Student loans are a terrible burden for many Americans. There's not much you can do to get out of paying your student loans -- they even survive bankruptcies! But there is something you can do to lower your monthly payments: refinance your loans. Refinancing can help you make consistent, on-time payments without getting deeper into debt or going broke. Sounds pretty ideal, doesn't it? Here's everything you need to know about refinancing your student loans.
What does it mean to refinance?
Let's first start with a simple definition before diving into the details. When you refinance a student loan, a private lender pays off your current loan, then issues you a new loan with a new interest rate. A lower interest rate means lower monthly payments. It can also mean paying less overall because you won't be paying as much in interest, which increases the total amount of the loan. This makes it easier to keep up with your monthly payments and avoid defaulting on your loan.
Is refinancing the same as consolidating?
No, it's not. When it comes to student loans, refinancing and consolidating each one has its own set of rules and achieves different goals. Student loan consolidation typically refers to federal student loans only. It's the process of combining two or more federal loans into one loan, resulting in a single monthly payment. This is done using a Direct Consolidation Loan offered by the Department of Education. It cannot be used with private student loans. Federal consolidation is not considered refinancing because the new (fixed) interest rate is simply the weighted average of the interest rates on the loans being consolidated. It won't help you save money on interest, and you may even end up with higher interest. Student loan refinancing, on the other hand, is done through a private lender and can include both federal and private student loans. Unlike federal consolidation, private refinancing results in a completely new loan with new terms and a new interest rate. Therefore, you can get a lower interest rate and monthly payment when you refinance through a private lender. To learn more, read our complete guide on private vs. federal student loan consolidation.
The pros and cons of student loan refinancing
- It can simplify your life
- Reduce interest rates and lower monthly payments
- You can choose a better loan servicer
- Option to remove a cosigner
- Put a Parent PLUS loan in your name
- You lose some federal loan perks
- You can apply for federal student loan forgiveness programs
The benefits of refinancing
There are many positives to refinancing your student loans through a private lender. Here are five:
1) It can simplify your life
If you are currently making separate payments on two or more student loans, refinancing these loans will result in only one monthly payment.
2) It can lower your monthly loan payment
The goal of refinancing a student loan is to get a better interest rate, which results in a lower payment.
3) You can get a better loan servicer
If you're unhappy with the lender who currently services your student loan, why not do your research to find a better fit? This is possible when you refinance.
4) You can remove a cosigner
Maybe one of your student loans required a parent or friend to cosign on the loan. If that loan is paid off during a consolidation and refinance, then your cosigner can be off the hook. What a relief!
5) You can put a Parent PLUS Loan in your name
Parent PLUS Loans are a type of student loan given to parents so they can pay for their child's education. Perhaps you needed your folks to take out the loan when you began school, but now you're earning your own money and want to relieve their burden. The way to do this is to refinance the Parent Plus Loan and put the new loan in your name.
Should you refinance all of your student loans?
Not necessarily. For example, you may want to think twice before refinancing student loans that already have a very low interest rate. You should also reconsider refinancing federal loans if:
You're worried about losing federal loan perks
If you're worried about losing some of the federal perks that you can't get with private loans, you may want to hold off on refinancing those federal loans. This includes income-driven repayment plans, as well as deferment and forbearance options if you suffer a difficult financial period.
You want your federal loans forgiven
If you want your federal student loans forgiven, don't refinance them under a private loan. There are a few programs that allow for federal student loan forgiveness, including teacher student loan forgiveness and public service loan forgiveness. If you refinance a federal loan, you will no longer be eligible for forgiveness. However, there are private student loan forgiveness alternatives you can consider.
Which loans are best for a refinance?
Private student loans with high or variable interest rates
Interest rates vary over time depending on the Federal Funds Rate range set by the Federal Reserve. So, if your loan has a variable rate, you'll likely experience interest rate hikes throughout the life of your loan. This makes your monthly payments unpredictable and, therefore, potentially more difficult to keep up with. You don't need to worry about that with a fixed interest rate, though, as your monthly payments will remain the same throughout the life of the loan. Because interest rates are always changing, you'll want to compare your current rates against the rates offered by top lenders. Do the math, and see how much you'll save in the long run by refinancing.
Federal student loans that need to be extended
If you're struggling to make on-time payments and want more control over your repayment terms, you can lower your monthly payments by refinancing your loan with a longer term. For example, the Standard Repayment Plan on a federal student loan is 10 years. You can drastically lower your monthly payment by refinancing that loan to a 15 or 20-year plan. Keep in mind, though, that a longer a repayment term means you'll be making more payments as well as paying more in interest over the life of the loan. So, if it's feasible, try paying your loan off early or consider refinancing again with a shorter repayment term down the road. You may also want to refinance your federal student loans if you have a secure job with a high income. Locking in a lower interest rate may be worth the risk of giving up federal loan perks, especially if you have a secure job with a stable income. Here are five scenarios where refinancing student loans makes sense.
When can you seek a refinance?
You can refinance anytime after graduation. However, some lenders will require income for six or 12 months, in which case if you’re a typical student, you may need to wait. However, you can get round this if you have a cosigner.
What are lenders looking for?
When seeking any type of loan, including a refinance of your student loans, lenders will take a hard look at your credit history and your ability to repay your loans. What exactly will lenders be looking for?
Most lenders want to see that you either have a steady job or a job offer. The longer your history of steady employment is, the better. Most lenders are looking for six to 12 months of steady employment. How high does your income need to be? That all depends on your debt-to-income ratio.
Debt to income ratio (DTI)
A DTI looks at your ability to manage monthly payments based on your income and your debts. Your DTI is calculated by dividing your monthly debt payments by your monthly gross income. Most lenders are looking for a DTI no higher than 35 to 40%.
680 is the lowest credit score most lenders will consider. However, there are a couple of lenders who will go as low as 660, including Earnest and CommonBond.
Who isn't eligible for a refinance?
If you're still in school, you can't refinance your loans. But that's OK because you aren't required to start repayment until six months after graduation. Also, you have to complete your program of study and graduate. Generally, lenders consider you ineligible if you didn’t complete your degree. PLUS loans are an exception. If you’re the parent borrower, some lenders will let you consolidate or refinance your loans even if the degree isn’t completed.
Tips for improving your chances:
If your credit score and DTI aren't up to snuff for a refinance, work on improving both of these and try again in six months. How can you do this? Pay down your debt. Put all of your extra income for the next six months toward debt. Forget about new clothes, going out for dinner, or expensive vacations; just focus on your debt. This will improve both your credit score and your DTI. Earn extra money to put toward debt. How can you do this? You can sell stuff you don't need. You can take on an extra job or some freelance work. There are tons of options out there for a side hustle. You just need to find the right one.
If you're ready to get started, review all the top lenders above and do a side-by-side comparison to find the best one for you. There's no time like the present to improve your financial situation!