said.

Meanwhile SoFi
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is currently offering 4.99% to 9.99% for a fixed rate, with a 0.25% discount for borrowers who sign up for automatic payments. Its variable rates range from 5.99% to 9.99%, and also have a 0.25% autopay discount.

Another lender, Discover
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has fixed rates ranging from 5.99% to 9.99% and variable rates from 7.37% to 11.37%.

Both say the lowest rates are for the most creditworthy candidates.

In March, SoFi sued the Department of Education over the payment pause. The company agreed with government lawyers to drop the case in early June after the debt ceiling legislative deal put a final expiration date on the pause, court papers show.

Through early July, interest on a 10-year student loan at a fixed rate averaged 6.91%, according to Credible, a platform to compare rates for various loans including student loan refinances. A year ago, the average rate was 5.36%. There was a record-low 3.33% APR on refinances in December 2021, according to Credible’s data.

A five-year variable rate averaged 9.93%, well higher from 2.51% a year ago, Credible noted.

The day of the Supreme Court decision, the platform had a “several hundred percent increase” in preliminary applications to see what sorts of rates and terms they could fetch, said Robert Humann, Credible’s chief revenue officer.

Smaller monthly payments in a longer duration loan might be the allure right now, he said. “If folks are making a decision to refinance, it’s likely because they are wanting to free up money in their budget as opposed to refinancing to a private loan for a lower rate,” he said.

Another option for borrowers is to consolidate federal loans, which merges various federal loans into one federal loan, with one hybrid rate. Rate shoppers should compare the rates they get on a refinance with the rate they could get on a consolidated federal loan “and see what feels better in the big picture,” MacPhetres said.

What protections do federal student loans offer vs. private loans?

Though payments restart in October, President Joe Biden said federal borrowers will have a one-year grace period during which missing payments will not get reported to credit bureaus or referred to debt collectors. He also said he’d keep fighting for debt cancellation. “With federal loans, you maintain certain rights and privileges,” said MacPhetres. And that goes beyond the leeway afforded to people struggling to repay.

If a borrower’s focus is on whittling down monthly payments, that could be a good argument to stick with federal loans, she said.

That’s because of the array of income-driven repayment plans, which base a borrower’s monthly payment on their ability to pay. Borrowers typically participate in these programs for 20 years and can then have their balances wiped away.

One repayment plan is currently getting an overhaul in order to subject less income to repayment, which should result in smaller monthly bills for borrowers. “That will become really important,” MacPhetres said.

The existing Revised Pay As You Earn (REPAYE) plan will be replaced with a program called Saving on a Valuable Education (SAVE). The changes will be rolled out in two phases between this summer and next summer.

The federal system also still has ways of canceling debt for certain people even faster, like the Public Service Loan Forgiveness program, which forgives student loans for public sector workers like teachers and nurses after they make 10 years of payments.

There’s no loan forgiveness in the private refinance market. Likewise, lenders don’t have to abide by any grace period that the Biden administration uses, Graf said.

That’s not to say there’s no wiggle room if someone is suddenly struggling, he added. But the degree of leniency could depend from lender to lender. “If difficulty arises, we work with our borrowers to figure out a way forward,” he said.

What to ask before you refinance your student loans

There are three questions borrowers should ask themselves when they weigh a possible refinance, said Brian Walsh, manager of financial planning at SoFi and also a certified financial planner.

What type of employer does the borrower work for? Some jobs make the person eligible for loan forgiveness later if they have federal student loans, which would be a clear case to stick with federal loans, he said.

How affordable will the payments be when they resume? “If somebody definitely can’t afford their payment, or the only way to afford them is by drastic cuts in lifestyle,” then their focus is probably on minimizing payments quickly — and that could be a strong argument for income-driven repayment, Walsh said.

If payments are more affordable in a person’s budget, that could make a refinance more useful, he said.

And what’s the goal: smaller monthly payments or less money paid overall? Smaller monthly payments might be a point in favor of sticking with the income-driven federal plans, he said.

But if you’re trying to pay less money over the entire life of the loan, that could be a good reason to look hard at refinance rates. “Even a small change in interest rates can have a really big impact,” Walsh said.

A good refinance candidate is confident in their ability to pay and knows the protections they are giving up by leaving their federal loans behind, said Francisco Ayala, financial life planner with The Coleridge Group in Phoenix, Ariz. They also have to understand the political fight over student debt isn’t over, he noted.

Ayala has a software engineer client with $145,000 in student loan debt who could have had $20,000 wiped off her balance under Biden’s cancellation program.

Now it’s time for that client to open “the other playbook,” which is refinancing the debt in search of a better interest rate, Ayala said.

But what if Biden or other politicians find a different way to cancel federal student debt in the coming years — which leaves the refinanced software engineer on the outside looking in at forgiveness?

“We go knowing that risk,” Ayala said.

The author refinanced his student loans with SoFi in 2021.