Here’s Why You Should Refinance Your Student Loan

If you want to know how to refinance your student loan, this is the right guide for you.

One good thing to have come out of October (besides your killer Halloween costume that got all the likes) is the Federal Reserve’s decision to reduce interest rates. Which means that most lenders have now also reduced their rates to a near-term low. What better way to take advantage of this than by refinancing your loan?

How Refinancing Works

Basically how student loan refinancing works is that a private lender pays off your existing loan and gives you a new loan with a lower interest rate. This is a good idea if you want to lower your interest rate, monthly payments or the length (aka the term) of the loan. I mean, who doesn’t want to do that? 

And did you know? You can refinance both federal and private student loans. Typically what happens is that you refinance to today’s lower rate and stick with it for the next several years through a fixed-rate loan, or go with a variable rate (explained below) loan where the rate follows an index interest rate, such as the prime rate.

Why You Should Refinance

While most students have federal loans, a good number have private loans, which typically either have a fixed rate or variable one. The variable interest rate is based on a borrower’s credit history and say you first take out the loan while still in college, you probably still have a limited credit profile and are treated as high risk by lenders. 

As a result, private student loan interest rates can be quite high. However, once you graduate, get a job and build up your credit history, you are then classified as low risk and may be able to qualify to refinance your existing private student loans with a new private loan at a lower rate.

Because private loans are variable, when the Fed cuts rates, it means that borrowers will likely pay less in interest, although how much less will vary by the benchmark and the terms of the loan.

How to Refinance

Now let’s assume you have $100,000 of student loans with an 8% interest rate and 10-year repayment term. If you can refinance student loans with a 3% interest rate and 10-year repayment term, you can lower your monthly payment by $248 and save $29,720 total. Who doesn’t want to save that much money? But, just like with everything in life, there are a few things to think about if you choose to refinance.

“You can save as much as $29,720 by refinancing a $100,000 loan”

Use this calculator to determine how much you can save by refinancing your student loan.

What To Keep In Mind

Don’t get me wrong, refinancing is a great thing, especially now in this low rate environment. But there are still some potential downsides to refinancing. 

For one, some student loan refinancing companies will make false exaggerated claims about the amount of debt they can save you. Beware of these and make sure you can do the math.

Secondly, you should also consider the tax consequences of your refinancing. Your new refinanced loan may not be considered a student loan for the purposes of the student loan interest tax deduction. If you regularly claim this deduction, be sure to consider whether the new loan will allow you to continue to do so.Last but not least, you’ll probably sign away certain benefits if you refinance. Federal student loans feature a number of options for borrowers that run into trouble, including Income-Based Repayment (IBR). Borrowers working in certain professions—like those employed in public service or as teachers may be eligible for loan forgiveness for certain federal loans.

How to Know when to Refinance your loan

Final verdict? If you want to save money and pay off student loans faster, a refinancing is an effective tool to do just that. Current student loan refinancing rates have dropped so low and at the moment are as little as 2.06%. Why? The Federal Reserve cut interest rates, and lenders have now reduced student loan refinancing rates to a near-term low. 

This is great news if you have a student loan, so go out there, get a lower interest rate and save money!

Tips to increase your chances of refinancing your loan

1. Know Your Loans

Make sure to take inventory of the current loans you have. Which lenders are they with? Are they private or federal loans? What’s the balance owed and the interest rate for each loan? It’s important to know where you are today to better evaluate your best options for student loan refinancing.

For example, the Federal Direct Loan consolidation program won’t let you combine your private and federal student loans to a single payment or interest rate. You should also understand what deferment and forgiveness benefits are, and if they’re applicable to your loan and circumstances.

2. Do the Math

In order to better understand how much you’ll benefit from refinancing, it’s best to know your numbers. Specifically, the overall balance owed and average interest rates across both your federal and private loans. Once you have that info, you can use an online student loan calculators to see how refinancing will impact your current situation and the monthly and lifetime savings you can expect.

Remember to look closely at the APR. The monthly payment on your new loan might be lower, but the interest rate could be higher. This can occur because the loan term might be spread out over more years.

3. Credit Score

As with applying for a mortgage, credit or most things really, your credit score is a barometer of your financial responsibility. Most lenders evaluate your credit score and want to ensure that you can meet your financial obligations and have a history of on-time payments. Generally, top lenders expect a minimum credit score in the mid to high 600’s, while others do not have a minimum.

4. Understand Fixed vs. Variable Rates

Also look closely if you’re switching from a fixed to a variable rate loan. Interest rates for most outstanding federal loans have fixed rates, which means that you never have to worry about your monthly payment going up when interest rates rise in the future. If you switch to a variable rate loan, know that your interest rate could rise higher than the original fixed rate loan over time.

5. Income

Private student loan lenders want to ensure that you have sufficient income to repay your student loans. Lenders want proof that you have stable and recurring monthly income and cash flow. Examine your pay stubs and identify your after-tax monthly income. When you subtract your proposed monthly student loan payments, does a sufficient amount remain for other essential living expenses? In case you don’t have enough income, you can still increase your chances of approval by getting a co-signer with a strong credit profile.

6. Other Debt

Your other consumer debt such as mortgage, credit card or auto debt will influence underwriting your student loan. If you have existing debt obligations, lenders will account for your total monthly debt payments as part of the underwriting process. Repaying your other debt obligations before applying for refinancing will ensure that you get a good refinanced rate. 

7. Debt-To-Income Ratio

Student loan lenders will focus on your debt-to-income ratio, which is the ratio of your total monthly income compared with your monthly debt obligations. For example, if you have $10,000 of monthly income and $4,000 of monthly debt expenses, then your debt-to-income ratio is 40%.

8. Employment

Make sure that you are employed or have a written job offer when you apply to refinance student loans. Some private student loan lenders will refinance your student loans while in school or residency, while others will require some work experience.