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Most people should not refinance their student loans. However, in some niche situations it may make sense to refinance your student loan.
Refinancing a student loan has several potential advantages and disadvantages. So when deciding whether you should refinance your own student loans, there are several factors to consider.
The decision often depends heavily on the type of loan you have, whether federal or private. If you have federal loans and are currently receiving one or more federal benefits, you may want to avoid refinancing so you don't lose them.
But even if you're not currently taking advantage of federal student loan benefits, that doesn't necessarily mean you should refinance your loans right away. Here's how to decide when to refinance your student loans and how to get the lowest interest rate while doing so.
How does refinancing a student loan save money?
For many borrowers, the most important question is whether they can save money by refinancing their student loans. Refinancing can generally save you money in two ways:
- Reducing the interest rate you pay on your balance
- Shortening your repayment period to reduce the total interest paid
These two savings options often go hand in hand, as a borrower may need to agree to a shorter repayment term in order to get a better interest rate. Typically, the shorter the repayment period, the lower the interest rate a lender is willing to offer.
Borrowers often mistakenly believe that halving their interest rate will also halve their monthly payments. But a halved interest rate typically only reduces a payment by 10 to 20% because the majority of the payment is on principal, not interest. So a one percentage point reduction in the interest rate is likely to save a borrower only $5 to $6 per month for every $10,000 of student loan debt.
In reality, most of the savings when refinancing come from switching to a shorter repayment term, not a lower interest rate. But it's also important to note that a shorter repayment term can increase your monthly loan payment, even with a lower interest rate.
Should you refinance your federal student loans?
Federal consolidation loans do not offer interest rate reductions. So the only way to lower the interest rate on federal student loans is to refinance them into a private student loan.
This can result in a lower interest rate if the borrower (or co-signer, if applicable) has excellent credit. But refinancing federal loans into a private student loan causes the loans to lose the superior benefits of federal loans, such as:
There are several other factors that can influence whether borrowers choose to consolidate or refinance their federal student loans, including:
- Potential for new student loan forgiveness policies: If widespread federal student loan forgiveness occurs, you'll want to make sure you don't refinance your federal loans into private student loans.
- IDR waiver: IDR waiver allows you to receive credit for payments you made on your student loans under an income-driven repayment plan. If you have old FFEL loans, you may not want to refinance.
In general, federal loan borrowers should only refinance their student loans if (A) they do not qualify for PSLF and (B) their income is high enough that they would not benefit from participating in an IDR plan and are unlikely to be targeted will be covered by future student loan forgiveness guidelines.
Should you refinance your private student loans?
There are no prepayment penalties for private student loans. Therefore, there is nothing stopping a borrower from refinancing their private student loans if they can qualify for a lower interest rate. Some borrowers have refinanced their private student loans multiple times, each time to get a lower interest rate.
Refinancing is a good option for borrowers who have excellent credit or have student loans from several years ago when interest rates were higher. Even if the borrower's credit score has improved since they last applied, they may qualify for a lower interest rate.
A potential downside to refinancing student loans, including private loans, is that multiple loans are replaced with a single loan. This can make repayment easier, but also prevents the borrower from choosing the loan with the highest interest rate for faster repayment.
Accelerating repayment of the loan with the highest interest rate instead of refinancing can save money by reducing the average interest rate paid by the borrower. However, if you choose this route, be sure to inform the lender that the additional amount paid should be considered an additional payment and not an early payment of the next installment.
How can you qualify for a lower refinance rate?
The interest rate you are offered on a private refinance loan depends on your credit score. And if you have a cosigner, their credit score will also affect your interest rate.
Interest rates can vary from about 2% to about 12% depending on your credit score and lender. Here are a few things you can do to increase your chances of getting a refinance rate at the lower end of this scale:
- Get your college degree. Students who drop out are less likely to be approved for a private refinance loan because they are statistically more likely to default on their student loans.
- Pay your bills on time. Making your monthly payments on time or before the due date will improve your credit score and qualify you for student loan consolidation.
- repaying debts; to repay debts. Do not carry any balance on your credit cards. A low debt-to-income ratio increases your chances of being approved for a private refinance.
- Ensure you have stable employment. Lenders value income stability. Therefore, borrowers who have worked for their current employer for at least two to three years have a higher likelihood of qualifying for refinancing.
- Add a creditworthy cosigner. Applying with a creditworthy cosigner can result in a lower interest rate, even if the borrower could qualify for a refinance on their own. However, keep in mind that cosigners assume risk because their credit score will be affected (positively or negatively) by loan payment activity.
The most important thing is to shop around some of the best refinance lenders to find the lowest interest rate available to you. You can also use a lender marketplace like Credible to get quotes from multiple lenders in minutes.
Why is it so difficult to refinance your student loans?
It can be difficult to refinance your student loans because lenders look at your entire financial picture. You need a good income, good credit, and a good debt-to-income ratio.
Depending on the amount of student loan debt you want to refinance, it may be difficult to qualify based on the criteria above.
Many lenders want a debt-to-income ratio of less than 50%. You also want to see a credit score above 700. To get the best advertised student loan rates, you'll likely need a credit score above 800.
When is the best time to refinance a student loan?
While refinancing activity occurs year-round, it often peaks in November and December. This is because the six-month grace period after completing your studies expires at this point.
However, refinancing so soon after graduating from college may not be optimal because your credit score will decrease and your credit utilization will increase with each school year. It takes several years of steady employment and timely bill payments to improve your credit score.
However, interest rates on private student loans are currently at or near record lows. Even if credit isn't great, borrowers can still qualify for a lower interest rate, especially if they apply with a creditworthy cosigner.
Where to Look for Student Loan Lenders?
We have our full list of the best places to refinance student loans. If you're looking for quick ways to refinance, check out these offers:
Final thoughts
When considering whether to refinance your student loans, it is important to consider the total cost of the loan. Compare the total loan payment before and after refinancing the loans. This is particularly important if the refinancing has a different term.
A longer repayment term could reduce the monthly loan payment but actually increase the total amount paid. And while a shorter repayment term might increase your monthly loan payment amount, it could save you a lot of money overall.
Finally, keep in mind that private lenders can vary widely in the benefits they offer borrowers, such as: B. the ability to forbear or defer loans during difficult economic times if you decide to go back to school. Here you can compare our top refinance companies to find the right lender for your needs.
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