Should Lawyers Refinance their Student Loans?
Executive Summary
Student loan payments will begin in May 2022. For many lawyers these payments represent a significant monthly cost. To reduce how much they will pay, many lawyers consider privately refinancing their student loans. While this may result in a single lower monthly payment, there are trade-offs that lawyers should be aware of. These include not being eligible for student loan forgiveness, losing flexibility to change repayment plans, and more severe consequences for missing payments. Privately refinancing is not for all lawyers. Some will not qualify and others will choose to keep their federal student loans because of various reasons. Regardless of what lawyers decide, it is important to understand both the pros and cons of this decision.
On May 1, 2022, the interest rate and payment freeze for student loans will end. Lawyers, who have benefited from not making their student loan payments for the last year, will now be facing a substantial monthly cost for their student loans.
The average lawyer will graduate owing over $100,000 in student loans with interest rates typically between 5-7%.
Over a standard ten-year repayment, these interest rates can lead to monthly payments over $1,000. These interest rates also mean that lawyers will pay tens of thousands of dollars more over the life of the loan than what they originally owed.
So it makes sense for lawyers to consider refinancing their student loans to lower these monthly payments and total interest payments over the life of the loan. But is privately refinancing student loans the right choice for young lawyers?
What is a private refinance?
When someone privately refinances their federal student loans, a new lender, who is not the federal government, will pay off your entire current student loan balance and issue a new loan for the amount they paid off. The new refinanced loan amount reflects the amount agreed to on the refinancing agreement.
Example: A lawyer will begin paying off $150,000 in federal student loans at 6% for the next ten years starting in February. If they privately refinance, then a new loan servicer will pay off the $150,000 of loans and issue a new $150,000 loan to the lawyer at a possibly lower interest rate and time frame.
Do you have to refinance all of your student loans?
No. When you refinance, you can decide how much of your loans to refinance. Borrowers may not refinance all of their loans if some loans are close to being paid off or if the loan has a lower interest rate than the refinanced loan offers.
Some students who believe the government might forgive a certain amount of student debt may choose to refinance $140,000 (from the example above) and leave $10,000 as federal student loans. Doing so allows them to benefit if the federal government forgives this amount. While student loan forgiveness is a possibility, it is unlikely to happen soon. Deciding to avoid refinancing based on the hope of federal student loan forgiveness may result in lawyers paying more over the life of their loans.
How long does it take to repay a refinanced student loan?
For a standard federal student loan, repayment terms can last between 10-30 years. Privately refinanced loans range from 5-25 years.
The length of time to repay the privately refinanced student loan is up to the borrower. Private refinancing companies have multiple options on repayment timelines. The general rule of thumb is that a shorter-term loan, like a 5-year loan, results in the total interest paid to be lower than a longer-term loan. The downside to paying off a loan in a shorter time is that the monthly payments are much higher. For borrowers who do not mind making student loan payments for a long time, a longer-term loan results in a lower monthly cost but more interest paid over the life of the loan.
What are the benefits of a private refinance?
There are pros and cons to refinancing federal student loans. It is not the best decision for every lawyer. Lawyers with bad credit may not be eligible to refinance their student loans in the first place. For those that do qualify, there are benefits to consider.
Lower interest rates
The primary benefit of a private refinance is that it lowers the interest rate on a borrower’s student loans.
Credible.com found that average student loan borrowers could reduce their interest rate by more than 2%. This decrease in interest rates can save thousands of dollars over the life of a loan.
So what can saving 2% on interest rates save?
Example: A recently graduated lawyer has $150,000 in student loans with a 6% interest rate that they plan to pay off over ten years. Since they have a good credit score, they can secure a private refinance for the $150,000 at a 4% interest rate over ten years.
Here is the breakdown of the decision:
Not only does the privately refinanced loan save about $150 each month, but over the life of the loan, the borrower will save about $17,500 of interest.
One monthly payment
As lawyers take out loans in college and law school, they are issued loans each session. Over time someone who has taken out student loans for college and law school can have multiple student loans to pay off after graduation.
When a lawyer privately refinances their student loans, the loan servicer will pay off all the outstanding loans with the federal government and issue one loan for the total amount paid off. For borrowers, it can be nice to make payments on one loan rather than a collection of multiple loans with different outstanding balances and interest rates.
The choice between variable and fixed-rate loans
The interest rate on federal student loans is set by Congress each year. These interest rates do not change over the life of the loan. If a law student has a student loan in their first year with a 6% interest rate and the following year, student loans have a 5% interest rate; then the law student will have both a 6% fixed interest rate loan and a 5% fixed interest rate loan.
When borrowers privately refinance their student loans, they can choose between a fixed and variable interest rate. A fixed interest rate is just like a federal student loan rate where the interest rate at issuance is the same for the life of the loan.
A variable interest rate is different. A variable interest rate is typically less than a fixed rate refinance rate initially, but that can change over time. Each lender differs in determining the interest rate to charge and how often it is updated. If lawyers consider a variable interest loan, they should ask their lender about:
How often the interest rate is updated?
How does the lender calculate interest rates?
Is the variable interest rate capped?
The answers to these questions can affect how much a borrower pays over the life of a loan.
A variable interest rate loan may have a lower interest rate initially, but in the future, it may have an interest rate higher than a fixed interest rate. If this higher rate persists over the life of the loan, the borrower may even end up paying more than if they had just stayed with a federal student loan.
The future is uncertain. It is not possible to know what future interest rates will be. For that reason, most borrowers choose a fixed-rate refinance. A variable rate loan works best for borrowers who intend to pay off the loan as quickly as possible. The shorter time frame reduces the risk that the average variable interest rate is higher than the fixed-rate option.
What are the cons of privately refinancing student loans?
Saving money on student loan repayment with a lower interest rate is great, but it comes with trade-offs. While they may not result in a student loan borrower being worse off by refinancing, it is possible depending on what happens to the borrower over the life of a loan.
Lose out on federal student loan repayment forgiveness
When COVID struck, the federal government froze student loan payments and the interest accrual of the loans. Private student loan borrowers did not automatically receive this benefit. Privately refinanced borrowers ended up making payments throughout the COVID student loan freeze.
Borrowers who privately refinance their loans not only miss out on federal government payment freezes, but they may potentially miss out on federal student loan forgiveness.
Government officials have mentioned $10,000 - $50,000 of student loan forgiveness. While it looks unlikely that this will happen soon, it is guaranteed not to benefit borrowers once they privately refinance their federal student loans.
While this may be a possible benefit, borrowers should compare the chance of forgiveness to the higher chance of a lower interest rate through a private refinance.
Losing access to more flexible federal student repayment options
Federal student loans allow borrowers to switch repayment plans from a standard 10-year repayment plan to income-based or extended-term repayment plans. Once borrowers privately refinance their loans, they cannot change their loan terms without refinancing again. Borrowers can refinance a federal student loan to a private refinanced loan at any time, but after refinancing, a borrower cannot return to a federal student loan.
Fewer options when a borrower has difficulty making payments
Life is uncertain. Sometimes unforeseen events happen where borrowers cannot pay their monthly student loan payments in full. Federal student loan borrowers have access to deferment and forbearance options. Deferment and forbearance give borrowers experiencing hardships the ability to delay making payments or partially stop interest from being accrued.
Private student loans do not have these options. Missing payments can trigger acceleration clauses in the loan agreement. Missing a privately refinanced loan payment may result in owing the entire student loan balance immediately. Acceleration clauses can make a bad financial situation worse for an unlucky borrower.
Privately refinancing with a co-signer typically leads to an even lower interest rate. But borrowers who privately refinance their student loans with a co-signer should know about the death and bankruptcy clause. This clause states that if a co-signer dies or goes bankrupt, the balance of the privately refinanced loan is due immediately. For a borrower who has a parent co-sign, this can make their death even more painful. Borrowers with a co-signer should always check if this provision exists when refinancing. If this clause exists in a private refinance agreement, a borrower can benefit from asking to pull out this clause.
Another consideration lawyers should be aware of, especially those in BigLaw is the high turnover of their industry. If a lawyer privately refinances and burns out after a year or two, they may feel stuck in their job because they cannot make their student loan payments if they were to quit. Sticking with a job due to student loan payments can be avoided. BigLaw lawyers who want a private refinance should either:
Consider waiting for a year or two before refinancing to ensure they are more confident they will not want to leave before completing their payments.
Increase their emergency fund to ensure that they can make student loan payments even if they quit or lose their job.
Some lawyers may start their careers by clerking or in a low-paying position before moving to a higher-paying firm or in-house role. If they decide to refinance their loans immediately after graduating, they may have student loan monthly payments they cannot possibly hope to pay while working in these positions. In these cases, it may make more sense to stay with a federal student loan plan that provides lower monthly payments instead of rushing to obtain a lower interest rate initially without the ability to make the payment.
Some lawyers also may start with a high-paying law firm but intend to change to a non-profit or public law position before paying off their student loans. Since these positions pay substantially less, it may force lawyers to delay switching jobs due to their student loan payments. Lawyers may decide it is better to stick with a higher interest federal loan and pursue other repayment methods instead of refinancing.
Lawyers should not feel stuck at a job they do not like because of student loans. Unfortunately, privately refinanced student loans make this a more likely scenario.
The decision to privately refinance student loans is not always straightforward. It may be the right choice for some lawyers, and other lawyers may benefit more from other options. If you would like to have a Certified Student Loan Professional™ analyze your student loan options with you and provide recommendations, schedule a free Meet & Confer meeting today. Developing Financial offers both one-time student loan repayment solutions and ongoing financial planning options that include both student loans repayment recommendations as well as comprehensive planning around all aspects of a lawyer's financial life. Schedule your Meet & Confer today to see how Developing Financial helps lawyers like yourself!
Disclaimer: Nothing in this blog should be considered financial advice or recommendations. Your questions are unique to you and your own personal financial circumstances. You should consult with a financial professional before making a financial decision. See full blog disclaimer.