The term “refinancing” is one we hear a lot in the realm of student loan repayment, but how many of us know what it actually means?
Refinancing is actually surprisingly easy to understand: a lender will pay off your existing loans and give you a new one with a lower interest rate or shorter repayment plan. It’s basically a chance to swap your current loan for a better one, with better terms.
In the long run, the goal of refinancing is to help save you money. And the best part is, you are allowed to refinance as many times as you like, free of cost. Most lenders allow you to refinance both your federal and private student loans.
Jump Ahead > How It Works • What to Consider Before Refinancing • Am I Eligible to Refinance? • When You Should Refinance • How to Prepare
So How Does Student Loan Refinancing Work?
Let’s say you took out a student loan of $50,000 at an interest rate of 5% during undergrad and you plan on paying it off over the next 10 years at a monthly rate of around $530. By the time you finish paying it off, you will have actually paid $63,640 — the original $50,000 plus $13,640 in interest.
On the other hand, if you refinance at an interest rate of 2.5% over the same ten-year period, you can reduce your monthly payments to $471, and pay only $6,562 in interest, saving $7,078 over the lifetime of the loan.
What to Consider When Refinancing
There are many things to consider when refinancing. Here are a few different factors that are important to consider:
Financial situation
Most lenders require you to have a good credit score (in the mid 600s). Lenders also want proof of a stable income and cash flow to support your new loan.
If your credit score has improved since taking out your original student loan, you may be well-positioned to refinance.
If your credit score is poor, you may struggle to find a lender willing to help you refinance because you will be viewed as a higher risk. If this sounds like you, consider adding a creditworthy cosigner to your application to increase your changes of qualifying for a lower rate.
Change in interest rate and loan term
Before you refinance your student loans, consider the change in interest rate and loan term. A lower interest rate means you will pay less interest each month, resulting in a lower total payment.
The loan term dictates how long you will be paying back the loan. A shorter term typically means a higher monthly payment, but allows you to get out of debt faster. On the other hand, a longer term usually means a lower monthly payment, but increases the amount of interest that you have to pay throughout the lifetime of the loan.
Type of loans
When you refinance, you are essentially applying for a private loan. If you already have private loans, refinancing is a great way to decrease the amount of interest you pay on your loans.
If you have federal loans, however, you’ll want to weigh the reduction of your interest rate with the loss of federal student benefits that you’ll miss out on when you refinance with a private lender, such as:
Income-driven repayment plans
Income-driven repayment plans readjust the amount you pay as your income falls. This keeps your repayment from ever totaling more than 10% of your monthly income, and it can help you stay financially secure.
Loan forgiveness
Federal student loans have some loan forgiveness options, such as the Public Service Loan Forgiveness and Teacher Loan Forgiveness. When you refinance a federal student loan, you lose access to all these long forgiveness programs.
Deferment and Forbearance
Federal student loans include deferment and forbearance which allow you to postpone your loan payments if you suffer severe financial hardship. But if you refinance, you’ll likely lose these protections.
Am I Eligible to Refinance My Student Loan?
While everyone’s situation is different, here are some of the qualities that will make you well-positioned to refinance your student loans.
- You’ve graduated or are no longer in school.
- You have a high-interest private or federal student loan
- You earn a steady flow of income
- You’ve kept up with your loan payments and have a credit score in the mid/high 600s or above.
- You do not work for the government, and you do not foresee the need for an income-driven payment plan.
If this describes you, then you are in good shape to refinance your student loans, and will likely save a substantial amount by doing so. If you answered yes to some of these and not others, you should consider refinancing only your private student loans.
Situations Where it Makes Sense to Refinance
Here are some situations where it would make sense:
You have a private student loan with a high interest rate
If you’ve got a private student loan with a high interest rate, you should try refinancing as soon as possible. That will maximize your potential savings.
If you can lower your interest rate (even by just a half of a percentage point), it could save you thousands of dollars throughout the lifetime of the loan. If you previously refinanced your loans, you can refinance again to lock down an even lower rate. Since refinancing is free, you are almost guaranteed to save money.
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Your finances improve
Credit score and income are the two main factors that determine the interest rate on your private student loans. If your credit score increases or you get a pay raise, it could be a great time to shoot your shot at refinancing your student loans. Refinancing to a shorter repayment plan at a lower interest rate will allow you to pay off your loans faster and save money in the long term.
In order to refinance, you generally need a credit score at least in the high 600s and enough income to consistently pay your debts and other expenses. If you don’t meet those criteria, you could refinance with a cosigner who does.
You have a federal student loan but don’t plan on using of the federal protections
If you don’t plan on taking advantage of federal loan benefits, such as income-driven repayment and Public Service Loan Forgiveness, refinancing might be a good option for you. Only refinance your federal student loans if you know you can get a lower rate. There is no reason to refinance your loans unless you end up paying less in interest.
You have a creditworthy cosigner
A cosigner is a person – such as a parent, close family member or friend – who pledges to pay back the loan if you do not. If you can find a cosigner with strong credit and high income, you’ll have a better chance of qualifying for a low interest rate. This could end up saving you thousands of dollars of interest expense over the lifetime of your loan.
How to Prepare For Refinancing
1. Explore all private loan options.
Determine if the private loan being considered will have a fixed or variable interest rate. A fixed interest rate remains the same throughout the lifetime of the loan, while variable rates will likely fluctuate throughout the lifetime of the loan depending on interest rates set by the banks.
Although a variable rate may be lower at certain points throughout the loan, they are largely unpredictable. On the other hand, fixed-rate offers more stability since you’ll know exactly how much you owe each month. Both can be good options depending on your circumstance and the movement of variable rates.
2. Know where you stand.
A strong credit score will almost certainly be required. While most lenders want to see scores in the mid-to-high 600s, aiming for 700 or higher will help with both the approval process and the rate you will qualify for. This means you will need to know where they stand before starting the process.
3. Carefully examine your credit report and score.
There are a number of sites that allow you to check your credit report for free. If there are mistakes, you will need to take the time to correct them before you start the process of applying for refinancing. If your score is not where it needs to be, you will need to take steps to improve your score before starting on the path to refinancing.
4. Shop around for the best rates.
Some borrowers may be concerned about damaging their credit score by having too many hard inquiries over a short period of time. Luckily, we’ve built a free tool that allows you to see what rates you’ll qualify for without impacting your credit score.