Wondering whether to refinance your student loans right now? It all depends. Ask yourself these questions to see if now is the time… or whether it’s a bad idea. When you’re ready to refinance, pay special attention to these six steps before applying and signing on the dotted line.
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Wondering whether to refinance your student loans right now? Looking for a smart way to cut corners on repaying your student loans? Refinancing can be an option.
But it would be a mistaken to automatically assume that refinancing your student loans is the best option for you. Like so many financial decisions, the question, “Should I refinance my student loans right now?” has different answers for different people.
There are definite perks to refinancing student loans. Many times, the sooner you refinance your student loans, the more you’ll save.
But there are also drawbacks. And the cons could outweigh the pros in your situation.
Here’s what you should know about the pros and cons of refinancing student loans before you walk down that path. Do any of these conditions apply to you? Find out whether (and when) it makes sense to refinance your student loans.
When Should I Refinance My Student Loans?
You can stand to save some serious money if you refinance your student loans as soon as you have a stable job and income. We’re talking thousands or tens of thousands of dollars – depending on your outstanding loan balance, interest rate, and repayment term.
But not everyone qualifies for refinancing. Typically, you’ll need your college degree, good credit, and a low debt-to-credit ratio. Even then, there are a few caveats.
That said, if you can answer “yes” to these questions, refinancing your student loans now may be right for you. Read on for a list of indicators that you should wait to refinance student loans.
1. Do you have a credit score of 670 or higher?
Some lenders require 650. Others expect it to be around 700. Here’s how to raise your credit score.
2. If you have a low credit score, do you have a potential co-signer who is willing to put their money at risk for you?
A co-signer is every bit as responsible to repay the loan as you are. So this co-signer will probably be someone who loves and trusts you very much and also has the means to repay your loan if you don’t. They must also have good credit. Bear in mind that many people have a personal policy of never co-signing a loan, so this could be a tough one. You might need to focus on boosting your own credit score.
3. Are your finances strong?
Lenders are risk-averse. They won’t give you a new loan if your income is inconsistent or insufficient. If you’re on sturdy financial footing and have made all your past payments on time, you might qualify for a lower rate at this point. But if you’re worried about your job security, consider waiting. Or get going on a side hustle to earn more income.
4. Will you get a new lower interest rate?
One of the main reasons to refinance is to lower your interest rate and save a bundle of money. If your rate is already low, a new lender might not be able to beat it. Also, if you’re already nearly out of debt, refinancing just might not be worth the headache and potentially longer repayment term.
5. Is your debt-to-income (DTI) ratio low enough?
Add up your total debt – student loans, mortgage, car payment, credit cards, etc. What percentage of your monthly income is your debt? That’s your debt-to-income ratio. Lenders have varying requirements, but most hit a hard stop at 48% DTI.
6. Are your loans private student loans?
It can be a winner to refinance private student loans, because private student loans are not eligible for federal loan programs anyway. Public Service Loan Forgiveness (PSLF), Teacher Loan Forgiveness, income-driven repayment plans, and other federal loan forgiveness options are not available on private loans. But when you refinance federal student loans, they automatically become private loans. Meaning you’ll lose your public student loan benefits.
7. Do you still have a lot of student loans left to pay off?
If you’re almost done paying off your student loans, or have total loans of under $10,000, it’s probably not worth it to refinance.
8. Do you currently have a variable rate student loan?
Variable rate loans can start low, but they can wreak havoc on your finances when rates jump. So if you have the chance to lock in a lower fixed rate now, it can make sense to get ahead of future increases and lock in a predictable rate that you can actually budget for.
Just How Much Money Could You Save by Refinancing Your Student Loans?
Let’s say you currently have $80,000 in student loans, financed at 8% interest for 10 years (120 months).
If you can refinance at 3%, you’d save $23,776 in interest over the life of the loan.[i] That’s a cool bit of extra cash you can set aside for retirement during those 10 years. Plus you’ll have another $23,880 ($199/month x 120 months) during that same 10 years. It doesn’t get much better!
Here are those numbers in chart form:
|Original loan value||$80,000||$80,000|
|Interest paid over the life of the loan||$36,474||$12,698|
|Savings over the life of the loan by refinancing at 3%||$23,776|
On the other hand, some people should not refinance their student loans… at least not right now.
When Does It NOT Make Sense to Refinance Student Loans?
Don’t refinance (at least right now) your student loans if any of the following conditions apply. They may disqualify you. Or be inadvisable for other reasons.
1. Your income is insecure.
Your old student loans will be paid off by your new lender when you refinance. But this is a new loan. So even if the terms are better, you still need actual income to repay your new loan. If you run into financial hardship, a private lender may be less flexible about your options than federal loan servicers. Plus, as a new borrower, you may be viewed by your lender with a more critical eye.
If you’re worried about losing your job, wait till it’s more secure before refinancing. Make sure you’re confident of your ability to make your monthly payments. Boost your income with a side hustle or aim for a promotion or new, more secure job, if possible.
2. You have weak credit (and no credit-worthy cosigner).
If neither you nor a cosigner has strong credit, you could have trouble being approved for a refinanced student loan at all. Or you might get an interest rate so poor that it doesn’t save you any money. Work to improve your credit score as soon as possible and reconsider in six months.
3. You’re working toward federal loan forgiveness.
The federal government offers various loan forgiveness programs – among them the Public Service Loan Forgiveness (PSLF) and Teacher Loan Forgiveness programs. These programs cancel your remaining debt after meeting certain requirements (number of years of service). You’d lose these federal programs if you refinance public loans.
4. You have low income and might need an income-driven repayment plan.
Refinancing would disqualify you from income-driven repayment plans.
Income-driven repayment plans adjust your monthly payments based on your income. They cap your repayments at 10-15% of your monthly income. In fact, the Revised Pay As You Earn (REPAYE) program caps payments at just 10%.
Some income-driven payment plans let you spread out your payments for 20 to 25 years, whereas most private lenders set the cap at 15 to 20 years (with no income-based protections).
Do you anticipate needing to tap into these programs in the future? If so, don’t refi right now.
5. You already have low weighted interest rates for your student loans.
Refinancing can save you a lot of money over the remaining life of your student loans. But only if your new interest rate is actually lower than your existing one. If your rate is already low, a lender may not be able to beat your current rate, meaning it wouldn’t benefit you to refinance.
But if refinancing let you lower your rate from say, 7% to 5%, and you still have nine years left to pay (so you choose a 10-year plan), that extra 2% in your pocket could amount to a hefty bit of interest over the next 10 years, even though it adds an extra year to your repayment term.
6. You have low loan amounts (<$10,000) or a low balance.
If you’re already nearing the end of your repayment term, a lower rate may not help you much. Especially since when you refi, you’ll choose a new repayment term of five, ten, fifteen, or twenty years. You don’t want to add time to your term unless your new interest rate would be significantly lower than your current rate.
7. You recently defaulted on student debt or had late payments.
Missed payments and defaults are always red flags for lenders. You may be able to make up for missed payments by paying the missed payments and making all future payments on time. A default, on the other hand, can take seven years to wipe off your credit report. Find out how to correct bad credit here.
8. You recently declared bankruptcy.
Like defaults, bankruptcy stays on your record for a long time – from four to ten years. It may not be impossible to refinance during that time. But it certainly makes it tough. Remember the comment above about lenders being risk-averse?
9. You’ll add years to your repayment term.
If you’ll add to your repayment term, be cautious. If you’re already five years into a 10-year student loan repayment plan, and then refi to a new 10-year plan, you’re now paying interest for 15 years total. This will cost you. It’s a losing plan. You can’t get ahead if you keep moving the boundary further away.
10. You’re taking advantage of the CARES Act forbearance on federal student loans.
On March 13, 2020, President Trump signed the CARES Act into law. It provides for 0% interest accrual plus a payment freeze period from March 13, 2020 till January 31, 2021 (as it currently stands). In other words, right now, no interest is added to your balance, and you don’t need to make a payment till January 31, 2021 for any loan from the Department of Education.
If your job is secure and you can swing making extra payments, this is a perfect time to pay down your loan, while no interest is being added to it. Especially since this golden opportunity likely won’t last forever.
Assuming the powers that be choose not to extend this 0% forbearance period again, you should wait till it ends in a few weeks before rushing out to refi your student loans. If they do extend it, see how much you can pay down while your interest rate remains at zero.
11. You have plans to make, or are already making, accelerated repayments.
If you’re in the middle of an accelerated plan to get your debt paid off, and can get it paid off before a variable rate hike kicks in, you might be fine just pre-paying according to the plan you’re already on, and not refinancing.
Ready to Refinance Your Student Loans? What to Do Next…
Think you’re ready to refinance your student loans right now? Here’s what to do to boost your odds of qualifying for a new loan.
Lenders will look at your credit report during the application process to determine your likelihood of repaying your loan(s). Your credit score is created based on this information.
Before you apply for any new loan, review your credit report closely. Check to be sure all the info is current and accurate. You can get a free copy of your credit report from each of the three major credit bureaus once per year. Check it out here: Equifax, Experian, and TransUnion.
2. Pay all bills on time.
Your payment history is the most important factor in your FICO score. This is the credit score most lenders use to assess your creditworthiness. It’s crucial that you make all payments on time, every time. Especially when you’re considering a new loan. Recent missed or late payments can ruin your credit score. This also goes for your rent, utilities, and cell phone bills, as well as your credit cards, mortgage, and all other loans.
3. Pay off other loans to improve your debt-to-income (DTI) ratio.
Another key factor that lenders assess is your debt-to-income ratio. The lower the ratio, the more likely you are to be able to cover all your obligations.
To find your DTI, divide your total monthly debt payments by your gross monthly income. Let’s say your gross monthly income is $4,000, and your total monthly debts come to $1,800. That’s a 45% DTI, which is hugging the maximum most lenders are comfortable with. If you can pay off a loan that has a $200 monthly payment, your DTI drops to 40% – and just like that, you have a ratio lenders will more readily accept.
4. Decide whether a cosigner is realistic in your situation.
We discussed cosigners above. Many people will be reluctant to commit to this because they’d be just as responsible for repaying the loan as you are. Though there’s a big difference between cosigning for a $20,000 loan and cosigning for a $120,000 loan.
5. Decide which student loan(s) to refinance.
Due to the fact that federally subsidized loans come with some distinct benefits that don’t transfer to the private sector, you might decide to leave them alone and only refinance your private loans. Especially if you think you might use any of those benefits in the future.
6. Compare offers from various lenders.
Gather offers on interest rates and terms from multiple lenders. The info they use to prequalify you counts as a soft credit inquiry. It doesn’t show up on your credit report and has no bearing on your credit score. And it can be done online.
Lender(s) will let you know whether you’re likely to be approved or not. If they think the answer is yes, they’ll give you estimated rates and terms.
Pay special attention to these factors:
- Interest rate
- Interest rate type – fixed or variable – plus monthly payment (whether fixed, or your initial variable payment)
- Repayment period
- Forbearance options (not all private lenders offer this)
- Cosigner release policy – if you have a cosigner, can they be released after a certain number of on-time payments? Make sure you know and can meet these terms if you have a cosigner.
- Prepayment penalties – some lenders impose prepayment penalties if you pay off your loan early. If you’re serious about getting out of debt fast so you can build assets, you should reject offers with prepayment penalties.
Bottom line… It often pays to refinance to a lower rate at your earliest opportunity. But it’s not for everyone. Do what’s right for you based on these criteria. Before you make your decision, make sure it’ll benefit you for the long haul.
Whether or not you refinance your student loan, always make all your payments on time. Never ever miss them or be late. Your future financial success (home loan rates and more) depends on your credit score. Every on-time payment enhances your creditworthiness. So build now for the future.