If you’re like 44 million other Americans, you have student loans. And the average balance of those loans is a hefty $35,359, according to Experian. That can be a big burden, particularly when you’re starting your career and attempting to live on your own.
Plus, student loans can continue to haunt you for decades, hampering your ability to buy a home, afford a wedding, or even your decision to have children.
It makes sense, then, to pay off your student loans as quickly as possible. There are lots of ways to pay off your loans faster, including cutting your expenses and making extra money outside of your day job.
Another option to consider is refinancing your loans. In some cases, it can reduce the interest you pay, helping you get rid of debt faster. It can also reduce your monthly payments, freeing up cash for more immediate needs.
But how does student loan refinancing work? And is it right for you? Read on to find out.
Student loan refinancing sounds like something you need an economics degree to understand, but the basic concept is simple.
When you refinance your student loans, a private lender gives you a loan to pay off your student debt. They effectively take over your loans, and you now make payments to the new lender instead of the company (or companies) you originally borrowed from.
Here’s a simple example:
Let’s say you have 5 student loans, each in the amount of $5,000. Each loan has an interest rate of 7%. You apply to refinance your student loans, and your application is approved.
Now, instead of paying 5 different loans, you’re paying one large loan with a (hopefully) lower interest rate.
If it can reduce your interest rate, refinancing your student loans is often a smart financial move. And in some situations, it can also be worth it if it reduces your monthly loan payment (though be sure to watch out for some of the pitfalls we discuss below).
So should you refinance your student loans? It depends.
Let’s look at some reasons you should (and shouldn’t) refinance.
While refinancing your student loans can be a good move in some situations, it’s not always a good idea. Here are three reasons not to refinance:
1. You have a low credit score
Lenders are picky about whose student loans they’ll refinance. They want to be sure that you won’t default on your payments, and one common way to check this is through your credit score.
While it isn’t the only factor lenders use, a good credit score is one of the first things lenders look for when deciding to lend to you in the first place.
And assuming you qualify for a loan, your credit score can also affect the interest rate you’ll get. The higher your credit score, the more likely you are to get a lower rate.
So what credit score do you need to refinance your student loans? Credible, a service that connects borrowers with student loan refinancing lenders, states that most of their lenders look for a credit score of “between 670 and 700” when evaluating borrowers.
If your credit score is below this range, it’s unlikely that you’ll qualify to refinance (or qualify for a low interest rate). You can check your credit score for free using Credit Karma.
2. You have a high debt-to-income ratio
In addition to your credit score, lenders will also look at something called your debt-to-income ratio.
This number expresses the relationships between all the debts you owe (minimum credit card payments, student loan payments, mortgage, etc.) and your monthly income. The lower the number, the better your financial position.
So what debt-to-income ratio do you need to qualify for student loan refinancing? There’s no exact number, but Investopedia reports that most lenders prefer a debt-to-income ratio lower than 36%.
To calculate your debt-to-income ratio, you can use this free calculator. If you’re looking to improve your debt to income ratio, your best bets are to boost your income or pay down your consumer debt.
3. You’ll lose protections on federal student loans
If you have federal student loans, you should think twice before refinancing. Even if a private lender can offer you a lower interest rate, federal student loans come with important protections and repayment options that you’ll lose if you refinance.
First, refinancing your federal loans makes you ineligible for income-driven repayment plans. Under these plans, you can lower your loan payments to match your income. This can provide great relief if your monthly loan payments are too high.
Second, refinancing your federal student loans makes you ineligible for loan forgiveness programs. If you have federal student loans, it’s possible to get them forgiven if you work for the government or a non-profit organization. Teachers can also be eligible for federal student loan forgiveness in some circumstances.
Finally, you can often defer or reduce payments on federal loans in certain circumstances such as cancer treatment, unemployment, or active duty military service (to name just a few). This is a great option to have if you encounter financial hardship or unexpected life events.
If you refinance your federal loans, you’ll lose all of the above options. It could still be worth it if it reduces your interest rate, but be sure you’re willing to give up federal loan protections and repayment programs.
While there are many compelling reasons not to refinance your student loans, it can still be a smart financial move in some cases. Here are three reasons to consider refinancing:
1. To get a lower interest rate
The best reason to refinance your loans is to lower your interest rate. For instance, let’s say you have $35,000 in student loans with an average interest rate of 7%. If you pay that loan back over the standard 10-year repayment term, you’ll pay $2,450 in interest.
But if you refinance those loans so that your interest rate is only 5%, your total interest payments drop to $1,750. That’s a $700 decrease. And the higher your student debt amount, the bigger the difference a lower interest rate will make.
2. To lower your monthly payment
Another common reason people consider student loan refinancing is to lower their monthly payment. This can free up money to put toward things like an emergency fund, high-interest credit card debt, or just regular household expenses.
While a lower monthly payment can be compelling, make sure it doesn’t come at the cost of a higher interest rate or a longer repayment period.
For instance, a lender might offer you the chance to repay your loan over 15 years instead of 10. While this will reduce your monthly payments, you’ll end up paying more in interest overall, and you’ll be in debt for longer. You might be okay with this tradeoff, but be aware of what you’re agreeing to.
3. To simplify your loan payments
If you have student loans from a variety of companies or servicers, refinancing can simplify your loans into one monthly payment to a single company. This can make it easier to keep track of your payments and prevent you from missing one.
However, this is only a good reason to refinance if:
- It doesn’t increase your interest rate.
- You have mostly private student loans.
Refinancing just to simplify your payments doesn’t make financial sense if it increases the amount of interest you pay.
And while refinancing can be an effective way to combine private loans, there are better options for federal student loans such as a Direct Consolidation Loan.
This type of loan lets you combine your federal student loans without losing access to federal loan protections.
If you’ve decided that you want to refinance your student loans, the next step is to choose a lender. There are many out there, so we put together this list of questions to help you choose the lender that’s right for you.
Is the lender a reputable, ethical company?
Refinancing your student loans is a serious financial decision, so you want to make sure you’re dealing with a company you can trust. Before doing business with any lender, look for reliable third-party reviews as well as consumer complaints.
To search for consumer complaints against companies, you can search this database from the Consumer Financial Protection Bureau. Be sure to take complaints with a grain of salt (some people just like to complain).
To find reviews (and additional consumer complaints), you can look up the company on the Better Business Bureau website.
Can you qualify to refinance with the lender?
Different lenders have different criteria for screening potential borrowers, but all are going to want a good credit score, low debt-to-income ratio, and proof of employment (or at least an offer of employment if you’re currently job hunting).
Generally, you’ll also have to have graduated from the educational institution that you took out student loans to attend.
You can find specific qualifications on the lender’s website (and sometimes on third-party websites). If you’re not sure if you’ll qualify, go ahead and inquire; it doesn’t hurt your credit score to get quotes on student loan refinancing.
What’s the interest rate?
If the company can’t offer you a lower interest rate than you’re currently paying, it’s probably not worth it to refinance with them.
Is the interest rate fixed or variable?
There are two main types of interest rates: fixed and variable.
A fixed interest rate doesn’t change, no matter what happens in the economy.
Variable interest rates, meanwhile, vary within a certain range of interest rates. For instance, SoFi currently offers variable rates as low as 2.05% and as high as 9.95% (with rates subject to change each month).
If a lender quotes you a variable interest rate, it’s tempting to focus on how low your rate can be. But you should be more interested in how high the rate can go and expect the possibility of paying that higher rate.
In general, we recommend sticking with fixed rates since they make your loan repayments and overall finances more predictable, as well as eliminating the risk of paying more interest than if you hadn’t refinanced.
What support and services does the lender offer?
When you refinance your loans, you’re committing to working with your new lender for years (unless you decide to refinance again in the future). So you want to be sure this is an easy company to deal with.
To start, assess how easy the company is to contact. If you have questions about due dates, interest rates, or how to make payments, you don’t want to deal with a company that’s hard to get ahold of. This is another reason to check complaints and reviews filed with the Consumer Financial Protection Bureau and the Better Business Bureau.
Also, look at the tools that the lender offers for refinancing. Do they let you complete all of the refinancing documents online? Do they have an online system for checking your loan balance and making payments? Can you set up autopay?
Refinancing your student loans can be a confusing topic full of financial jargon. To help you understand the process, here are answers to some common questions about student loan refinancing.
Is refinancing student loans the same as consolidating them?
No, it isn’t. While refinancing and consolidating your student loans are similar, there are some important differences.
To start, you can only consolidate federal student loans. To do this, you’ll need to apply for a Direct Consolidation Loan.
Next, your interest rate is calculated differently when you consolidate. The interest rate you’ll pay on your consolidated student loans is the weighted average of your previous interest rates rounded up to the nearest ⅛ of a percent, meaning it will never be lower than any of your original interest rates.
Finally, because consolidated loans are still federal loans, they generally have most of the same federal protections and benefits such as the ability to defer your loans or have them forgiven (though be sure to clarify this before you consolidate).
Should I get someone to cosign on my refinanced loans?
If you can’t qualify for refinancing on your own, some lenders will let you refinance if someone cosigns for your loans. A cosigner is someone with sufficient credit and income to repay your loans if you’re unable to. Usually, this will be a parent or another family member, though it could also be a friend.
While getting a cosigner can make it possible to refinance your loans, you should be very careful before asking someone to cosign. Because if you can’t make your payments, the cosigner will be fully responsible for them (as well as any late fees).
If the cosigner can’t repay your loans, it could damage their credit or even lead to legal action. And besides the financial damage, this could potentially hurt or even ruin a relationship with a friend or loved one.
Will refinancing student loans hurt my credit score?
Generally, no. Getting quotes on student loans only requires a “soft” credit inquiry, which has no effect on your score. So feel free to shop around and get as many quotes as you want.
Once you apply to refinance, however, the lender will have to conduct a “hard” credit inquiry. Generally, this shouldn’t cause your credit score to drop by more than a few points.
Just make sure you don’t apply with lots of different companies at once, as that could cause a larger drop in your score.
How often can I refinance my student loans?
There’s no limit to how many times you can refinance your student loans. As long as you meet the lender’s qualifications, you can submit a refinance application.
However, we don’t recommend refinancing your student loans frequently; only do so if you have the chance to drastically lower your interest rate.
Does the federal government offer student loan refinancing?
No, but they do offer student loan consolidation, which we discussed above.
You should now understand the ins and outs of how to refinance your student loans, as well as how to decide if refinancing is the right move for you.
If you take nothing else away from this article, remember this: refinancing your student loans is a serious financial decision. Never refinance without researching lenders and understanding exactly what you’re agreeing to.
Refinancing your student loans can save you lots of money in the correct situations. But it can also end up costing you more money if you aren’t careful, as well as eliminate your ability to defer your loans or have them forgiven.
If you’re looking to compare student loan refinancing offers, we recommend starting with Credible.
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