How Does Student Loan Refinancing Work?
Student loan refinancing involves exchanging your current student loans for a new loan. The new loan will have a completely different loan term and interest rate. The terms and conditions will be different too.
Student loan refinancing is offered by banks, credit unions and a few private lenders. When you refinance, the lender pays off your old loans and issues you a new loan with a new rate and term.
The interest rate on your refinanced loan will depend on a couple of different factors.
– One is the prevailing market rates. You’ll pay a higher rate of interest if you refinance when market rates are high. If market rates are low when you refinance, your interest rate will be lower.
– The second significant factor in calculating interest rates is your credit score. A good credit score of 670 and above will qualify you for a lower interest rate. Poor credit will make it difficult to get approved for refinancing. Even if you do get approved, the lender will almost certainly quote a higher interest rate.
Is Loan Refinancing The Same As Loan Consolidation?
No, loan refinancing is not the same as loan consolidation. The terms are often used interchangeably but that’s not correct.
Both refinancing and consolidation involve exchanging an old loan for a new one but the similarities end there.
Student loan refinancing is offered only by private lenders. You can combine federal and private student loans and refinance them into one new loan. The new loan will have a new term and a new interest rate. The important thing to know is that the new loan will be a private loan. If you refinance federal student loans, you’ll lose all the benefits and protections associated with the original loan.
Student loan consolidation is offered by the federal government and only applies to federal student loans. You can combine multiple federal student loans and consolidate them into one federal student loan. The interest rate on the loan is calculated as the weighted average of all the loans consolidated. You cannot consolidate private student loans.
Pros & Cons Of Student Loan Refinancing
Refinancing student loans offers significant benefits but it does have a few downsides too. Understanding the pros and cons of student loan refinancing can help you determine if this is the right option for you.
Pros of refinancing student loans
- You may be able to score a lower interest rate and save money. This can happen if market rates are down or if you have a good credit score. A lower interest rate means less interest will accrue over the loan term, potentially saving you hundreds or even thousands of dollars in accrued interest. Even a marginal drop in the rate can translate into huge savings over the term of the loan.
- You can lower the monthly payments to make them more affordable. If you miss a loan repayment, the lender will charge you a late payment fee and interest on the outstanding. Both these fees can make the loan even more expensive and push you further into debt. When you refinance student loans, you can choose to lower your monthly payments, making them more affordable. The lower payments will extend the loan term and cost you more in terms of accrued interest. But it will minimize the risk of defaulting on your loan, which has more serious consequences.
- You can increase the monthly payments and pay off your debt earlier. If you’re earning a high income, it’s a good idea to put the extra cash toward your loan payments. The higher monthly payments will reduce the total loan term so you’ll be debt-free earlier. It will also lower the cost of the loan because less interest will accrue over the shorter term. The only way to change the terms of your original loan is by refinancing it.
- You can combine multiple loans into one new loan. Juggling multiple loans, each with its own repayment amount and payment deadline can be overwhelming. Worse still, there’s a higher likelihood of missing payments, resulting in late fees and interest. With one loan, you only have to keep track of one payment amount and deadline. This makes the loan so much more manageable.
- It allows you to change your lender. When you’re struggling with your loan payments, it helps to have a lender who will offer practical solutions. Unfortunately, not all lenders will take the time to do this. If your lender is giving you a hard time, you can change lenders by refinancing your loan.
Cons of refinancing student loans
The downside to refinancing federal student loans is that you’ll lose access to all benefits such as income-repayment plans and forgiveness programs. This is because the federal government doesn’t offer refinancing. You can only refinance with private lenders and when you do, you’ll lose all federal loan protections. You should consider refinancing federal student loans only if you’re very sure you won’t need any of the associated benefits.
There are no downsides to refinancing private student loans.
Is Student Loan Refinancing The Right Choice For You?
As with all financial decisions, there’s no single option that’s best for everyone. Your current financial situation and your long-term term financial goals are key factors that will determine if refinancing is the best option for you.
Student loan refinancing may be the right choice for you if:
- You’re struggling with loan repayments and want to lower the monthly payments to make them more affordable.
- Loan interest rates have dropped below what you’re currently paying on your student loans.
- Your high credit score qualifies you for a lower interest rate.
- You can afford to increase the monthly payments and pay off your debt faster.
- You want to make your monthly loan payments more manageable.
Regardless of the benefits of refinancing, don’t be in a hurry to refinance federal student loans. You must put some serious thought into making this decision. When you refinance federal student loans, you’ll lose all benefits connected with the original loan. Only consider refinancing federal student loans if you’re 100% sure you won’t need any of the associated protections.
If you’ve determined that student loan refinancing is right for you, here’s what you need to do next.
How To Refinance Student Loans
Step 1. Check your credit score
Your credit score plays a key role in your ability to get approved and qualify for the best student loan refinance rates. You need a credit score of 650 and above just to meet the basic eligibility criteria. Most lenders will not approve your refinancing application if your score is lower than 650. But getting approved is only the first step.
Your interest rate depends on your credit score. Generally, you’ll need a score of 750 and above to qualify for a lower rate. The higher your score, the lower your interest rate will be.
You’re entitled to get one free annual credit report, which you can get by applying here.
Step 2. Research lenders and their eligibility requirements
Eligibility requirements, interest rates, and terms and conditions vary widely among lenders. Doing your research and comparing lenders is the only way to get the best deal when refinancing student loans.
Start by checking lenders’ eligibility criteria, particularly the minimum credit score requirements. Most lenders will reject your application outright if you don’t meet this criterion.
Check interest rates to get a general idea of what rates lenders are quoting but remember, these are not the rates you’ll pay. Lenders publish their lowest rates on their website but only borrowers with excellent credit scores qualify for those rates. Your rate will depend on your credit score.
Step 3- Get prequalified interest rate quotes
Create a shortlist of lenders whose requirements you meet and ask them for an interest rate quote. Remember, at this stage, you are only asking for prequalifying quotes. Do not submit a loan application yet. There’s a reason for this.
Lenders need to check your credit score before they can give you a personalized interest quote. In order to access your credit score, they will do a soft credit check. This is a cursory check that doesn’t appear on your credit report. Asking around and receiving prequalified quotes won’t damage your credit score.
However, when you submit a loan application, the lender will do a hard credit check. This involves requesting your credit report so they can check your credit history more thoroughly. A hard credit check will pull your score down by a few points. If you submit multiple loan applications with different lenders, each application will trigger a separate hard credit check. Too many of these can do significant damage to your credit score.
To avoid damaging your credit score, get prequalifying rates first to identify the best lender for you. Then go ahead and submit one application to your chosen lender.
Step 4- Get clear on your refinancing goals
Once you’ve chosen your lender, there’s just one more thing you need to do before you start your refinancing application. Consider your refinancing goals.
The lender determines the interest rate on your refinanced loan but you will be able to choose the loan term. Most lenders offer loan terms of 10 and 15 years. Some may offer longer terms of up to 20 years. A shorter loan term will involve making higher monthly payments but it will lower the overall cost of the loan. A longer-term will lower your monthly payments but increase the overall cost of the loan.
In order to choose the right term for you, you have to consider your refinancing goals.
Do you want to make the monthly payments more affordable? In this case, you’ll have to choose a longer term.
Do you want to pay off your debt faster? To do this, you’ll have to increase the monthly payments, which will reduce the loan term.
In either case, it helps to use a student loan refinance calculator to calculate your monthly payments at different terms.
Step 5- Decide between fixed and variable rates
With a fixed rate, the interest rate and monthly payments remain fixed until the debt is paid off. With a variable rate, the interest rate and monthly payments fluctuate with market conditions. Both options have their own advantages and disadvantages.
Take time to understand the pros and cons of fixed and variable rates before making this decision.
Step 6- Gather your documents
The documents you need to submit may vary among lenders but there are a few that all lenders will ask for. You know you’re going to need these documents so keep them ready in advance:
- Government-issued ID such as your Social Security card or driver’s license
- Proof that you’re a U.S. citizen or permanent resident
- Proof of graduation
- Student loan statements
- Student loan balance
- Proof of employment or source of consistent income such as recent pay stubs, W-2s or 1099s
Step 7- Fill out and submit your loan application
Once you’re sure you’ve chosen the best lender for you, it’s time to go ahead with your loan application. If you’re not sure about any questions on the lender’s application form, don’t hesitate to call the lender and ask for clarifications. Don’t presume anything. It’s better to ask now and get crystal clear on the terms before signing the agreement.
Step 8- Read the terms and fine print of the agreement
The lender may take anywhere from a few days to a couple of weeks to process your loan application. They will then send you a finalized copy with details of the terms and conditions. It’s important to take time to read through everything carefully and understand what you’re agreeing to. You cannot change the terms or back out of the agreement once you’ve signed and returned the loan agreement document.
Things to look for in your loan agreement:
- How long will you be paying off the loan?
- Is the interest rate fixed or variable?
- Are there any origination or fees tucked away in the fine print?
- Are there any early payment penalties?
Do you agree with all the terms and conditions detailed in the agreement? If you come across anything that seems amiss, call the lender. Get all your questions answered and only sign the agreement once you’re satisfied that you’re getting a fair deal. If
3 Important things to know before refinancing student loans
1 – You must continue making payments on your current loans until the new loan process is complete
When you refinance a student loan, your new lender is responsible for paying off your old loan. But it takes time to process a new loan. The lender will pay off the loan only after the process is complete. Until that time, you must continue to make loan payments. If you stop prematurely, it will be considered as a missed payment and you’ll have to pay a late fee and interest. Stop payments to your old lender only after you receive the new loan documents.
2 – You can refinance student loans more than once
There’s no limit to the number of times you can refinance student loans. Also, there are no fees for refinancing. That means you can refinance your student loans as many times as you need to. However, this only makes sense if you are able to lock in better terms. Consider refinancing the second or third time only if your improved credit score qualifies you for a lower interest rate. Or if your income has increased and you want to increase your monthly payments.
3 – You can apply with a cosigner if you don’t meet the lender’s requirements
If you don’t meet the lender’s refinancing requirements, consider applying with a creditworthy cosigner. A creditworthy cosigner is someone who meets the lender’s eligibility requirements. If you meet the lender’s requirements but have a less-than-stellar credit score, refinancing with a cosigner can help you get a lower interest rate.
Make sure to understand what’s involved with applying for a cosigned loan before you choose this route.
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