Most people focus on the savings the can get by refinancing student loans. However, there are many student loan refinancing mistakes. These mistakes can cost you thousands.
Below I discuss three of the most common student loan refinancing mistakes we see at FitBUX.
Specifically, the student loan refinancing mistakes I focus on in this article are calculation errors. These mistakes cause people to make the wrong choice and cost the most.
Side note before we get started, if you want help making sure you don’t make these mistakes, check out our guide and be sure to use our free Student Loan Refinance Service.
Video Version Of The Mistakes
Before we get started, if you’d like to see example of these student loan refinancing mistakes, check out the video link below. Launch the video >>>
#1 Student Loan Refinancing Mistake
By far the biggest student loan refinance mistake we see people make is calculating how much they will save. Most of the time, this is not the fault of the borrower. Its actually because of really bad calculators on the lender websites.
The mistake people make entails the following:
- They are currently in a 10 year loan for example
- The borrower gets a refinance quote and loves the 5 year loan
- They like the 5 year loan because it saves them the most money
You might be thinking to yourself, “The 5 year puts the most money in my pocket so what is the mistake?” There are multiple mistakes but I’m going to focus on the biggest one.
On the lender’s site they may be showing you a savings $25,000.
The mistake occurs because this is an apples to oranges comparison…
The borrower is going from a 10 year loan to a 5 year loan. Therefore, their monthly payments are a lot higher than before. Thus, part of the $25,000 savings is divided into two components:
- Having a higher payment
- Having a lower interest rate
You must figure out exactly how much the lower interest rate saves you (I detail how to do this in the video above). When you do this calculation, you may come up with something like $5,000 of savings comes from the lower interest rate and $20,000 comes from the higher payment.
Once you know the true amount of savings, you can then decide is it enough to give up your Federal loan benefits and replace them with a private loan.
The appropriate amount to save differs for everyone. The goal is to know the real amount and decide if its enough for you or not.
#2 Student Loan Refinancing Mistake
Mistake number one occurs because people miscalculate the savings when comparing a shorter term loan versus their existing loan which is longer term.
The 2nd mistake we see is similar to the first mistake. However, this one provides people with bad information which causes them not to refinance.
This mistake occurs when people compare their current loan to a longer term student loan refinance offer.
For example, you may have a 10 year loan now but the loan offer you are looking at is 20 years.
You love the monthly payment because its lower but the lender may be saying you’d lose $20k by refinancing. However, that is not the truth.
The “Loss” of money is attributed to two components:
- The lower monthly payment
- The interest rate
The lower monthly payment costs you money because you are paying over 20 years versus your original loan which you were repaying over 10 years.
Therefore, the lower monthly payment may actually be costing you $25k. The lower interest rate may actually be saving you $5k!
Your goal is to compare them on an apples-to-apples basis. If you want to see how to do this, be sure to watch the video at the top of this article.
#3 Student Loan Refinancing Mistake
The third largest calculation mistake occurs once you decide to refinance and you choose the wrong term.
You must look at how much you save AND what it does to your financial plan.
Lets say you do the appropriate calculations to figure out how much you save versus your existing loans. You now have to calculate the real savings between the 10 year loan and the 15 year loan.
The 10 year loan may only $500 more in your pocket than the 15 year loan. You may be thinking “If it saves me more why not do it?”
Savings is only one side of the equation. You have to look at financial planning risk. In this case, the required monthly payment.
The 10 year loan might have a required payment of $1,250 a month. The 15 year loan might have a required payment of $1,000 a month. Remember you can still go into the 15 year loan and make an extra prepayment, i.e. you can still pay off the loan in 10 years if you want.
However, in the 15 year your required payment is $250 less. Therefore, if there is a month you can’t pay $1,250 you don’t have to. You are only obligated to pay $1,000.
Thus, you have to ask yourself, is an extra $500 in savings more important or would I rather have some budget flexibility should I need it?
Everyone has a different answer to this question. The key is knowing that you are comparing the right numbers. If you need help doing this, be sure to check out our Free Student Loan Refinance service. Our expert FitBUX Coaches do the calculations for you. You’ll also be able to build your financial plan and see how it impacts your FitBUX Score.
By Joseph Reinke, CFA
