At FitBUX, we provide advice to many student PTs (SPTs) and new physical therapists (i.e., recent-grad DPTs) who are confused about refinancing their student loans. That confusion usually stems from advertising and advice from unqualified acquaintances (my dentist still tells me what investments I should make even though he’s the worst investor I’ve ever met). But, this article is not your typical “how to refinance” post. Instead, I’ll cover four topics that, though not often discussed, are essential to deciding if and how you will refinance. However, the bottom line is that the decision to refinance typically comes down to two criteria: savings and flexibility. Before we get started, if you need a primer on what refinancing is, I recommend reading this article first. Okay, here we go!
Refinancing Doesn’t Have to Be an All-or-Nothing Decision
One of the top reasons people choose not to refinance is they’re under the impression that they have to refinance all of their loans at once. For example, they believe that if they have five student loans totaling $100,000, they would have to refinance all five loans into one new loan. Although quantitatively this may save them money, it’s also a deterrent to pulling the trigger. People are so scared of making the wrong call on such a huge decision that they ultimately choose to do nothing at all.
So, what’s so scary about refinancing multiple loans at the same time? Well, in doing so, you lose flexibility. Going back to our previous example of five loans totaling $100,000: We can assume that each loan has a different rate and a different monthly payment amount. Let’s say the required minimum payments are $242, $232, $222, $212, and $202, which is a combined total monthly payment of $1,110. Let’s also say you are prepaying $500 per month and paying off the loan with the highest interest rate first. Therefore, your total monthly payment is $1,610 ($1,110 + $500). After you pay off your high interest rate loan (in our example, it’s the loan with the $242 required monthly payment), your required monthly payment drops to $868. You can now decide to make a prepayment of $742 per month ($500 plus the $242 from the loan you just paid off) to the loan with the next-highest interest rate, or you can save that money instead.
Now, if you were to refinance everything into one loan, your required monthly payment would remain consistent throughout the term of the loan. In other words, you wouldn’t have the option of decreasing that total amount, as was the case in the example above. Therefore, when weighing the pros and cons of refinancing, you must decide whether the savings is worth the loss of flexibility.
The good news is that you don’t have to refinance all of your loans into one. For example, if you are unsure about refinancing, and one of the loans you have is $10,000 at 7.2%, you can choose to refinance only that loan and keep the others as-is. Also, you can decide to use a combination of products—such as fixed rate loans, variable rate loans, and income share agreements—and/or multiple companies to keep some of the flexibility that having multiple loans affords you.
Shortening the Term is Not Always Optional
Most people who choose to refinance are making prepayments on their loans. Therefore, they are usually scheduled to pay those loans off sooner than the terms dictate. For example, after you graduate, if you make only the required loan payments, you’ll pay them off in ten years (assuming the standard federal government loan). However, if you make a monthly prepayment, you can pay your loans off sooner—in five years, for example.
In this situation, many private lenders will try to persuade you to refinance into a five-year loan. Their reasoning is that it’ll save you the most money. In a sense, they are right, because the shorter the term is, the lower the interest rate will be.
Consider this, though: Let’s say that before you refinance, your required monthly payment is $500 and your prepayment is $600. If you choose to refinance, your new required payment would be close to $1,100. Thus, you would lose the flexibility to make a monthly prepayment of $600 on a discretionary basis. In other words, you’d no longer be able to decide whether or not you want to make that extra payment; you would have no choice but to pay the additional amount.
This isn’t to say you shouldn’t refinance; you just have to decide whether the amount of savings is worth losing that flexibility. For additional guidance, check out this video.
Refinancing May Not Fit Into Your Goals
Speaking of flexibility, one benefit of having a federal loan is the ability to change your repayment plan from 10 years to 25 years or to use a federal income-driven repayment plan. These options—which can help you lower your required monthly payment—may end up costing you more in the long-run. However, they may be beneficial to you based on evolving financial strategies or life circumstances. For example, you may want to lower your payments before starting your own private practice or having a child. In these circumstances, having the option to reduce your required monthly payment and allocate the money saved somewhere else may hold a greater qualitative benefit to you than the quantitative benefit of paying off your student loans sooner. When you refinance with a traditional lender, you no longer have these options.
There’s a Refinancing Alternative That is Often Overlooked
One refinancing alternative that’s becoming increasingly popular is refinancing a portion of your student loans with the Bank of Mom and Dad. It’s not a viable option for everyone, but it is something to consider. For example, if your parents—or another relative or friend—have an extra $10 or $20 thousand dollars in a bank account earning 0.25% interest, they could make more interest in the long run by refinancing the loan themselves and charging you a lower rate than your current loan (let’s say 4%). They are then making more money, you are saving money, and all of that money stays in the family instead of going to the government.
Are you considering refinancing your student loans? What questions do you have? Share your thoughts in the comment section below.Joseph Reinke is the CEO and Founder of FitBUX.