The average debt of a four-year college student is $26,830, according to the Federal Student Aid Office. For some graduates, that could amount to more than half of their starting salary.
“Student loan refinancing is a great way to save money and lower your monthly payments,” says Katie Ross, education and development manager for American Consumer Credit Counseling. “But not all borrowers are good candidates.”
Here are five reasons that will help you determine whether or not refinancing your student loans is right for you.
1. You have stellar credit and a cosigner
“Student loan refinancing is a great way to save money and lower your monthly payments but not all borrowers are good candidates.”
Apply with a cosigner who also has a great credit history and you will get the best interest rates they offer. That’s because a cosigner with great credit lowers the risk for the lender and makes it more likely that you’ll pay back the new loan on time.
If you choose to apply with a cosigner, know that he or she may be hesitant about the risks involved. Choose to work with a lender that offers a cosigner release. This process allows you to request that the lender remove the cosigner from the loan after a certain period of on-time payments.
2. You have a solid income
Your income plays a big role anytime you apply for credit, especially as it relates to your debt. Having a low debt-to-income ratio increases your chances of getting approved for a low interest rate. Keep in mind that the lender will consider all of your debt in that calculation, not just your student loan debt. As with credit history, it also helps to have a cosigner who has a good income.
3. You have high or variable interest rates
Refinancing is a great way to lower your interest rate on your student loans. But if you already have low interest rates, there’s little benefit to doing it. Interest rates are constantly changing, so compare your current rates with the rates offered by top refinancing lenders to see if it’s worth it to you.
Also, do the math to see how much refinancing will save you over time. Even if you get a lower interest rate, the new loan could have a longer repayment period, which could mean more interest over the long run.
“Be careful when choosing between a fixed and variable interest rate,” says Ross. “Interest rates, which are set by the Federal Reserve, are likely to increase, which could be harmful to your debt repayment plans.”
With fixed rates, you don’t need to worry about interest rate hikes from the Federal Reserve. With variable rates, though, you could see your interest rate go up over time.
4. You want more control over your repayment terms
Even if you can’t manage to get a lower interest rate, you can still lower your monthly payments by refinancing with a longer term. The Standard Repayment Plan for federal student loans is 10 years. If you were to refinance your loans to a 15-year or 20-year plan, you could lower the monthly payment significantly.
“Borrowers should be aware that increasing the term of the loan repayment means more payments and more interest paid,” says Ross.
It may be a good option if you’re struggling to keep up with your payments. However, down the road, you may want to consider refinancing again to a shorter repayment period or prepaying your loan to pay it off early.
Use the Federal Student Aid Office’s repayment estimator to see how much more you’d be paying with a longer repayment term.
5. You don’t need any of the federal student loan benefits
“Many grads obsess overpaying their debt off as quickly as possible,” says Ross. “But refinancing comes with risks, like losing the benefits offered with federal student loans.”
If you have federal student loans, you get certain benefits and protections that you’ll lose if you refinance your debt. For example, if you work for a government agency or a qualifying not-for-profit organization for 10 years, you can qualify for student loan forgiveness.
With federal student loans, you can also apply to one of four income-driven repayment plans. These plans limit your monthly payments to a fraction of your income, making it easier to afford your payments. Plus, if you still have a balance when your repayment period, your remaining student debt will be forgiven.
That said, not everyone qualifies for student loan forgiveness or needs an income-driven repayment plan. If you simply want to lower your interest rate or lower your monthly payment by a little, student loan refinancing is a great alternative.
Should you refinance your student loans?
The decision whether or not to refinance your student loans depends on your financial situation and your goals. Check your credit score and note your current payment and interest rate.
Next, calculate your debt-to-income ratio by dividing your total monthly debt payments by your monthly gross income. There’s no hard-and-fast rule for what your ratio should be, but the lower, the better.
Once you know your financial situation, compare the top student loan refinancing lenders to see which one offers the best feature combination for your needs.
“Weigh out your options,” says Ross. “Borrowers can choose to refinance through a traditional bank, credit union, or newer alternative lenders such as marketplace lenders,” like LendingClub or Prosper.
Many lenders even have a pre-qualification process that allows you to see what kind of rate they might offer you if you were to apply.
Once you have this information, refinancing could make things easier for you. For example, if it’s hard to make your monthly payments now, getting a lower interest rate may not help if it comes with a shorter repayment period and a higher monthly payment.
In the end, do what makes sense right now. There’s always the option to refinance again or add extra money to your payments in the future. When done right, refinancing your student loans could help you pay down your student loans faster and with less interest. In the long run, this frees up more time and money for things that are more important to you.
Ben Luthi is a personal finance writer and a credit cards expert who loves helping consumers and business owners make better financial decisions. His work has been featured in Time, MarketWatch, Yahoo! Finance, U.S. News & World Report, CNBC, Success Magazine, USA Today, The Huffington Post and many more.