Student loans can be a major financial burden. Refinancing is one way to help reduce the challenges associated with repaying your educational debt.
Before you move forward with refinancing student loans, though, there are three key things you absolutely must know. Here's what they are.
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1. Refinancing federal student loans is almost never a good idea
Refinancing student loans is possible only through a private lender. While the Department of Education offers a Direct Consolidation Loan, this doesn't change your interest rate.
Because you must refinance through a private student loan lender, you typically do not want to refinance federal student loans. That's true even if you could reduce your interest rate on those loans or cut your monthly payment.
There's a simple reason it makes no sense to refinance federal loans into private ones. Federal loans offer unique benefits to borrowers that no private lender can match. This includes things like income-driven payment plans capping monthly payment costs, loan forgiveness options, and many opportunities to pause payments in times of hardship.
Private student loan lenders will not offer these advantages. So, for most people, it makes no sense to give them up even if doing so could reduce their interest costs. Unless you are 100% confident you will never ever use any federal benefits and wouldn't be eligible for any future loan forgiveness plans put forth by the federal government, you should not even consider federal student loan refinancing.
This downside doesn't exist for private student loans, though, as you would just be changing to a different private lender and not giving up any special protections or chances to have debt wiped away.
2. Refinancing could increase your payoff time -- and your total costs
Refinancing usually makes sense only if you can reduce your interest rate, as there would be little reason to refinance debt into another loan that costs more each month. But, even if a refinance loan cuts your rates, you won't necessarily be debt-free sooner or spend less over time.
If you refinance, you can reset the clock on your repayment timeline. For example, if you've been working for three years on paying down debt with a 10-year payoff schedule and you refinance to a new loan with a 10-year payoff schedule, you'll have set yourself back three years.
Since you'll also be paying interest for extra time, it's possible that your total payoff costs will be higher even at a lower rate. Your monthly payments would be lower each month, though, which could provide breathing room if you're currently struggling to cover the cost of private student loan debt.
3. You may need a cosigner to qualify for the best rates
Finally, you should be aware that private student loan lenders do consider both credit and income when deciding if you can qualify for a loan and what rate you'll pay.
Usually, you'd need a minimum credit score of around 650 to qualify for a refinance loan, and you'd need a minimum score of 700 to get the most competitive rates. You'll also need plenty of income to show you can repay what you're borrowing.
If you're a recent grad and refinancing, you may not yet have the qualifications to get the best loan terms. Your lender may require a cosigner, which would mean you'd have to ask parents or other loved ones to put their credit on the line to help you refinance.
The good news is, a number of private student loan lenders do offer cosigner release after a certain number of payments, such as 12, 24, or 36 on-time monthly payments. So if you need a cosigner, consider looking for a lender that will relieve them of responsibility in a reasonable time frame.
By thinking about these issues, you can make sure refinancing truly is the right option for you, and choose a good lender offering a reasonable payoff timeline and a low interest rate that makes your debt payoff easier.
