According to a recent NerdWallet Household Debt Study, dentists and physicians have some of the highest student loan debt balances compared to other types of professionals. Regardless of income level, managing six-figure debt can be very difficult. To further complicate matters, many doctors and dentists already have a late jump on saving for retirement and other goals as they enter the workforce, so managing monthly student loan payments is especially important. Given today’s ultra-low interest rate environment, there is a unique opportunity for some professionals to refinance their student loans.
How are student loans interest rate determined?
The interest rates on federal student loans are set each May on the basis of 10-year cash flow. The rate is fixed, so while new borrowers may benefit from lower rates for the next academic year, today’s low rate environment will not change anything for existing federal loan borrowers, unless they don’t choose to refinance in the private market.
Loans for private education can be variable or fixed and are often tied to LIBOR 1 month rates. Outside of the current rate environment and economy, the exact terms a borrower may be offered depends on their personal financial situation: credit history, income, loan program, and even their occupation or profession. their degree can all influence the interest rate offered.
The Federal Reserve’s recent decision to cut interest rates in response to growing concerns about the economic impact of the coronavirus could be favorable to borrowers. Although the Federal Reserve does not set interest rates directly, the federal funds rate (which is a suggestion of what banks should charge each other for overnight loans) tends to move in the same direction as 1 month LIBOR and prime rate, which is another key interest rate benchmark.
The notable exception here is in 2008, when economic uncertainty and the financial crisis caused the 1-month LIBOR to rise sharply for a period of time. Given the recent volatility in the financial markets, a closer look is warranted if you are considering a variable rate loan.
Student loan refinancing strategies
As with any financial decision, it’s important to do your homework and study the options and risks before moving forward.
Compare the prices
As with any loan, you will want to speak with several lenders to get the best rate and terms for your situation. One of the biggest mistakes borrowers make is assuming that the rates are the same everywhere. Many lenders have specific underwriting criteria that they look for and only offer the best deal for those borrowers. Doctors and dentists tend to be sought-after clients by lenders, so it’s worth keeping an eye out for special programs.
Consolidate or refinance?
A bit like when you refinance a houseWhen you refinance student loans, your existing loan is paid off by the new lender and you start to pay off a new loan with a lower interest rate and possibly different terms. This is usually done by taking federal loans and transferring them to private lenders.
When you consolidate federal loans with a direct consolidation loan, all the loans are combined into one and the interest rate is the weighted average of all the loans. The loans stay with the federal government. The benefit is simplification more than anything, but borrowers may inadvertently sacrifice flexibility, for example by refinancing only the highest rate loans.
Timing is everything, but you don’t have to do it all at once
As mentioned above, you don’t need to refinance all of your student loans at once or not at all. If cash flow is tight, it may be a good idea to start with higher interest rate loans. Depending on your other financial goals and career plans, timing might be a more important factor. If you are start a business or buy a practice, refinancing can lock in needed cash flow, lower your credit, or tighten debt-to-income ratios with higher monthly payments.
The best rate that works for your finances
When you refinance your student loans, you will have options to consider. As a general rule, the longer the term of the loan, the higher the rate. If you currently have federal loans, you may need to agree to a shorter repayment period in order to refinance with a private lender. Repayment periods typically vary from five to 15 years, although some lenders offer 20-year repayment periods. Depending on the terms of your current loan, this could significantly increase your monthly payment, even with a multiple point reduction in your interest rate.
When considering which term is best for you, be careful not to sacrifice too much financial flexibility in exchange for a better rate as it could put you in a tight spot if your circumstances change.
Prepay or refinance?
Depending on the details of your financial situation, the optimal strategy for managing your student loans may be a combination of refinancing and prepaying certain loans. While prepaying existing loans won’t lower your interest rate, it will help you save on interest charges over the life of the loan. Since refinancing usually involves changing your monthly payments, prepaying loans instead of or in addition to refinancing can give you flexibility.
There is no one-size-fits-all approach, which is why it is important to work with your Financial Advisor and run the numbers for your situation and goals.
What you need to know before refinancing your student loans
Refinancing isn’t for everyone. When evaluating your options, be sure to understand the impact of refinancing on your eligibility for certain benefits only available to federal borrowers. Some of these safety net programs include loan deferral, forbearance, student loan cancellation, income-based repayments, and discharge on death or disability.
There is no going back once you refinance with a private lender, so weigh your risks and weigh the benefits against the potential cost and the availability of other alternatives. For example, you may be carrying additional life insurance early in your career to match student loan debt.
Also pay attention to the terms offered by the private lender. For example, you’ll want to ask if there is a prepayment penalty and a refinance limit again. Unless you plan to pay off your loans fairly quickly, it might not be a good idea to go with a variable rate if you could lock in a lower fixed rate. If you want to refinance with an adjustable rate loan, learn about rate caps and options for refinancing variable rate loans.
The current low interest rate environment presents unique opportunities for borrowers and buyers alike. Although rates have been relatively low over the past decade, there is no way to predict what will happen in the future. Borrowers should calculate the numbers and strive to determine a threshold rate (if any) at which refinancing makes sense for their situation.