Division of Student Assistance

HEAL Refinancing Interest Accrual

Summary

Once you are out of school, you are eligible for HEAL refinancing. In most cases, the optimal time to refinance is right around the time you enter your loan repayment period. If you plan to spend some time in payment deferment where you will not be making payments on your loans, such as in a residency program, you will most likely be better off waiting to refinance. The reason for this is the way accrued interest is handled when you refinance. Once you are in repayment, the handling of accrued interest is not an issue

Details

If you do not refinance until you enter repayment, the interest on your loans will accumulate, or accrue, based on the amounts you originally borrowed. If you refinance now, the interest you have accrued up until now will be added to the original amount you borrowed, and any interest accrued during the time you are in deferment will be based on the combined amount. In other words, your interest accrued to date is capitalized when you refinance. So:

        If you do not refinance, you may be paying a higher interest rate on a lower balance.

        If you do refinance, you might be paying a lower interest rate on a higher balance.

The answer to the question of whether it is beneficial to refinance now or to wait lies in what your balance will be when you start your repayment period. Whichever option will give you the lowest balance at the start of your repayment is the way to go. How we evaluate which is better can be shown with a simple example.

EXAMPLE

Let's consider the case where you had HEAL loans of $10,000 per year for each of four years in school, so you borrowed a total of $40,000. For illustration, we'll assume the rate on your loans was a constant 8%. So when you leave school, your outstanding principal balance is $40,000 and your accrued (unpaid) interest is $8,000 as follows:

Now you are out of school, not yet making payments on your loans, and you hear about HEAL refinancing. You know you can get a better rate than 8% by refinancing, but you also know you are going to spend four years in residency, and you have heard that this capitalized interest thing is something you need to consider. Here's how you determine if refinancing is right for you at this time.

If you stay with your current lender(s) and don't refinance, your loans will continue to accrue interest on the original principal amount you borrowed ($40,000) for the four years you are in residency. This means that your loans will accrue interest of $40,000 x 8% = $3,200 per year while you are in residency, or $12,800 over the four years. In addition, you will accrue nine months (3/4 year) of interest during your grace period after residency, or 3/4 x $3,200 = $2,400. So when you are ready to enter repayment, your loan balance will be:

Now let's consider the case where you refinance when you leave school, and let's assume you get a refinancing interest rate of 7%. When you refinance, the $8,000 interest you accrued in school is added to the amount you originally borrowed ($40,000) to get a new loan balance on which interest is accrued during your four year deferment period. So your refinanced loan will accrue interest of $48,000 x 7% = $3,360 per year while you are in residency, or $13,440 over the four years. In addition, you will accrue nine months (3/4 year) of interest during your grace period after residency, or 3/4 x $3,360 = $2,520. So when you are ready to enter repayment, your loan balance will be:



This comparison shows that you would enter repayment with a balance of $63,200 if you stayed with your current lender at an 8% interest rate, and $63,960 if you refinanced at a 7% interest when you left school. Since the balance at the time you will enter repayment is lower with your current lender, you should not refinance now with the refinancing lender offering a 7% interest rate (even though you may save on your total loan cost if you refinance now, you will save even more if you wait to refinance until you are closer to completing your deferment period).

When you enter repayment, your accrued interest is treated the same by both your current lender and refinancing lenders i.e. the interest is capitalized when you enter repayment. So, once you enter repayment, if you can get a lower interest rate you will always save by refinancing, without worrying about accrued interest.