high income, not rich yet

Why I Refinanced My Student Loans 5 Times in 4 Years

Why I Refinanced My Student Loans 5 Times in 4 Years

This week I’m talking about student loan refinancing.  Student loan refinance is a hot topic and for good reason. Numerous millennials graduating between 2009-2015 faced rates of 6.8-7.9% interest on six-figure student loan debts. Loan interest rates have since slowly dropped, but at between 5.29-6.4%, federal student loan rates are still higher than the 3.43-4.75% rates that many high-income professionals can find in the private market.

The chart below shows the average student loan interest rates.

 

student loan interest rates
Credit: Forbes

One of the greatest line items holding millennials back from building wealth is the large portion of income that must be devoted to student loan repayments.  Even with a high income, it’s really hard to get ahead and build wealth if 25-50% of your take-home pay goes to student loan payments.  This is particularly true given the ever-increasing cost of living.

At times, it can feel like six-figures of student loan debt is an albatross that will keep you from ever reaching other financial goals, such as home ownership, saving for retirement, or having children.

I’ll be back later this week to write about more of the nuts and bolts of refinancing, but for now, let’s look at how this became an issue for me (and for so many other millennials).

How did I get to $190,000 in outstanding student loan balance upon graduation?

A small portion of my loans were a holdover from my undergraduate degree.  I went to a small, liberal arts university that gave me generous financial aid, a partial rowing scholarship (earned the last two years), and work-study.  Even with this financial assistance, my overall loan burden was approximately $40,000 graduating undergraduate.  For comparison, this was just over the national average of $37,712 for the Class of 2016.

But the vast majority of my debt, approximately $140,000, was from law school loans. I went to a relatively low-cost in-state school.  My first-year tuition was only $17,000!

So how did this happen?

First, I also had to borrow money for living expenses, including renting a room, books, and an unexpected medical bill of around $7000.  This meant I was borrowing around $40,000 each year.

For the bulk of the loans for many students, including mine, these loans accrued interest during deferment (a.k.a. while I was taking classes for my degree and studying for the bar exam). 7.9% interest accruing over six semesters can balloon a $40,000 tuition payment to $50,508.67. This interest is then “capitalized” (a.k.a. added to your original loan balance). The next year you have the new $40,000 tuition payment + $50,508.67 accruing interest. This increased amount leads to increased interest – around $15,000 if capitalized quarterly.  This capitalization of interest during deferment periods adds thousands upon thousands of dollars to student’s loan burden.

Interest kills your efforts to repay your loans.

After graduation, I learned that my (approximately) original student loan principal of $150,000 had ballooned to just under $190,000. Ouch!  Here’s my original chart I made during the summer of 2013 calculating the interest on my loans when I was preparing for deferment to end in November of 2013:

Lender Interest Rate Current Outstanding Balance Yearly Interest (Underestimate, assumed annual capitalization)
ACS 0.068 2103 143.004
ACS 0.068 2450 166.6
Sallie Mae 0.0275 8805 242.1375
Sallie Mae 0.0675 2138 144.315
Sallie Mae 0.0925 11317 1046.8225
Sallie Mae 0.0925 10017 926.5725
Sallie Mae 0.045 8577 385.965
Duke Perkins – ECSI 0.05 3305 165.25
Great Lakes 0.068 10030 682.04
Great Lakes 0.079 62211 4914.669
Great Lakes 0.068 65784 4473.312
Total $186,737 13290.6875

 

Over $13,290.68 of interest a year using quick, back of the envelope math! Note that the actual interest would have been higher given that each loan was amortized separately.  Assuming a 25% marginal tax bracket, the interest alone represented almost 20% of my first year starting salary.  Wowzer.

More importantly, it meant that I would need to pay a minimum of  $1133/month in interest.  So if I was paying $1500 a month in student loan payments (more than a 1/3 of my take-home pay), only $367 would go towards decreasing the principal. That’s a mere $4404 each year to decrease the principal on my student loan balance.

Worse yet, the federal government loan repayment options were very limited.  I could consolidate into a 30-year loan or I could pick various 10-year repayment plans.  The 10-year repayment option was approximately $2500-2700, which was over half of my take-home pay at the time.  The 30-year plan was more reasonable in the monthly payment at $1314, but with the bulk of the payment going towards interest, it meant the first year I would only pay about $1500 on the principal balance owed.

In 4 years on a 30-year plan with no additional payments, I would end up paying approximately $8-10,000 in principal, with an outstanding balance of $180,000.

After 48 months of payments, I would still owe $180,000!

(This is because loans are amortized, which means you pay the bulk of the interest up front and the bulk of the principal near the end of your term.)

Let that highway robbery sink in for a moment.

However, for those that read my first post, you know that I currently have about $75,000 in student loans outstanding.

So, what happened?

I quickly made the decision that I would have to refinance my student loans. At the time, Sofi and Darian Rowan Bank (now Laurel Road) were pretty much the only two players in the market. I believe I was one of the very first students to be financed by DRB.

After getting over my fear of losing federal student loan protection (something I struggled with for many years, particularly given the legal market was still recovering from a game-changing Great Recession when I graduated law school).

That said, at $190,000 in debt, I was pretty desperate.

I couldn’t afford rent + a government 10-year plan, and the only other option at 30-years left me in the insanity-driving position of paying down just $1500 in principal the first year.

So, I took the leap and became the first person I knew to refinance.  Since 2013 when I first applied for a refinance, over $4 Billion dollars in primarily federal student loans have been refinanced. There are now a dozen or so student loan companies, each with slightly different pros and cons.

I’ll spend another post discussing the merits of each student loan refinance company, but for now, it breaks down to this:

  • Apply to several companies, at least three or four, because it’s free and there’s no effect on your credit score for the pre-approval “Get My Rate” option.
  • You may be turned down by some companies and not others. So cast a wide net.
  • Applying has zero fees, zero prepayment penalties, and you can typically refinance into a different loan term should your circumstances change.
  • In fact, I’ve refinanced my student loans over 5 times in 4 years, chasing lower interest rates and more favorable terms.
  • Most student loan companies offer an automatic 3-month deferment in case of job loss or other hardship.  This provides some cushion in case of an emergency.

After refinancing, I slashed the interest paid each year by half.

I refinanced into two loans: a third at a variable interest rate of approximately 2.8%, and two-thirds at a fixed interest rate of approximately 5.75% (as memory best serves).  My monthly student loan payment for a 15-year term (note: I have since refinanced into a 5-year term) was approximately $1500.

This single action meant that in the first year my interest paid dropped to approximately $8828.21, and the principal balance declined to $181,003.01.

For the same hypothetical payment of $1500 at 7.4% interest (average rate), I would pay down almost six times as much principal a year by slashing the interest rate through refinancing.

In my original 15-year plan, my four-year forecast was to have a balance of $151,635.

Much better than $179,000 under the federal government’s 30-year plan!

Continue to Refinance to Save Money on Interest. 

As noted above, I’ve always thought as interest as the devil and tried to get the amount as low as possible. Thus, I periodically check back and see the current rates, particularly if there have been changes in the economy as a whole (student loan interest rates are typically tied to the LIBOR rate).

I’ve had the best luck on rates with Sofi, though I actually just refinanced today with Earnest.

Earnest is currently offering 3.73% on a 5-year loan.  At my current balance, that will be a savings of $40/month, or $1500 if I take the full five years to pay the loan off.

While it may seem silly to refinance to save $40/month, that means I’ll pay my loans off a full month sooner.

And after 49 months of loan payments, the end cannot come soon enough. (I’m projecting full payoff in the next two years.)

Strategically refinancing has saved me thousands of dollars in interest rates.  

Just because you’re in a 5.25% 10-year refinanced loan, or a 6.4% federal loan, or still in a 7.4% 30-year loan, doesn’t mean that you have to accept those terms.

For example, let’s say you have $150,000 in a 15-year loan at 5.25% interest.  That’s not too bad, but you’re still paying over $642/month in interest the first year, with a monthly payment of $1205.82.

Now, let’s say at the end of year one your credit score has increased, the market is favorable, and you now qualify for a 4.25% interest rate on a 10-year term, and you think you could pay a little more each month.  Refinancing your outstanding $143,000 balance will give you a monthly payment of $1464.86 and your interest drops to $487/month the first year.

The decrease in interest rate gives you an additional $155 month to put towards the principle that you originally were putting towards interest. This accelerates your loan payment.

Every little bit adds up.

While an extra $155/month or $40/month may seem insignificant at the time compared to the six-figures of debt, believe me when I say it adds up.

Over 5 years, an extra $200 month in interest savings can knock an additional $12,000 off the principal.

Combine an extra $200/month in interest savings with an extra $200/month in payments, and you can knock almost $25,000 in principal off in 5 years of regular payments.

It adds up.

So, what do you think? Have you refinanced your loans or thinking you might?

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