I often encourage borrowers to “do the math” when deciding between two student loan options.
In some cases, the right student loan calculator can be very helpful.
Unfortunately, these same calculators can lead borrowers to make a mistake. Like many other tools, student loan calculators are great when used properly but dangerous when used incorrectly.
The Mistaken Assumption Most Calculators Make
Most student loan calculators assume that borrowers will make minimum payments each month.
In some cases, this is a correct assumption and provides the borrower with valuable information. In other cases, this flawed assumption may induce a borrower into making a mistake.
I recently heard from a borrower who had the opportunity to refinance his private loan at a lower interest rate. He was scheduled to pay off his loan in three years, but the shortest private loan repayment length was five years.
Using a student loan calculator, he noted that the total interest spending was about the same whether he refinanced or not. As a result, he figured that refinancing wouldn’t save any money.
In reality, refinancing offered this borrower significant savings. He could have refinanced and stuck with payments at his current level. This route would have gotten the loan paid off faster, resulting in less interest spending. Because the calculator assumed the borrower would only pay the minimum on the refinanced loan, this borrower was deceived into thinking that the lower interest rate wouldn’t help him save money.
Calculators Don’t Understand Loan Terms and Federal Perks
In the previous example, a calculator discouraged a borrower from refinancing a private loan even though it was the better decision.
However, calculators are often guilty of the opposite mistake – telling a borrower to refinance their loans when it is a bad idea.
Calculators look at interest rates, repayment lengths, and loan balances. They rarely distinguish federal debt from private loans.
A calculator might tell a borrower that refinancing a federal loan with a 5% interest rate makes sense if the borrower qualifies for a 4.5% interest rate. In the vast majority of cases, this would be a horrible mistake.
Federal student loans offer numerous borrower protections that private lenders can’t match. Refinancing federal loans into private loans only makes sense in very limited circumstances. Student loan calculators are not sophisticated enough to help borrowers navigate this question.
Student Loan Calculators Group Loans Together
Suppose a borrower is considering refinancing their loans. They have three equal-sized private loans with interest rates of 7%, 6%, and 3%. If the borrower qualified to refinance at 5%, most calculators would suggest that the borrower refinance all of their student debt.
Here again, student loan calculators don’t have the nuance necessary to help a borrower navigate this situation.
In this hypothetical, the best choice would be to refinance the two high-interest loans and leave the third loan unchanged.
Consider the Motives of Most Student Loan Calculator Creators
Most people behind student loan calculators also profit from relationships with student loan refinance lenders.
The calculator builders may have good intentions, but it is hard to handle situations where the interests of the company don’t match the interests of a borrower.
If a calculator is designed to highlight the benefits of refinancing, it may miss many of the dangers or risks.
The Lesson: Don’t Substitute Your Good Judgment for Student Loan Calculator Results
Student loan calculators are tempting because they take a complicated financial question and provide exact numbers to help borrowers navigate their options.
In some cases, these calculators are a valuable resource. They can determine how long it will take to pay off a loan or how quickly it gets eliminated with extra payments.
The problem is that student loan decisions usually can’t be distilled into a single equation. Student loan rules are complicated. A borrower’s personal preferences or individual goals may change the analysis.
Researching and making a plan for student loans is frustrating. Unfortunately, it is a necessary step. Sadly, student loan calculators don’t have all the answers.