Back in 2005, as I finished my Master’s degree, I decided to consolidate my federal student loans. Consolidating your student loans is essentially refinancing them all. You borrow enough money to pay off all of your student loans, and then you repay all of your loans at one interest rate, making a single payment each month.
At the time, I was able to consolidate all of my undergraduate and graduate student loans into one large loan, with an interest rate of less than 2%. I refinanced everything to a 25-year term, and the result has been largely favorable to me. A few years later, when my husband finished his Ph.D., we consolidated all of his federal undergraduate and graduate loans as well. By then, interest rates had risen, and his rate isn’t as low as mine, but it’s still acceptably low, and making only one payment a month is much easier than making multiple payments on multiple loans.
Our reluctance to pay off our student loans early has created some controversy among those who know us, but refinancing in this way has created better cash flow for us on a monthly basis, as well as allowing us extra money to invest at a higher rate of return than what we pay in interest on our student loans. For us, refinancing and consolidating made sense, and we continue to reap the benefits.
Cash flow management with student loan refinancing
Cash flow management offers one of the biggest advantages to student loan refinancing. When you refinance through consolidation, your monthly payments drop since many lenders offer a standard 25-year loan. Rather than paying between $500 and $600 a month total, and trying to keep track of between three and six (or more) payments each month, refinancing often means one payment of between $200 and $300 per month.
That creates a cash flow situation that is much easier to manage over time. You worry less about due dates falling through the cracks, and you also have more money to spend on other items. If you are first starting out, you might not be able to afford high student loan payments. Refinancing results in a more manageable situation. If you want to pay off your loans faster later, you still have the option to make extra payments each month, and you can scale back your payments in the event of a financial setback.
Your credit and student loan refinancing
“From a credit score standpoint, it makes perfect sense to consolidate student loans,” says Michelle Black, a credit expert with HOPE4USA.com.
She points out that 30% of a consumer’s credit score depends on the amount of debt you have, including the number of accounts you have with balances. “The more accounts with balances, the worse the impact on a consumer’s credit scores,” Black says. “Consolidating multiple student loans into a single, new loan as the ability to have a positive credit score impact.”
Black also points out that refinancing student loans through consolidation can also make sense from a credit defense standpoint. If you experience a financial setback and can’t make your student loan payments, you will end up with delinquencies on multiple accounts. If you have consolidated your student loans, you only have one past due account.
“Having multiple past due and late student loan accounts is like throwing a grenade into someone’s credit reports and scores,” Black says. “Even one past due account is bad for a consumer’s credit scores, but one derogatory account is not as detrimental as five accounts would be.”
Making sure that your student loan payments are doable is also important when you consider that student loans can’t be discharged during bankruptcy. You will have to repay those loans anyway, so refinancing them through consolidation can create a situation that is easier to manage, and that won’t end up causing you as much trouble in the long run. Protecting your credit means ensuring that your financial situation is as manageable as possible, as well as doing what you can to limit the damage when you run into unexpected trouble.
Downsides to student loan refinancing
Before you decide to refinance your student loans, make sure you pay attention to the pros and cons associated with consolidation. When you refinance, you extend the loan term, and that means you will be in debt for longer if you don’t repay your student loans early. It can also mean that you pay more in interest over the course of your loan. Even though the interest rate might be lower than what you would pay without refinancing, the longer time period can cost you, since you will pay over a period of 25 years, rather than the standard 10 years.
If you are concerned about the loan term, though, you can refinance now to better manage your cash flow, and then repay your loans early as your financial situation improves.