Student Loan refinancing is a huge decision.
Even though many of the student loan refinance lenders make the process quite easy, borrowers should understand that it is a major commitment. Refinancing isn’t moving money from one bank to another. Instead, borrowers are essentially shredding one contract and replacing it with a new one.
While many of us may be guilty of signing contracts without actually reading them, a student loan refinance contract is not a contract that can be glossed over.
Contract Terms to Look for and Expect
Interest Rate – The headline term on any student loan refinance contract will be the interest rate. Borrowers should only refinance the loans that can be improved — existing loans with lower interest rates do not need to be included. This is also the term that borrowers should carefully investigate. Many lenders advertise low interest rates, but finding the lowest possible refinance rate usually requires submitting several applications first.
Fixed vs. Variable – The lowest interest rates are on variable loans, but the risk is that the rates can increase with time. Borrowers who have selected longer repayment plans would be wise to opt for the security of a fixed-rate loan.
Repayment Length – This is the big variable that will impact monthly payments. Many lenders offer loans up to 20 years, but the best rates come with the 5-year loans. The longer the repayment length, the lower the monthly payment will be.
Auto-pay discounts – The industry standard on this term seems to be a .25% interest rate reduction. A quarter of a percent is not a ton of money, but it is something.
Red Flags: The Terms to Avoid
Many of the terms we are about to describe are rarely seen in student loan refinance contracts.
However, borrowers should still understand what these terms are and why they should be avoided. Each year new lenders enter the marketplace and existing lenders review their loan programs. The only way to avoid the negative terms is to carefully read the contract.
Origination Fees – The Department of Education still charges origination fees for student loans, but private refinance lenders should not be charging origination fees. An origination fee is normally listed as a percent of the loan. For example, a $10,000 refinanced loan with a 3% origination fee would have a total fee of $300. The borrower would be charged interest and expected to pay back $10,300 instead of the $10,000 that they actually borrowed because of the origination fee.
Application Fees – An application fee is charged prior to approval. This fee is normally charged to “cover the expenses” of running a credit report. No reputable refinance company should charge an application fee.
Prepayment Penalties – A prepayment or early payment penalty should never be a part of any student loan or student loan refinance contract. This penalty basically charges borrowers extra if they pay the loan back early. Any lender that tries to impose a prepayment penalty should be avoided.
The good news is that there are many reputable student loan refinance companies that do not impose these fees.
Terms to Live with
There are also a couple of items worth investigating, but not worth getting hung up over. These are items that can be changed over the course of the loan.
Loan servicing – Some lenders service their own loans while others pay an outside company to handle things like bill collections and answering borrower questions. The problem with loan servicers is that they can change and borrowers cannot prevent this change.
Who owns the debt – This is another issue where borrowers don’t really get a say. Many borrowers are disappointed when they learn that a new company has bought their debt. If a lender chooses to sell the loan, borrowers have little power to stop it. For this reason, it is a good idea to work with established companies.
Final Tip: Keep a Copy of the Contract
Even though loan servicers can change and lenders can change, the thing that cannot change is the contract.
Borrower rights as outlined in the contract will last as long as the loan.
New lenders may not closely read or understand the original contract. For example, if the contract says a variable interest rate loan can only be raised once per year, the new lender may attempt to raise it quarterly. These oversights are common when a company buys out a bunch of existing debt where all the contracts may not be the same.
Keeping a copy of the original contract can help borrowers ensure that they get the original deal as agreed upon.