Student loan debt remains a tremendous financial burden for millions of Americans.
According to an October 2020 report by The Institute for College Access and Success, a nonprofit group, more than six in ten (62%) Americans who graduated from college in 2019 have student loan debt and owe an average of $ 28,950.
It’s not all bad news: federal student loan interest rates have dropped below 3% – and some private student loans are even lower. This could make student loan refinancing an attractive option for many.
But it’s not as easy as it seems.
The best interest rates are only available to borrowers with strong credit profiles and high incomes. And depending on what type of student loan you have, a refinance can be a bad move.
At the moment, all payments, interest, and recoveries on government-held federal student loans have been put on hold. The deferral and interest freeze for federal student loans is currently set to end on December 31, 2020. Until then, there is little reason to think about refinancing such loans. “They will never surpass a 0% interest rate, so at least for now there is no reason to [refinance federally held student loans]”, Adam S. Minsky Esq., A student loan attorney specializing in student loans.
When refinancing student loans doesn’t make sense
“I’m very cautious about telling people to turn all federal loans into personal loans because you’re giving up what you’re giving up,” says Minsky.
There are a number of benefits and safeguards that federal student loans can qualify for: death or disability relief, default resolution, and deferment or deferral options. Federal student loans may be eligible for repayment plans based on your income and loan waiver if you make qualifying monthly payments while working full-time for a qualifying employer.
That’s a lot to give away – and this route would only make sense if you can drastically lower your interest rate or pay off the loans quickly. Even then, Minsky recommends mitigating some of the risk with a fully funded emergency fund and adequate life and disability insurance.
Instead of refinancing federal student loans, you can take advantage of the federal student loan consolidation program. When you consolidate federal loans, you retain all of the benefits, but the interest rate is a weighted average of the previous loans. It won’t lower your interest rate, says Mark Kantrowitz, vice president of research at Savingforcollege.com, but it has other benefits.
Consolidation consolidates all of your loans into one easy-to-manage payment. You may also be able to extend your repayment period through a consolidation and lower your monthly payment. Remember, just like with a personal loan refinance, if you renew your loan you will increase the interest you will pay in the long run.
When should student loans be refinanced?
If you have a private student loan, refinancing usually makes sense if you can save interest in the long term or lower your monthly payments.
If you cut your interest rate by just one percentage point on a $ 37,000 loan with a 10 year term, you can save approximately $ 18 per month and $ 2,200 in interest over the life of the loan. And you have the potential to save even more when you refinance higher-interest debt, such as student loans. Even if you can’t qualify for a lower interest rate, refinancing the same loan over a 15-year term would save you about $ 100 per month.
Unlike other loan types, there are generally no upfront fees when refinancing student loans.
But be careful: if you extend the term of a loan, you will pay more interest during the term of the loan. For the example above, if you extended the loan term by five years, you would be paying more than $ 5,500 in interest.
Since it is easy to refinance student loans without paying upfront fees, there are many other situations when it makes sense. You can refinance to convert a floating rate into a fixed rate loan. Refinancing is also a way for a borrower to remove a co-signer from the loan.
Mary Hobbs, founder of the personal finance website Pennies Not Perfection, was able to refinance her mother’s PLUS loans to the state-owned parent company and transfer them to her name. “I didn’t want my mother in particular to have a steady income with this huge pile of student loans. So I decided because I could pay for it, ”says Hobbs. By refinancing these loans in their name, Hobbs was able to lower the interest rate from 8.5% to 2.57% floating rate. Hobbs plans to pay off the loan in two to three years – so the lower floating rate allows her to pay off the loan a little faster.
How to Refinance Student Loans
Student loan refinancing has a great advantage over other types of debt, such as mortgages, because upfront lending fees are very rare.
Since most lenders don’t charge student loan refinancing fees, it is easy to compare offers. It’s about finding the lowest interest rate or ideal repayment term.
Filling out a refinancing application is fairly easy, but you will need to include supporting documents to verify your income and identity. And to qualify for a refinance, you need a healthy credit score (usually 650+) and typically a debt-to-income ratio (DTI) of 50% or less – although these numbers vary depending on the lender. As your financial profile improves, a lower DTI and higher credit score can help you qualify for lower interest rates.
“It’s not just your creditworthiness that affects your eligibility for a personal loan. You will also look at information that is not in your credit history, ”says Kantrowitz. Lenders will want to know your income and how long you have been in your current job. “Generally, the lender wants to see that you’ve been with the same employer for at least two years,” he says.
This can be a dilemma for new graduates with no strong credit history or high income.
Samantha Sands, 22, of San Diego, Calif., Completed $ 120,000 in student private loans with interest rates between 7% and 10.5% and found it difficult to find a lender willing to refinance her debt. “It was quite a nightmare,” says Sands. She says she didn’t make enough money to qualify for a refinance and had to add her mother as a co-signer. Even then, she couldn’t qualify for a lower rate. She managed to cut her monthly payment by $ 600 by refinancing to a longer 15-year loan period.
If you need a co-signer to refinance your student loans – or get a better interest rate – it is important that the co-signer understands the commitment. “The co-signer is just as legally responsible for the entire loan as the borrower,” says Minsky. “If the borrower stops paying, the co-borrower is on the hook.”
Student loan refinancing can be a minor catch. You are more likely to qualify for a lower tariff if you have high income and good credit history. But the borrowers who are most in need of the financial relief a student loan refinance can provide are the least likely to qualify for good business. However, because you can refinance student loans with no upfront fees, even small financial gains can make refinancing a worthwhile move. Just make sure that you don’t give up the valuable safeguards that come with federal loans without serious consideration.