When you take out a student loan, you agree to a specific interest rate and repayment schedule. But what are your options when other lenders offer better deals than your current loan or your monthly payment gets too high?
Refinancing student loans can be the solution to high interest rates. When you refinance, you take out a new loan that pays off the balance of your existing student loans. This new loan could either have a lower interest rate, saving you money in interest over time, or a new repayment schedule, which can make your monthly payments more manageable.
With– and the possibility of several rate hikes this year – now may be the perfect time to refinance your student loans. Here’s everything you need to know to get started.
Refinancing Private vs. Federal Loans
If you have student loan debt, you have either a private loan or a federal loan – private loans are made by a lender such as a bank, state agency, or school, while federal loans are funded by the federal government. An estimated 90% of student loan debt held is in federal loans. In most cases, it will make sense to refinance private loans, which tend to have higher interest rates and not federal loans, which tend to have lower interest rates and more regulation.
When you refinance a private loan, you do so with another private lender. You cannot refinance a private loan into a federal loan. Student loan expert Mark Kantrowitz, author of How to Appeal for More College Financial Aid, says that if you have a private loan, it’s currently advisable to refinance a fixed rate loan before.
If you have a federal loan, your, and you may be debating refinancing if you’re worried about paying the monthly payment when the freeze lifts. In this case, there are other options you should explore first, such as income-contingent reimbursement (IDR), which can help make monthly payments more affordable, pandemic relief benefits, and , especially, loan cancellation programs, such as .
Although refinancing your federal student loans is often discouraged, if you think it’s the right choice for you, Kantrowitz advises waiting until the midterm elections in November to refinance: Federal students aren’t growing that fast and, if student loan forgiveness passes, it will be before the midterms. So refinancing now will void your eligibility for the rebate.
What to consider before refinancing
1. Check your credit score and improve it if necessary
In order to qualify for a lower interest rate than your current loan, you will need a good credit rating. Aof at least 670 is considered “good” and can help you qualify for student loan refinancing…although a may also qualify you for lower rates. Your current loan repayment history will also contribute to your credit score: if you’re struggling to pay your current student loans and have missed a few payments, lenders may be hesitant to sign you up for a new one.
If your credit is weak, talk to your lender about adjusting your payment plan so you can get back on track. In the meantime, work on improving your credit, because the key is to pay off your debt and make your payments on time.
Before refinancing, Kantrowitz advises checking your credit reports (for free) and looking for errors. If you find errors, you can delete them; your creditor will have 30 days to confirm the accuracy of your report or remove errors, so it’s best to access your credit report 30 days or more before refinancing.
2. Evaluate your income and debt-to-income ratio (DTI)
Lenders will also likely look at your income, your co-signer’s income (if you have one), and your DTI ratio (your total monthly debt payments divided by your total gross monthly income).
Your income level shows lenders that you make enough money to repay your loans and meet your payments. Kantrowitz suggests looking at refinancing minimum income thresholds, which typically hover around $30,000.
Your DTI ratio represents the debt you have compared to the amount of money you earn. A high DTI, which shows you have more debt, can be a red flag for lenders. For example, if you have a monthly debt of $1,000 and earn $4,000 per month, your DTI would be 25% ($1,000 divided by $4,000). However, if you have monthly debt of $2,500 and earn $4,000 per month, your DTI will be much higher – 62.5% – which could affect your ability to get a new loan.
Typically, to refinance your student loans, you want a DTI of 50% or less.
3. Compare lenders
It’s important to shop around with different lenders to make sure you get the optimal rates and terms. Kantrowitz emphasizes consideration of monthly loan payments, total repayment terms, and interest rates. He says, “Remember that longer repayment terms mean lower monthly payments, but more interest over the life of a loan. Try to avoid repayment terms longer than ten years and make sure choose a plan that offers the highest monthly payment you can afford.
4. Find out if you are prequalified
When researching lenders, many may offer the option to prequalify, allowing you to see what your potential interest rates and monthly payments would look like. Depending on the change from the terms of your current loan, you can decide if refinancing is right for you. Prequalification requires a, so it won’t affect your credit score. Keep in mind that prequalification does not guarantee loan approval or specific rates.
5. Consider a co-signer
Student loan refinance lenders often allow you to add a cosigner to your loan — or release one. If you don’t have a long-standing credit history, you may need someone with good or excellent credit to co-sign your loan. When you add a co-signer, they also assume responsibility for the loan. This means your co-signer will have to make payments if you’re unable to, and your repayment history will impact their credit rating.
Conversely, if you want to release a current co-signer, you can refinance a private student loan in your name alone. To do this, make sure you meet the criteria for credit and consecutive on-time payments.
Next steps to refinance
Once you’ve committed to refinance your student loans, there are steps you can take to get the interest rate and payment plan you want.
First, start shopping around with other student lenders. Compare rates and terms and get prequalified to browse your options and decide which loan term and lender best suits your budget. Once you have chosen a lender, you submit a formal application and wait for their approval, which usually takes two to three weeks. Once your new lender approves your application, they will repay your old loan directly and you will begin making regular payments to your new lender.