5 Downsides to Refinancing Federal Student Loans

Christy Bieber, The Motley Fool

Updated Fri, Feb 14, 2020, 4:00 AM 5 min read

Paying back student loans can take a lot of time and can be expensive. During your repayment period, you may decide to consider refinancing your loans. This would involve getting a new loan and using it to repay existing student debt.

There's a host of options for student loan refinancing on offer from private lenders. Depending on your financial situation and the lender you choose, you can usually borrow enough to refinance the entire amount you owe, including both federal and private student loans.

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But while refinancing private student loans can often make a lot of sense -- as long as you can get a lower rate, there are huge downsides to refinancing federal student loans.

You need to consider these big disadvantages if you're thinking about refinancing any of the federal loans that you obtained from the Department of Education.

1. You'll lose the chance of loan forgiveness

With most types of federal student loans, including Direct Subsidized Loans and Direct Unsubsidized Loans, it's possible to qualify for Public Service Loan Forgiveness (PSLF) if you work in an eligible job. This could include working for the federal, state, or local government, or for a qualifying nonprofit organization.

PSLF makes it possible to get any remaining balance on your loan forgiven after you make 120 on-time payments on an eligible income-driven payment plan.

Private student loan lenders won't forgive your loans simply because you work in public service. So if you refinance your federal loans, you give up any possibility of getting a portion of your debt wiped out -- even if your job serves the public good.

2. Changing your repayment plan will become a lot harder

When you have federal student loans, you can change your payment plan if you need to, just by contacting your loan servicer.

For most types of federal loans, you can choose from many different plans, including:

A standard plan to pay off your loans with fixed payments over 10 years
A graduated repayment plan that raises payments over time
Extended repayment plans with lower monthly payments
Income-driven payment plans

The flexibility to change your plan means you have a lot more control over your monthly payment and can make adjustments as needed to fit your budget.

If you refinance with a private lender, you'll lose this flexibility. You'll have to pay back what you owe on whatever schedule you agree with your lender. And you can't change the payment terms unless you refinance again -- which may not always be possible.

3. An income-driven payment plan will no longer be an option

One of the best borrower protections associated with federal student loans is the option to choose an income-driven repayment plan.

There are several options for these plans and they allow you to limit your monthly payment to a percentage of your income. And after 20 to 25 years of making payments on an income-driven plan, you can even have the remaining balance on your loan discharged.

The option to cap payments at a percentage of your income helps ensure paying back your loans never becomes unaffordable. But private lenders don't offer this option, so you'll be giving it up when you refinance. If your income falls and you struggle to make payments on your refinanced loan, this could put you at risk of default.

4. Deferring your loan payments will no longer be a possibility

While you are in school and in the six months after graduating, your federal student loans are automatically in deferment. Once you graduate, if you meet certain requirements -- such as economic hardship or active military service -- you can apply for student loan deferment.

When your loans are in deferment, the government pays the interest on Direct Subsidized Loans. This means that subsidized loans will not accrue interest while payments are paused, although unsubsidized loans will.

You will not have the option to defer any loans once you've refinanced with a private loan lender. So if you go back to school or face unemployment or other economic hardship, you can't just pause your payments and expect to not be charged interest.

5. Forbearance options won't be as generous

The federal government also allows for payments to be paused even when you don't qualify for deferment or when you've maxed out the time your loans can be deferred. You can do this by putting your loans into forbearance.

Student loan forbearance allows you to defer payments, but there's no subsidization of interest. It keeps accruing and can be added onto your loan balance so you end up paying interest on interest. While forbearance can make your loans more expensive to repay, it also provides financial relief when you cannot afford to continue making payments and have no more deferment options.

Some private lenders that you refinance with will allow you to put loans into forbearance when you face economic hardship. But generally, you won't be able to pause payments for as long as you could with federal loans.

Be sure to consider these downsides before you refinance

These are serious downsides but they don't necessarily mean it never makes sense to refinance federal student loans.

If you can't qualify for loan forgiveness, you make enough money that an income-based plan leaves you with high monthly payments and refinancing your federal loans will lower your interest rate, you may decide it's the right way to go. Just be sure you have a full understanding of what refinancing could mean before you take out a private refinance loan to pay off the debt you owe the Department of Education.

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