Graduating from college and landing your first job are great achievements to celebrate. But as you start to pay back your student debt, the reality of graduation starts to sink in. Student loan debt is a burden that can make it take longer to reach goals like buying a home or investing for retirement.
That’s when you start to wonder: Should I refinance my student loans? This is one of those personal finance topics that you have to ask yourself when you have student loans. The answer depends on certain circumstances, so let’s dive in and find out what is right for you.
When to Refinance Student Loans
You’re not the only one out who has student loans. There are 45.3 million borrowers out there with student loan debt, with the average amount owed at $37,691. Whether to refinance your student loans is one of the topics that many of these borrowers consider.
How much will Refinancing Save You?
You don’t necessarily have to wait until you have a perfect credit score to consider student loan refinancing. But you should get a better interest rate with a new loan which will save money. Use a student loan refinancing calculator to verify the amount of savings if you want to refinance your student loans.
You have a high variable interest rate on your loans
If you have student loans with a variable interest rate, your payments will fluctuate due to market conditions that impact interest rates. That means your loans are more expensive to repay. A variable rate is typically not a good choice on most types of loans for this reason. Student loan refinancing can lock in with a fixed rate when interest rates are lower and provide more stability.
The Interest Rate Environment is favorable
When economic factors are in your favor to take advantage of lower interest rates, this might be the time to consider refinancing. Events like the Federal Reserve cutting rates will typically impact student loan rates, potentially lower your rate, and saving money. Plus, if you have a variable rate, you can lock on a fixed rate.
You have a solid income and good credit
After graduating, you might not be making a lot of money. But after a few years of working your income could be much more. Once your income is stable and providing a level of security, the option to refinance student loans will make sense.
Having a good credit score is also important. Make sure that you’re paying back on your student loans, credit cards, and other debt on-time.
You have several loans that are expensive
If you have one student loan that you owe less than $10,000 and that’s it, it’s probably not worth refinancing. But if you have multiple, expensive debts then refinance student loans and combine them into one new loan will make sense.
Your Grace Period is Over
After graduating from college, all borrowers have a six-month grace period on federal student loans before repayment begins (undergraduate program). Once your grace period is over might be time to refinance student loans.
What’s the Difference between Consolidation and Refinancing?
It’s common for borrowers to come across the term, “consolidation” when researching options for student loan refinancing. It’s certainly related to refinancing, with a key difference. With refinancing you can combine your private and federal student loans and receive a new lower rate. Consolidation will combine your existing loans together into one new loan, but not at a lower rate.
Federal Loan Consolidation
Only the government has programs available to consolidate federal student loans. The federal loan program makes up the vast majority of student loans. If you have private student loans, they can’t be combined with this option. This option allows you to put together all your federal loans and they will give you a new interest rate with a single loan term. This interest rate takes the weighted average of all the original interest rates and will give you a new weighted average.
The advantage of consolidating your federal student loan with the government is that you have only one monthly payment. This is very convenient for people who want to worry about making a single payment instead of several. This type of consolidation will not save you any money because you won’t get a lower interest rate. If your main goal of a refinance is to get a lower interest rate, this option might not be for you.
Private Loan Consolidation
Only private lenders such as a bank may offer private student loan consolidation. Private student loans are loans that borrowers may take out if they’ve exhausted federal student loan options. Some lenders may even allow you to mix private and federal student loans with a private student loan consolidation. With this option, you can roll all of your loans into one loan, and monthly payment, just like the program offered by the government and one loan term. The difference is that you get a new interest rate. Because of this, it’s possible to get a lower interest rate than what you have on some or all of your loans. You may be able to choose a new repayment plan such as a 10 year, fixed rate.
You will also enjoy a lower monthly payment than what you’ve been paying for all your loans. That could save you serious money in the long run. Because of this, this option is actually considered student loans refinancing. It can be advantageous to refinance federal and private loans. You should check to find out if there are origination fees or other costs associated with going with a private lender.
Other Borrower Relief Options
If you’re looking for other resources to help with paying back your student loans, it’s out there. Keep in mind that some of these programs are very restrictive or may not save money. Refinancing your loans is usually the best option for most people.
- Income-Based Repayment – You can cap your monthly payments to a certain percentage of your discretionary income when chosing your timetable. You could have the choice of a 10 year repayment plan or much longer. You get a lower monthly payment too. However, since it slows down your repayment even more it’s not that helpful financially.
- Student Loan Forgiveness – This program is intended to forgive federal student loans who work in public service for ten years. The goals of this loan forgiveness program aren’t exactly reality. Only about 1% of applicants of the Public Service Loan forgiveness program have had their loans forgiven since its inception.
- Student Loan Forbearance – This option is only for those who’ve applied for a deferment and were rejected for their federal loans. It allows you to temporarily stop paying back your student loans. Meaning you still have to repay them so you’re just increasing your repayment schedule.
How to Qualify for Student Loans Refinancing
Since refinancing student loans is done through private lenders, you’ll need to qualify based on their understanding requirements. You might be asking yourself “Do I qualify to refinance my student loans?” Requirements will vary because private lenders have different criteria, but here are some items that you should have at a minimum:
- Your credit score should be at least 660 or better.
- Annual income of $36,000
- A low debt to income ratio
Debt to Income Ratio
Your debt-to-income ratio will tell a lender how much you can afford on your monthly payments. The DTI is a percentage of how much debt you have relative to your income. A high DTI will tell lenders that you might not be able to afford your payments. Typically to refinance a student loan, your DTI should be no more than 50%, but the lower the better.
What to do if I have Bad Credit
Having bad credit will make it difficult to qualify for refinancing your student loans. If you have a family member or someone else who agrees to be a co-signer, you might be able to still do it. It can be tough to find someone who is willing to co-sign, if not more difficult than qualifying for refinancing. That’s because your co-signer is on the hook for repaying your student debt if you fail to make repayments.
Alternatives when Considering Refinancing
Whether you don’t qualify to refinance federal and private student loans or not ready to take that step, you have other options that you can take advantage of aside from a refinance or government program.
Make Extra Student Loan Payments
Making extra loan payments each month will help pay down your student loan debt faster. Another way you can pay down your debt faster is to increase the amount you pay. Instead of just paying the minimum monthly payment, add what you can so you’re paying down the balance instead of just making interest payments.
Use a Debt Payoff Plan
Using a debt strategy like the debt avalanche or snowball method will get you focused on paying off all your debt. To use one of these methods, you’ll write down all your debt, the amount remaining, and the interest rate. Your debt includes credit cards, auto, student, personal, and other debt payments you make.
If you use the avalanche method, you’ll make start with the loan that has the highest interest rate. You’ll make the minimum monthly payment on all your other debts. But you’ll put more money towards paying the loan with the highest interest rate. Once that’s paid off, you’ll move on to the next largest interest rate, and so on.
Another way you can pay off your debt is the snowball method. You’ll start with the debt that you owe the least on, instead of the one with the highest interest rate. You’ll focus on putting more money towards paying off these balances and move down to the next lower rate balance. The avalanche method will save you the most money on interest charges, but people have found the snowball method to be motivating.
The way that you pay off your student loan, credit card debt, and other debts doesn’t matter as much as choosing the method that works best for you. They have both been used effectively to pay off credit cards, student loan debt, and other loans. There are also many personal finance tools out there that can also help you organize your debt and start managing your money.
Get your Student Loans Current
When you’re behind on your student loan payments, you should work on bringing them back to being current. A missed payment on your student loan or any other debt will significantly impact your credit score. You should focus on getting current and keep making on-time payments so it will increase your chances of getting approved later on.
Work on improving your Credit Score
If your credit score is why you can’t be approved for a student loan refinance, take some measures to improve it. Make sure that you’re paying all your debt payments including your credit cards on-time.
Try to keep your credit utilization on your credit cards and other debt below 30%. Your credit utilization is the amount of credit you have versus the amount you’re using.