Picture this: it’s two years after you’ve graduated college. You’re half listening to the radio while you drive to work. A commercial comes on and you reach over to change the station. “Is your student loan debt crippling and unmanageable?” Voice-Over Guy says. Your hand shoots back to the “two” position on the wheel. “Consider refinancing with [bank] now!” You’re lost in all the finance jargon, but some words manage to catch your attention. “Low rates…money saving…interest…apply now!” Hmm, maybe Voice-Over Guy is onto something. Maybe you should refinance your student loans! But what does that actually mean? For some people, student loan refinancing can be a great option, but it’s not for everyone. Here’s a quick guide to help you see if it’s right for you.
What is refinancing anyway?
Good question! Refinancing means that your current loan balance is paid off by a private lender and they issue you a new loan for your student debt. Most students refinance because many private lenders offer lower interest rates and lower monthly payments (if they are eligible). Refinancing also consolidates your loans into a lump-sum amount at a singular rate, where your federal loan rates might be different for each year you borrowed.
Ooh—I like the sound of that
It definitely sounds like a good deal, especially since payment plans are usually offered for varying options between five to 20 years, with an average term of approximately 12 years. According to Forbes, refinancing at a lower rate could potentially save you $20,000 dollars in loan payments over time, and even more if your degree is in the health field. Not to mention that interest rates are at a historical low right now, so locking in a fixed rate could save you more money now than it could in a few years.
But how do I even go about refinancing?
The trick is to find the right lender. Do your research! Some lenders have minimum or maximum borrowing amounts. A lot of banks that offer loan refinancing require that you be a member of their bank, which can make for hassle-free payments. Do all your research before applying, and try to apply to multiple lenders at once within a 14-day window. Why? Because lenders will almost definitely pull your credit score, which can have a negative effect on it. However, according to FICO, for student and auto loans and mortgages (where rate shopping is common), credit inquiries done in a short period of time (usually up to 14–30 days) are often consolidated to reflect one pull and won’t negatively affect your credit score as much as several inquiries over a longer period. Currently, the top student loan refinancers are SoFi, LendEDU, Earnest, CommonBond, and LendKey.
Tell me more about rates
Some lenders advertise rates as low as 2.5%, but don’t let that fool you! Most rates under 3% are variable rates, not fixed rates. Fixed rates are locked in for the life of the loan, no matter what happens to market rates in the future. Variable rates can change as the market does. If interest rates start to rise over the next few years, so will the interest rate (and monthly payment) on your loan. Sometimes lenders have parameters around their variable rates, like they’ll only raise them a certain number of times per year or they cap to how high they can raise them. These parameters vary from lender to lender, so read the fine print.
Again, doing your research is important. Magnify Money suggests that if your repayment will take five years or less, it might be beneficial to take a low variable rate, as rising interest will have less of an effect. You should strongly consider a fixed rate if your repayment will take longer because it poses less of a financial risk.
What’s the catch?
For one, refinancing lenders are often finicky about who they lend to. According to a report by LendEDU, the average FICO credit score for approval by a private lenders in 2017 was 764, and over 50% of applicants were denied. Lenders advertise fixed rates as low as 3.25%; however, the average interest rate for a refinanced loan was 5.56% in 2017. That’s higher than the rates on both Perkins Loans—at a fixed rate of 5%—and Direct Loans—at a fixed rate of 5.05%—for undergraduate students, according to Federal Student Aid. (Direct PLUS Loans for parents and graduate students are 7.6%.)
Additionally, when you switch to a private loan, you’ll relinquish some benefits that come with your federal student loans. For example, most lenders don’t have income-based payment plans, where your monthly payment is based on your salary in case you lose your job or have to take a pay cut. And most lenders also don’t offer deferment and forbearance like federal loans do.
If you don’t think refinancing is right for you, you still have other options for lowering your interest rate. You can consolidate your federal loans without refinancing. That means the amount on your loans will come together in a Direct Consolidation Loan. The interest rate is based on the average rates of all consolidated loans. This can reduce your monthly rate while extending the life of the loan. Be aware that you can still lose certain privileges with your original federal loans. For full details, see the Federal Student Aid website.
There is no simple “yes” or “no” answer when it comes to refinancing your student loans. What’s important is to keep all these factors in mind and research all your options before applying.
Find more tips for paying for college in our Financial Aid section.