Fannie Mae, the nation’s largest buyer and guarantor of mortgage loans, made news recently when it announced it would sweeten the deal for folks who want to refinance their mortgage to pay off student loan debt. Fannie Mae works with 1,800 lenders nationwide, so their rule change affects many homeowners. At the same time, newer financial companies that target millennials have been pushing student loan refinances as a way to save money and simplify life.
Fannie Mae’s change will make it more affordable for graduates — or parents — to use home equity to pay off student loans by waiving the usual extra charge for taking out cash when you refinance a home. With mortgage interest rates still at historic lows, this could indeed be an opportunity for young adults with high-rate student loans to reduce their monthly payments. But proceed with caution.
If you have a private student loan, you probably have nothing to lose by converting it into a mortgage, personal loan, or other consolidation loan. But if you have a federal loan, you should be more cautious about making changes. You may not realize you’d be losing these protections and options when you give up your federal student loan.
If you lose your job or are unable to find a job after graduation, you may qualify for a deferment, which halts your loan payments until you’re in a better position to pay. With certain federal loans, the government will even pay the interest during deferment.
Similar to deferment, forbearance stops your payment obligation during a period of hardship. But unlike deferment, interest continues to accumulate.
3. Income-driven repayment plans
The government has rolled out a whole range of flexible payment options in recent years to help federal loan borrowers handle payments. These plans cap your monthly payment at a certain percentage of income (10 percent for the program known as Pay As You Earn and 15 percent for the Income-Contingent Repayment Plan). Another benefit of income-driven repayment plans that you would lose if you refinance: an end date. With PAYE, any balance you still owe after 20 years is forgiven; with ICE, loans are forgiven after 25 years. (See also: The Definitive Guide to Pay As You Earn)
4. A second chance if you default
The Federal Loan Rehabilitation Program is a one-time opportunity to get a default removed from your credit report by making a series of on-time payments. This can save you from wrecking your credit and being unable to buy a home later.
5. A central source for tracking loans
If all your student loans are federal, you’ll be able to check up on all of them online through the National Student Loan Data System. If you refinance some but not all of your loans, you may end up having to keep track of them using multiple resources.
6. An unsecured loan
If you default on your student loan, you can lose your good credit, but not much else. If you default on your mortgage, you can lose your house. Let that reality sink in before you jump to refinance a home loan to pay off student loan debt.
7. A fixed interest rate
Of course, you could use a fixed-interest mortgage or a fixed-rate personal loan to pay off your federal student loan. But make sure that’s what you’re getting. If you use a variable rate loan to consolidate your debt, you could get hit with a big payment increase when rates inevitably go up. Federal loans, on the other hand, are guaranteed to be fixed rate.
8. Prepayment penalties
Federal loans don’t charge a fee if you pay more than you owe on any given month, but some private lenders do — check on that before you commit to a refinance.