Do you want to spend another year struggling with student loan debt? Millions of Americans are looking for relief from their oppressive student loan payments and mounting loan payoffs. In fact, the collective student loan debt in the United States is currently well over $1 trillion, and most college students graduate with the heavy burden of well over $30,000 of individual debt. Those with professional degrees may find themselves saddled with three or four times this amount. So you’re definitely not alone with the onus of a significant student loan payback. It’s not all bad news, though. Depending on your situation, refinancing student loans may or may not be the answer for you.
- Secure a Lower Interest Rate
One of the most popular reasons for considering a student loan refinance is to secure a lower interest rate on the loan. Interest rates on student loans are important because they significantly impact the amount of money you’ll pay over the life of your loan. This is referred to as the overall payout. The lower your interest rate, the less money it will take to pay off your loan completely. Let’s look at an example.
Imagine that you have a $20,000 loan with a 9.25% interest rate and a monthly payment of $205.84. Let’s say you plan to pay this loan off over a 15-year repayment period. By the time you pay off this loan, you’ll have paid $17,050.60 in interest. If you refinance the loan at a 5% interest rate with the same monthly payment and repayment period, you’ll only pay $5,689.60 in interest over the life of the loan.
Many private lenders offer college students loans with high interest rates because they have little guarantee that the student will be able to pay off the loan in the future. At the time that they lend the money, it’s impossible to say whether the student will be able to get a decent job after graduation—or even whether he or she will graduate. Therefore, the significant interest that accrues on the loan is the bank’s way of ensuring that the loan will be worth the risk. However, there’s no reason the loan recipient should have to continue paying such a high interest rate after he or she has already established a career and, most importantly, built a record of making payments on time, not just on student loans but on other accounts, including home mortgages, car notes, and credit card payments, for instance. Banks evaluate a potential borrower’s financial history by checking his or her credit score. Those who have a credit score of 680 or better will most likely qualify for a student loan refinance with a lower interest rate, although each lender will have its own specific guidelines for loan approval. According to a recent report by Credible, borrowers who follow through with student loan refinancing enjoy interest rates 1.71 percentage points lower than the interest rate on their original student loan(s) and pay nearly $20,000 less over the life of their newly refinanced loan.
When applying for student loan refinancing to secure a lower interest rate, it’s important to consider the difference between a fixed rate and a variable rate. Fixed rates are interest rates that are locked in over the life of the loan; that is, they don’t change from month to month. Variable rates are interest rates that vary based on economic factors. They may start out very low and spike unexpectedly, which could affect both your monthly payment and the total payoff on your loan. Most lenders offer both types of interest rates because there are advantages and disadvantages to each. Although fixed rates are typically higher than variable rates when the loan is first originated, they provide lenders with the security of knowing exactly what their interest rates will be from month to month and year to year. Variable rates may be a better option for those lenders with shorter repayment terms. If you intend to pay off your student loan within five years, for instance, then there’s a fairly low risk that the rate will increase significantly before you pay off the loan. This strategy may help you save more money in interest than you would with a fixed rate loan. Borrowers with longer repayment periods of fifteen or twenty years may benefit more from a fixed rate loan, since the risk associated with a variable rate over the life of the loan is much higher.
- Get A Fixed Interest Rate
As we mentioned before, there are pros and cons for both fixed and variable interest rates. However, fixed interest rates tend to be the most popular. Unless you’re already pretty far into paying off your student loans, you’re likely going to be paying off your loans for a long time. The longer you have to pay off your loans, the more likely it is that you’ll end up paying more due to either a sudden spike in interest rates or a gradual rate increase.
Knowing exactly how much to expect a variable interest rate to increase isn’t feasible, but if you have a decent understanding of the economy, you can get a general idea of what to expect. Variable rates are based on two main factors: the Federal Reserve and base rates such as the London Interbank Offered rate. Base rates fluctuate organically with the economy. The Federal Reserve rate is set by policy makers in response to the economy. Base rates and Federal Reserve rates tend to be similar, but on rare occasions, such as an economic crisis, they can differ by a few points. Banks use these rates when lending and then add a small margin in order to make a profit. Whether you are a low risk or high risk borrower does affect the margin, but it does not affect the base rate.
If you’re like many borrowers who don’t like the idea of your interest rate rising based on factors outside of your control, a refinance might be a good opportunity to secure a fixed interest rate. It will likely be a bit higher than your variable interest rate, but it’s a great option if you don’t want to take the risk.
- Lower Your Monthly Payments
Another extremely popular reason for refinancing student loans is to lower the payments that borrowers are responsible for each month. When you refinance your original loan(s), you can extend the repayment period on your new loan. While the standard repayment plans for most loans is 10 years, many borrowers can choose longer periods of 15, 20, or even 30 years when they refinance. By choosing an extended repayment period, borrowers can reduce their monthly payments significantly. According to Credible’s recent report, borrowers who selected longer repayment periods upon refinancing cut their monthly payment obligation by $221 on average. These graduates also ended up paying more over the life of their loan, however. In fact, their total payout increased by an average of $4,928. Although this is a pretty significant trade-off, refinancing student loans to loosen the straps on your monthly budget could be a reasonable temporary solution if you’re having a hard time paying other bills.
- Change to a Shorter Term
Alternatively, you can change the amount of time you will spend paying off your loan if you are willing to stick with a similar or higher monthly payment. Technically speaking, you can pay off your loans early without officially choosing a shorter term by paying more than your minimum monthly payment each month. However, if you’re planning to pay off your loan in a shorter term than previously agreed upon, using refinancing to do this officially can save you more money.
Most lenders are willing to offer a lower interest rate in return for paying off the loan faster. This, combined with the lower rate most borrowers get when they refinance as lower-risk customers, can save you more money than if you’d payed off your debt early with the higher interest rate. One thing to keep in mind when considering refinancing for this reason is that in doing this, you will lose some amount of flexibility. With a longer term loan, you have the option to pay only the minimum monthly payment if you have a bad month financially. If you commit to a shorter term, you are held to the higher payment and lose this safety net.
Generally speaking, paying off your loans as early as possible is a good idea. Not only does it save you money that would have otherwise been spent on interest, but it also allows you to put more money into investments or an emergency fund. If you have plenty of room in your budget, you should definitely consider getting a shorter term loan even if it’s not your primary reason for refinancing.
- Simplify by Consolidating Your Student Loans
Another benefit of refinancing student loans is that it gives you the opportunity to consolidate several smaller loans into one larger loan. There are many valid reasons to consolidate loans. For instance, many borrowers feel a significant burden lifted once they realize they only have to manage one monthly student loan bill rather than the five or six they had to deal with previously. This benefit isn’t just a psychological one either. With only one student loan to manage, you’re much less likely to miss payments or make late payments, meaning you’ll save money in late fees while protecting your credit score as well.
If student loan consolidation sounds like a good idea and you have federal student loans, you may consider consolidating through the federal government’s Direct Consolidation Loan Program. Most all federal student loans can be consolidated through this program, though private loans are not eligible. Some of the most common federal loans eligible for consolidation include:
– Direct Subsidized Loans
– Direct Unsubsidized Loans
– Subsidized Federal Stafford Loans
– Unsubsidized Federal Stafford Loans
– Federal Perkins Loans
– Direct PLUS Loans
– Supplemental Loans for Students
– Federal Nursing Loans
Generally speaking, as long as you’re no longer in school, you’re eligible to consolidate your federal student loans through the Direct Consolidation Loan Program. No credit check is required, and the application is free. Before you decide to consolidate rather than apply for a student loan refinance, you’ll need to carefully weigh the benefits and disadvantages to ensure that consolidation is for you. First of all, if you are hoping to secure a lower interest rate, consolidation may not be the best option. That’s because when the government consolidates your loans, they use an average of the interest rates on your original loans to calculate your new interest rate. Thus, the amount of money you pay in interest on your student loan will not change significantly.
If your reasons for refinancing student loans is to free up some of your monthly budget for other expenses, though, then student loan consolidation may be just the silver bullet you’ve been looking for. Why? Because when you consolidate your federal loans into a Direct Consolidation Loan, you may be granted access to certain repayment plans that you didn’t have with your original loans. Specifically, consolidating student loans may make you eligible for one of the federal government’s income-driven repayment plans. These plans use your income to calculate your monthly payment, meaning you’ll only pay as much as you can reasonably afford on your student loan debt each month.
- Get an Income-Sensitive Repayment Plan
The federal government isn’t the only place you can find an income-driven repayment plan. Some private lenders offer these plans as well. If you’re anticipating a financial slump in the near future or just want to make sure you have alternative payment options if and when you do need them, you may consider refinancing student loans with a lender who offers such choices.
If you are thinking about a student loan refinance for the purpose of accessing an income-sensitive repayment plan, you’ll need to consider how these plans work and what they mean for the total payout on your loan. When you switch from a standard repayment plan to an income-driven repayment plan, your repayment period is extended. Some loans are extended to fifteen, twenty, or even thirty years! This can cut your monthly payment by up to half, but since interest is accruing over the life of the loan, you will be paying substantially more by the time the repayment period is over. That’s why many financial experts recommend income-driven repayment plans only when absolutely necessary and as temporary solutions, not long-term arrangements.
- Relieve Your Cosigner
Many college students are forced to rely on cosigners in order to qualify for student loans, especially those who want to be approved for private student loans. This is because private lenders use your credit score to decide whether or not you’re a good candidate for a loan, meaning whether you’re likely to pay the money back! There aren’t many college students with decent credit. In fact, most have yet to build a credit history at all. This is where cosigners come in. You can qualify for a private student loan based on your cosigner’s credit score as long as that person promises to make your student loan payments if you become unable to do so for whatever reason. If you were one of those students who relied on a cosigner to qualify for your original student loans when you were still in school, then you may be in the position where you can now let your cosigner off the hook. Since cosigning on a loan is a very risky endeavor, your cosigner may really appreciate this gesture, and it shows that you’re now a responsible adult who can take care of your own financial responsibilities, including your student loan debt. Of course, in order to relieve your cosigner when refinancing student loan debt, you will actually have to prove that you’re a responsible adult capable of taking care of your own financial responsibilities! In other words, you must have a solid track record of making payments on time—not only on your student loan account but on all of your other financial accounts as well.
- Add a Cosigner
This reason may not be as encouraging as the one above, but sometimes the most responsible thing you can do is get a bit of help with your finances. Many students have a cosigner when they get their student loan, but everyone’s situation is different. You may decide that the best course of action is to refinance and add a cosigner when you did not previously have one. Not every lender lets you add a cosigner when you refinance, but it’s not impossible to find one that will.
When it comes to adult students in particular, it’s possible to have a good credit score and steady income when you first get a student loan, but then have your circumstances change. For instance, your income could drop for reasons outside your control, such as layoffs or being forced to take a job that pays less. If you find yourself in an unfortunate situation such as this, you may want to refinance for the purpose of getting a monthly payment or rate that is more manageable for your now-lower income. At the same time, you may not be able to get a better rate now that you have a less than ideal debt to income ratio. If you have a history of paying on time, but have unfortunately found yourself dealing with the unthinkable, you may be able to find someone willing to help you out by being a cosigner. This isn’t exactly a common scenario, but it’s one example of why refinancing student loans could be a responsible course of action, at least from a financial perspective.
It’s also not unheard of for borrowers to add a cosigner not because they necessarily need one, but because they can use their cosigner’s high income or credit score to save more money by getting a better interest rate. This is generally considered irresponsible, but it can still technically be a good idea. However, you’ll probably have a difficult time finding someone willing to do you such a big favor.
- Switch to a Better Bank
It’s not unusual for people to become unhappy with their bank’s customer service. If you are frustrated with how your lender has handled your student loans, you don’t necessarily have to put up with it until you pay off your loans. With refinancing, you can move your loans to a bank with a stronger track record of good customer service.
When you researched lenders before first getting your loans, you may have wanted to use a bank that you knew had a good reputation for customer service, but then settled for another lender because you could get a better rate. As we’ve mentioned before, you may be able to get a more manageable rate from better lenders now that you are less of a risk (if this is, in fact, the case, so research again to see if it’s worth refinancing in order to switch to a bank that cares about their customers).
- Find a Nontraditional Solution
Traditionally, students turn to a bank for their private student loans. However, banks are not the only option when it comes to borrowing money. Many non-bank lenders such as Sofi and CommonBond are becoming more popular alternatives to traditional bank loans. Some of these lenders operate similarly to traditional banks when it comes to loans, but offer additional services. Others use more experimental methods, such as peer-to-peer lending.
One of the most appealing aspects of most of these nontraditional lenders is that they consider more than your credit score and income when it comes to calculating your rate. Many of them also consider factors like educational background and income-to-expense ratio. This makes these lenders a viable option for people who have yet to establish a credit history. However, they have the potential to be riskier, so do your research to make sure the lender you choose is well-established and has a good reputation before committing.
If you currently have a traditional bank loan, but find these other options appealing, you can use a refinance to try them out. Not all nontraditional lenders offer refinancing, but most of the more popular ones do.
There are many valid reasons for refinancing student loans. Whether or not a refinance is for you depends on your individual loans and circumstances. Consider the above information when deciding if this is the right time to analyze your student loan debt.
