Should I refinance my student loan?

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Point of Interest

It’s a good idea to regularly review the terms of your student loans. You may be able to save money through a lower interest rate or better terms!

For many households, student loan debt is high on the list of monthly budget items to review. But it can be hard to know if it’s worth refinancing the loans or where to start. There can be many reasons why borrowers might want refinancing, but if you’re unfamiliar with the process, you may be left wondering, “Should I refinance my student loans?” There are many scenarios where refinancing may be the best option, but it’s important to consider other factors before making that decision.

What is student loan refinancing? 

Refinancing is the process of restructuring the terms of the original loan. Typically, that means obtaining a lower interest rate, a better repayment period, or a more suitable monthly payment. Debt, in most cases, is “fungible.” Fungible means that the original thing is replaceable with something similar. Ever heard the phrase, “everything is negotiable?” That can also apply to student loans.

Since debt is fungible, you can always ask to adjust the terms of the deal. The lender will respond with their terms, and then it’s up to you to decide if you wish to accept. It may not always feel like it, but the ball is in your court more than you think!

When to refinance your student loans?

Exactly when can you refinance student loans? Generally, you’ll want to consider refinancing your student loans if you can obtain a lower interest rate. Interest is the amount a lender charges the borrower for the right to use the lender’s money. More creditworthy individuals are charged lower interest rates; less creditworthy individuals are charged higher interest rates. Your creditworthiness depends on several factors, but generally calculated on payment history, depth of credit, and debt-to-income ratio (your total debt divided by your take-home pay).

Be careful about refinancing a Federal loan versus a private loan. Generally, refinancing may make sense if your circumstances sound like this:

  • Your loan has a high interest rate. If current rates are lower than the rates on your loan, you might save money by refinancing.
  • Your debt-to-income (“DTI”) ratio is below 2-to-1. For example, if you have $150,000 of debt (including credit cards, rent or mortgage payment, personal loans, etc.) and earn $75,000 per year, your DTI is 2:1.
  • You have excellent credit. Your FICO score is a standard measure of creditworthiness; the better your score, the lower your interest rate, generally. The lowest score is 300, and the highest score is 850. 670 or higher is considered a “good” score; a score above 800 is considered “exceptional.”

When not to refinance your student loan?

This question is trickier to answer than it seems because it depends on the type of loan you have. Federal loans have special borrower protections and repayment options. If you refinance a Federal loan into a private loan, you will lose these benefits.

Generally, you want to avoid refinancing a private student loan if you can’t reduce your interest rate or if you get a lower interest rate but a longer repayment period.

Let’s say you have two offers to refinance your $50,000 loan at 7% interest in the fifth year of your 10-year repayment period. The first offer cuts your interest rate in half to 3.50% and doesn’t change the repayment period. Cutting your interest rate reduces your monthly payment from $580 to $533.

The second offer cuts your interest rate further to 2.50% and reduces your monthly payment from $580 to $195 – sounds good, right? However, those lower payments are a result of adding another 10 years to your repayment period. Which do you choose?

If you can afford to keep paying about $500 per month, the first offer at the higher interest rate but shorter repayment period is better because it saves you $3,000 in interest payments throughout the loan. If you’re considering refinancing Federal loans, most include a full forgiveness provision after 20-25 years of payments (depending on the terms), so be careful when considering offers that include extended repayment periods.

Where to start?

First, sort out which of your loans are private and which are Federal. Start with the National Student Loan Data System (“NSLDS”). This system will show you which student loans are part of Federal programs, as well as the relevant loan details like interest rates and repayment terms.

Then, cross-reference what you find in NSLDS with your credit report.

Tip: You can get your Federal annual credit report free once every 12 months.

Any loans on the credit report that aren’t on the NSLDS report are private loans. Generally, you only want to refinance private loans and consolidate Federal loans to keep the Federal benefits. Notable benefits include income-based repayment, loan forgiveness provisions, and borrower protections.

If all of your loans are Federal, then you should start the Federal Direct Consolidation Loan process. This program consolidates multiple Federal loans into one loan with one payment. However, it doesn’t change the interest rate.

Student loan refinance calculator

Online loan calculators allow you to quickly compare the terms of a new loan with your original loan. Remember to enter the current balance, not the total loan! 

Tip: You can learn how to build an amortization table yourself in Microsoft Excel.

The final word

Generally, it makes sense to refinance a private loan if you can get a lower interest rate. Approach Federal loans cautiously as they come with benefits that private loans often lack. Take stock of your financial situation – credit history and score, debt-to-income ratio, and anticipated take-home pay – to determine if refinancing your student loans makes sense for your situation.

FAQ

Is it worth it to refinance student loans?

It may make sense to refinance your student loan if you can obtain a lower interest rate lower earlier in your repayment period. Be sure to verify which student loans are Federal before refinancing.

Is there a downside to refinancing student loans?

Generally, it’s always a good idea to inquire about refinancing options. Avoid refinancing your student loan if you’re offered a higher interest rate or an extended repayment period as these can cost you more in the long-run. 

Which is the best student loan company?

The best student loan company is one that aligns with your situation. One company may offer to refinance higher dollar amounts but charge higher interest rates, another may provide the lowest interest rates but longer repayment periods.

How much does it cost to refinance student loans?

Refinancing shouldn’t cost you anything. Avoid lenders that charge fees to refinance your student loan. 

Alexander Clark

Personal Finance Contributing Writer