Why Refinance a Student Loan?
The average student graduates with $25,000 to $39,000 in debt, depending on the college they went to, according to The Institute for College Access and Success. That debt is often in the form of multiple student loans, taken at different times and with different interest rates.
The result is that graduates not only start their post-college life in debt but are juggling multiple payments to several lenders. Refinancing simply means getting a single loan to pay off all the other loans you have. Then you only have to worry about the single loan.
By refinancing your student loan, you can combine these payments into a single monthly payment. In addition, with a job and credit built up, you may qualify for lower interest rates. This not only cuts down your monthly payment but can reduce the amount you'd pay in interest, giving you more cash to invest in your future.
There are plenty of pros and cons to refinancing your student loans, but convenience and savings are the two biggest motivators. Read on for what you should know about refinancing student loans, then check out our Best Student Loan reviews for lenders who can help you refinance.
How Does Refinancing Student Loans Work?
Just like refinancing any private loan, when merging all of your student loans into one loan, you will work with a loan officer, providing your financial information, including income, tax returns and credit history. If you're not yet employed, some lenders accept an official notice of intent to employ as proof of income. As with any loan, the bank does a credit pull, and in most cases, the interest you'll pay is determined by your credit score, the loan amount, and the length of the loan.
If you are turned down or are not pleased with the interest rate you qualify for, finding a co-signer may allow you to get the loan and, often, at a better rate.
With refinancing, the lender pays off your federal and private student loans. In the case of federal loans, any benefits you may have received end. You then make your single payment to your new lender.
When should I refinance my student loans? In general, these conditions are good signs that refinancing is a good idea:
- Your interest rate(s) on your current loans is higher than what's currently available.
- You find yourself slipping on payments for one loan in order to pay the other.
- You have several years left to pay off your loan. (If you can pay your loans off in a year, it might be smarter to keep plugging away at them rather than start anew with a refinancing loan that may have fees and stretches your year of payments into five.)
You are unable to pay the separate monthly payments. Refinanced loans usually result in a lower monthly payment. This can ease the financial burden for some people.
What about federal student loans? These are loans given by the government. Very often, they are at lower interest rates than you can get even with strong credit. In addition, they often come with waivers and forgiveness programs – benefits you could lose if you refinance. Before including a federal student loan in your refinancing, check that you don't qualify for any benefits or, if you do, that the benefits don't outweigh the convenience of dealing with a single payment.
The Department of Education also has federal student loan consolidation programs. If you have more than one government student loan, you may qualify for consolidation. While these only apply to government loans, they nonetheless have lower interest and benefits that a private loan cannot supply. You can have a federal consolidation loan in addition to refinancing your private loans. Learn more about federal student loan consolidation here.
Does refinancing help or hurt my credit rating? It depends on your long-term focus and spending habits. Refinancing may cause an initial drop in your credit score, because lenders make inquiries on your credit, and a larger loan shows on your report. In addition, until you pay off all the student loans with the new one, you will show a huge amount of debt.
However, in the long run, your credit rating and score can improve if the single loan allows you to pay off your debt sooner than if you'd juggled the multiple debts. Very often, a refinanced loan not only has a lower interest rate but also a lower payment than the sum of the payments on the old loans. Make sure, however, that your spending does not increase because your payments are easier. Concentrate on paying off the loan.
How to Make the Most of a Refinanced Loan
Refinancing makes the most sense not only when you get a lower interest rate but also when you take advantage of the lower payments by putting more money into the principal to pay off the loan early. Let's look at the math.
Say you have three private student loans:
- Loan A: A five-year loan taken out in December 2015 for $5,000 at a 5.9 percent interest rate.
- Loan B: A five-year loan taken out in January 2015 for $7,000 at 11 percent interest.
- Loan C: A five-year loan taken out September 2014 for $10,000 at 7.25 percent.
Let's assume you've made payments faithfully and now you've graduated and have a good job. It's now August 2016, and you are wondering if you should refinance. (The dates are only to help us track passage of time.)
If you continue paying the loans as they stand, you will have everything paid off in December 2020. Your payments have run $488 a month. Overall, you'll have paid $4,869 in interest.
Let's say you find a bank that will refinance your student loans at a 4.29 percent interest, and you get a single five-year loan that starts in September 2016. By then, you'll still owe $15,846 on your loans, so you refinance for that amount. Your payments are now $293.91 a month, and you'll pay off the loan in September 2021. That's an extra 10 months of payments.
However, the total interest on the refinanced loan is $1,788. Up to this point, you've paid a total of $2,538 in interest on your old loans. If you add that to the interest you'll pay with the refinanced loan, it comes to $4,327, an overall savings of $542. So, you save money and lower your payments by refinancing.
Let's take it one step further. Let's say, you've been able to keep up with the $488 a month you've been paying with all three loans, so rather than making the minimum payment on your new loan, you pay $488 each month. You will pay off this new loan in November 2019 – almost two years ahead of schedule. In addition, you'll have saved yourself another $600 in interest.
Graphic: chart showing savings
Student Loan Refinance Package: What to Look For
You should look for a loan-refinancing program that offers interest rates lower than what you're currently paying with terms that are helpful to you. You will also want to read the fine print to make sure you're not incurring extra costs or fees in the refinancing package.
There are three options for refinancing your loans:
Federal Student Aid: Before you refinance federal student loans, you should check with the Federal Student Aid Office first to read up on what's new with federal loan refinancing. Its website is a great place to start, as there is plenty of information available to help you research refinancing options and know what to look for. Plus, you may be able to keep some of the benefits of your existing federal student loans.
In the case of federal student loan consolidation, the U.S. Department of Education sets the new interest rate by calculating an average of the rates of the federal loans you're consolidating. Commercial lenders may give you a better interest rate. Therefore, consider if the benefits from the federal loan outweigh the potential savings.
Commercial Banks & Lenders: If you have private student loans, you'll need to look to a commercial lender to refinance. A few commercial banks offer formalized student loan refinancing programs. Start at your current bank and ask if they have a program. Then check out our Best Student Loan reviews. Several of these lenders do refinancing as well. This will give you a set of options to compare and contrast.
Credit Unions: Some credit unions offer student loan consolidation programs, especially credit unions associated with universities. You can work with your credit union from your job or alma mater to see if they have a program, or you can shop around for a credit union that offers one. If you qualify to do business with the credit union, you might find slightly lower rates and additional perks, like higher savings rates for associated accounts.
When looking at private loan refinancing or working with a commercial lender or credit union, it's best to do your homework. Don't go with the first institution you happen to ask. Get quotes from three or more and compare them. In addition to interest, consider these factors:
Terms: Loan terms define the length of your loan. Some lenders will grant you a loan for as little as one year while others let you stretch payments to 30 years. You need to decide what works best for your budget. Keep in mind that the longer the loan term, the more you are paying in the long run, which can mean the difference between hundreds of dollars and tens of thousands of dollars.
Eligibility: As we said earlier, the average student loan debt is around $30,000, which most lenders can handle. However, some advanced degrees, such as medical degrees, can lead to debts of several hundred thousand dollars, which narrows your choices. Of greater concern, though, may be the minimum lenders are willing to consolidate. In our research, we found several lenders would not consider you unless your debt is greater than $10,000.
Another issue to be aware of is that some banks and credit unions set a minimum annual income. One bank we researched has a minimum annual income of $50,000, which was the highest of any of the private lenders we researched. It services higher loans in general, like medical or law-school loans. A few simply want proof of intent to employ. Others set no lower income limit because they examine your entire credit history.
Should you get a co-signer? It's possible you may not qualify for a new loan or that the interest rate and terms are worse than if you continued to pay for each loan separately. In those cases, you may want to get a co-signer. The lender can then use the co-signer's credit history to qualify you or get you the better rate, but it also makes the co-signer responsible for the loan. Outstanding loans also count against their credit rating, which can be a problem when you're dealing with a 30-year, $150,000 loan.
One item that can reassure a co-signer is a release, which allows him or her to be removed from the loan after a certain number of consecutive, on-time payments. These release terms range from 24 to 36 on-time, consecutive payments. Where a lender may not offer a co-signer release option, most let you refinance the loan at a later time for free, but you may not qualify for the same interest rate.
Help & Support: Many lenders don't specialize in student loans, but provide them through a third party. This can be a problem should you have questions later or have an issue. In our research, we found several lenders do not specialize in student loans but offer them as part of their repertoire. A few work with a third-party service. In these cases, the lender agents didn't always know much about the student loan programs while the outside service understood student loans but was not familiar with the specific lender's policies. A few depended on the information on their computer, looking up details on charts. While we found it reassuring that the information was readily accessible, it also indicated that student loan consolidation isn't the lender's primary focus.
Therefore, we suggest you speak to a loan officer, looking especially for how knowledgeable the agent is and whether they answer your questions without passing you to a different department or agency. Also check to see if they will speak to you without needing you to disclose private information or subjecting you to a credit pull or online identity search. Acceptable questions for an agent to ask center on how many loans you have, the total amount, and whether they were federal or private; they may also ask about your income.
Alternate Ways to Repay Your Student Loans
Even if you don't qualify for student loan refinancing, there are ways to get yourself out of debt. In fact, some of the alternatives listed below ought to be considered before applying, as they could reduce your debt without additional payments.
Snowball method. Also known as debt stacking, this process has you paying off one loan quickly, then putting that payment amount into the next loan until it's paid off, then putting both those payments into the next one, and so on, until all debts are paid. For a detailed explanation with examples, check out our article on paying off student debt quickly.
Waivers. If you have federal student loans, there are some conditions where the loans can be waived. This includes community service and extreme financial need. Check with the Federal Student Aid Office for more information.
Public service loan forgiveness. This federal program allows you to get your federal student loans forgiven after 10 years of full-time employment in select public service fields. You will have to make 120 payments to your loans while employed in public service.
Time to Graduate Out of Student Debt
A good education takes four to 14 years, depending on the degree and any residency programs. However, some people are still paying off student debt 20 or 30 years later. Refinancing can be an effective way to get ahead of the debt, especially if you take advantage of the lower payments to put more toward the principal.