Should You Refinance Your Student Loans?

Most people should not refinance their student loans. However, for some niche situations, it can make sense to refinance your student loans.

There are various potential benefits and drawbacks to student loan refinancing. So when you're trying to decide if you should refinance your own student loans, there are multiple factors to consider.

The decision will often heavily depend on the type of loan that you have, whether federal or private. If you have federal loans and are currently taking advantage of one or more federal benefits, you might want to avoid refinancing so that you don't lose them.

But even if you aren't currently utilizing any federal student loan benefits, that doesn't necessarily mean that you should rush to refinance your loans right now. Here's how to decide when you should refinance your student loans and how to get the lowest rate when you do.

How Does Student Loan Refinancing Save Money?

For many borrowers, the most important question is whether refinancing their student loans will save them money. Refinancing can generally save you money in two ways:

• Reducing the interest rate you pay on your balance
• Shortening your repayment term to reduce the total interest paid

These two money-savers often go hand-in-hand in that a borrower may need to agree to a shorter repayment term to get a better interest rate. Usually, the shorter the repayment term, the lower the interest rate that a lender is willing to offer.

Borrowers often mistakenly believe that cutting their interest rate in half will also halve their monthly payments. But a halved interest rate will typically only reduce a payment by 10% to 20% since most of the payment goes to principal, not interest. So a 1% percentage point decrease in interest rate is likely to save a borrower just $5 to $6 per month for each $10,000 in student loan debt.

In reality, most of the savings from refinancing will come from moving to a shorter repayment term, not from having a lower interest rate. But it's also important to note that a shorter repayment term may 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 option for decreasing the interest rate of federal student loans is to refinance them into a private student loan. 

This might yield a lower interest rate if the borrower (or cosigner, if any) has excellent credit. But refinancing federal loans into a private student loan will cause the loans to lose the superior benefits of federal loans, such as:

• Longer deferments and forbearances
• Income-driven repayment
• Existing loan forgiveness options

There are a few other factors that may influence whether borrowers choose to consolidate or refinance their federal student loans including:

• Potential for new student loan forgiveness policies: If broad forgiveness of federal student loans occurs, you want to make sure you don't refinance your federal loans into private student loans. 
• IDR Waiver: The IDR waiver will provide credit for payments 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 don't qualify for PSLF and if (B) their incomes are high enough that they won't benefit from joining an IDR plan and are unlikely to be targeted by future student loan forgiveness policies.

Should You Refinance Your Private Student Loans?

There are no prepayment penalties on private student loans. So nothing stops 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 an excellent credit score or who have student loans from several years ago, when interest rates were higher. Also if the borrower's credit score has improved since they last applies, they might qualify for a lower interest rate.

A potential drawback of refinancing any student loans, including private loans, is that it replaces multiple loans with a single loan. This might streamline repayment, but it also prevents the borrower from targeting the loan with the highest interest rate for quicker 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. But if you decide to go this route, just be sure to tell the lender that the additional money you pay should be counted as an extra payment and not an early payment of the next installment. 

How Can You Qualify For A Lower Refinance Rate?

The interest rate you're offered on a private refinance loan will depend your credit score. And if you have a cosigner, their credit score will impact your interest rate as well.

Interest rates can vary from about 2% to about 12%, depending on credit scores and lenders. Here are a few things you can do to increase your chances of qualifying for a refinance rate that's on the lower end of this scale:

• Graduate from college. Students who drop out of college are less likely to be approved for a private refinance loan because they're statistically more likely to default on their student loans. Note: There are lenders that specialize in refinancing if you didn't graduate college.
• Pay your bills on time. Making your monthly payments on or before their due dates will contribute to a better credit score, which will help you qualify for student loan refinancing.
• Pay down debt. Don’t carry a balance on your credit cards. A low debt-to-income ratio will increase your likelihood of being approved for private refinancing.
• Maintain steady employment. Lenders love to see income stability. That's why borrowers who have worked for their current employer for at least 2-3 years are more likely to qualify for refinancing.
• Add a creditworthy cosigner. Applying with a creditworthy cosigner can yield a lower interest rate, even if borrowers could qualify for refinancing on their own. Just know that cosigners take on risk as their credit scores are impacted (positively or negatively) by the loan's payment activity.

Most importantly, it's important to shop around with several of the best refinancing 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 Hard To Refinance Your Student Loan?

It can be hard to refinance your student loan because lenders will be looking at your entire financial picture. You'll need a good income, a good credit score, and a good debt-to-income ratio. 

Depending on how much in student loan debt you're looking to refinance, it can be hard to qualify based on the criteria above.

Many lenders want to see a debt-to-income ratio of less than 50%. The also want to see a credit score above 700. In fact, to get the best advertised student loan rates, you'll likely need a credit score above 800.

When Is The Best Time To Refinance Student Loans?

While refinancing activity occurs throughout the year, it often peaks in November and December. That's because the six-month grace period after students graduate expires around that time.

Refinancing so soon after college graduation, however, may not be optimal because credit scores decrease with each year in school as credit utilization increases. It takes several years of steady employment and on-time bill payment for credit scores to improvement.

That being said, interest rates on private student loans are currently at or near record lows. So even with a less-than-stellar credit record, borrowers may qualify for a lower interest rate, especially if they apply with a creditworthy cosigner.

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