Over 42 million borrowers have a combined 1.28 trillion dollars in outstanding student debts. This averages to around $38,000 per borrower, which is a major concern for many young adults. One quick way to fix the problem is through refinancing your student loans which simply means selling your current loans to a private lender in return for a new loan with more manageable loan terms and ideally lesser interest rates.
Refinancing a loan has its pros and cons. Although, in most instances, you have to pay a smaller amount than you would initially need, but if you are not careful, you may end up paying a lot more in the long run. So should you refinance your student loan? Here is everything you need to decide.
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Things to Consider Before Refinancing Your Student Loan
Before you consider refinancing your student loans, here are a few things you must consider to help you find the best interest rates.
- Credit Score: Your credit score is the most critical factor when considering refinancing your debts. As you do not need to pledge any collateral to refinance your student loans, lenders will want to make sure that you can pay off the debt on time. One great metric to measure your financial capabilities is your credit score. If you have a good score of above 800, you will most likely qualify for the best interest rates. Anything above 700 is also good and gets you decent savings on your interest rates, but if your score is below 600, you are unlikely to make any savings on your new loan. So always consider refinancing your student loan if your credit score is above 700; the better the score, the more you save.
- Income: Having a stable income is essential if you want to show the lender that you have the financial means to pay off the monthly installments on time.
- DTI (Debt-to-Income) Ratio: The debt-to-income ratio (DTI) is the ratio of your debt when compared to your income. You might not be able to repay your loan if your DTI is too high. This also shows that you do not have a solid financial background, and lenders will find it hard to trust you with payments.
- The Total Amount Owed on Student Loans: Some lenders will only refinance loans with a certain maximum loan sum. If your current debt exceeds that, you may not get approval.
- Background Education: If you didn’t graduate, you might not be able to refinance your student loans, depending on the lender.
- Apply with a Co-Signer: If you do not have a long record on your credit history, lenders may be hesitant to offer you a refinance on a student loan. One way to avoid this problem is to apply for a loan refinance with a co-signer ( the person responsible for paying off the debts in case you fail to do so).
Pros of Refinancing Student Loans
The most significant benefit of refinancing your student loans is that you may be eligible for a reduced interest rate, which can help you pay off the debt quicker and or reduce the amount you pay each month, thus helping you achieve financial freedom.
Other advantages to consider while refinancing your student loans include:
Refinancing Allows You to Change Your Payment Schedule
Once you’ve been approved for refinancing, you can pick when you want to pay off your loans. You can choose to pay a high monthly premium to pay off the debts quickly. This way, you have to pay an overall lower amount. You may also choose to take your time and pay your loans over a period of time; this will allow you to pay a smaller amount each month but may be subjected to higher overall payments. Refinancing student loans gives you the freedom to choose how quickly you want to pay your debts.
Managing Multiple Loans
If you have multiple debts, refinancing will allow you to keep track of them easily. You can make one monthly payment to one lender, thus better managing your loans and reducing the chances of missed payments.
Option to Apply with a Co-Signer
When it comes to refinancing a student loan, lenders would like to see a solid credit and a low debt-to-income ratio. If you don’t meet the requirements, you may be able to apply with a co-signer who does.
Help Improve Your Credit Score
Refinancing can help you pay off your debts faster, thus improving your credit score. Making monthly payments and paying your debts in full are two essential aspects of improving your credit score.
Cons of Refinancing Student Loans
The most significant disadvantage of refinancing your student loans is that you lose the protection that comes with federal loans, such as income-driven repayment programs. As soon as you opt for a refinancing of your student loan, you would no longer qualify for any of the benefits that you would otherwise get, so consider this thoroughly before applying for a refinancing.
Other disadvantages to consider while refinancing your student loans include:
Not Every Borrower is Eligible
The requirements for refinancing student loans are fairly high. You need to have a decent credit score of at least 650 to be eligible. You also need to show that your income to debt ratio is below 50% just to be eligible for a loan refinancing.
Your New Interest Rate is Dependent on Your Credit Score
The higher your credit score, the lower your interest rate will usually be. However, keep in mind that there’s no assurance your rate will be reduced.
Refinancing May Increase the Time it Takes to Pay Off Your Loans
Refinancing your student loans midway through the term may result in reduced monthly payments for the remainder of the term, but it may also lengthen the time it takes to pay them off altogether. And the longer you take to pay off your debts, the more time it will take for your credit score to increase.
Insignificant Change
You have to give up on many perks when applying to refinance your student loan, but the benefits you can get may not be as significant. Therefore, it is always advisable to check with the lender on your actual savings before applying for the loan.
Refinancing Alternatives to Consider
Student Loan Consolidation
Refinancing involves you taking out a new loan to replace your existing debt, as well as converting any federal student loans into private student loans. Consolidation, on the other hand, is a technique for combining numerous federal loans into a single loan with a better interest rate than you previously had. Because your federal loans are still federal loans, you will continue to get all of the government’s helpful repayment perks.
Only federal student loans are eligible for consolidation, and there is no credit check. If you have many federal loans and want to simplify things by making only one monthly payment, it’s a good option.
Income-Driven Repayment Plan
Look into Income-driven Repayment (IDR) programs if you have federal student loans. You won’t pay more than you can afford because these plans are based on your discretionary income and your household size. If you’re having trouble making the minimum payments on time each month and are considering refinancing as a cost-cutting measure, this is an excellent option.
Make Extra Effort
Start paying your debts more regularly if you have the resources, such as every two weeks rather than once a month. You may also pay extra toward your amount by increasing your minimum monthly payment. Without refinancing your loans, you can minimize the amount of interest you pay over time by paying off your debt faster.
Ask for Alternative Payment Plans
Because some private lenders don’t provide deferment or forbearance options, you’ll need to speak with your lender about your specific circumstances. Inquire if they have any program to help you during unfortunate life events like losing your job or other emergencies. Some lenders might have policies to lower your monthly payments or interest rates in such unfortunate situations.
Bottom Line
While refinancing student loans has helped many students save money on their monthly payments, it isn’t suitable for everyone.
Double-check the payment protection you’d get from a private lender in case of a worst-case situation, like losing your job or facing urgent medical expenses. Once you’ve refinanced your student loans, it’s a permanent and irreversible decision so make sure you have the financial means to pay off your loans and pay them quickly, as it can help you improve your credit score as well. But if you are not too sure about your finances and are unwilling to give up on perks like federal loan forgiveness programs, you may be better served picking a loan consolidation service.
If you decide to refinance your student loans, calculate your debt to income ratio (DTI), check your credit score, and see if you qualify for the best interest rates before applying. If you want to learn more on different loans don’t forget to follow our daily blogs.
