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If you've been meaning to refinance your student loans but haven't gotten around to it, now could be a good time to start shopping around for rates. Private lenders set interest rates using benchmarks, such as the London Interbank Offered Rate (LIBOR) and Secured Overnight Financing Rate (SOFR). Rates have been low since the spring of 2020—but that may not last forever.
The Federal Reserve is projecting two rate hikes by the end of 2023 due to a forecasted increase in inflation. Since benchmark rates tend to move together, this means an increase in the LIBOR and SOFR rates could also be on the horizon.
While rates are still low, it may not hurt to compare loan offers to see how much you could save by refinancing your student loans. Read on to learn more about how student loan refinancing works as well as its pros and cons.
How Does Student Loan Refinancing Work?
Student loan refinancing is the process of taking out a new loan with better terms and using it to pay off your existing private or federal student loans. If you're paying a high interest rate on student loans, for example, refinancing could offer lower monthly payments and long-term savings on interest charges.
Whether to refinance federal loans is something to consider carefully, even if you're able to get a lower rate. Refinancing turns them into private loans that don't qualify for the same perks, such as student loan forgiveness, forbearance and income-driven repayment programs.
Plus, most federal student loans currently qualify for a pause in payments and interest until at least September 30 thanks to the CARES Act and subsequent extensions.
If you want to keep your federal loan perks but combine multiple loans into one payment, a Federal Direct Consolidation Loan through the Department of Education could be a better alternative. This option may not provide as much interest savings since the interest rate on the new loan will be the average rate of the loans you consolidate. But it is a way to simplify payment without losing government perks.
How to Apply for Private Student Loan Refinancing
If you are considering refinancing, know that your credit score is an important factor private lenders consider to determine if you qualify and at what interest rate. The higher your credit score, the better the interest rate you can potentially obtain, which can lead to greater overall savings.
If your credit score is less-than-perfect, applying with a cosigner could help you secure a better rate. Your cosigner may not have to stick around on the loan forever, either. Some lenders offer cosigner release if you make a certain number of payments and meet other credit criteria.
Most private lenders have an easy online application process. You may even be able to prequalify beforehand to check rates without a hard inquiry that can damage your credit scores. Then you can complete the full application if you like one of the offers. Once approved, funds are disbursed to pay off your old loans, and you start making payments to the new lender.
What are the Pros and Cons of Refinancing Your Student Loans?
Like any financial move, there are pros and cons to refinancing your student loans. Here are the advantages and disadvantages:
- Refinancing may lower your interest rate and monthly payment.
- There are usually no application, origination or prepayment penalty fees.
- Some private lenders offer borrower benefits, such as forbearance, if you face financial hardship or payment deferment if you decide to go back to school.
- You likely need a high credit score to qualify for a rate that makes refinancing worthwhile.
- Refinancing federal student loans will make you ineligible for generous federal loan benefits such as income-driven repayment and grace periods.
- If the government decides to forgive student debt, private loans may not be eligible.
When Should You Consider Refinancing Your Loans?
If you're thinking about refinancing your student loans, here are some instances where student loan refinancing could make sense:
- You have a stable job and income.
- You want a shorter loan term and can afford to pay off your loans early.
- You have a high credit score (or you have access to a willing cosigner with a high score).
- You are not considering working as a teacher or in a public service profession that might qualify for Public Service Loan Forgiveness.
If the scenarios above apply to you, refinancing could help you pocket savings. Say you have a student loan balance of $20,000, you have four years remaining on the term, the average interest rate is 8.5% and you make payments of $500. Refinancing to an interest rate of 4% could potentially save you $2,324.11 in total interest.
How much you'll save from refinancing depends on the interest rate and loan term you choose. If you can't qualify for a better rate, refinancing probably won't make sense, and it can be risky if your income isn't stable since you will no longer have government perks to fall back on.
Do You Need a Good Credit Score to Refinance Your Student Loans?
Good credit or better is generally necessary to qualify for student loan refinancing. That's because a high credit score shows lenders that you are a low-risk borrower, and low-risk borrowers are typically eligible for approvals that come with better interest rates.
That said, having less-than-perfect credit doesn't automatically mean you can't refinance your student loans. You may be able to qualify with a cosigner. If you don't have a cosigner who agrees to do you that favor, you could take steps to improve your credit before applying.
The first step toward increasing your credit scores is to check your credit and see where you stand. This will help you figure out where you need to improve and provide some guidance on where to start. Experian offers a FICO® Score☉ for free that includes a breakdown of factors impacting your credit. With this information, you can come up with a score improvement plan.
When you are ready to refinance student loans, be sure to shop around and compare offers with multiple lenders since that will help you find the best possible rates and terms.