Americans owe upward of $1.5 trillion in student debt, and many are struggling to keep up with their monthly payments. If you took out student loans for college and are having a hard time making your scheduled payments, then you may be wondering whether it pays to refinance that debt.
What is refinancing?
Refinancing essentially means swapping an existing loan for a new one. When you refinance any type of debt, student loans included, a lender pays off your remaining balance and issues you a new loan with an interest rate that's lower than what you were initially paying.
You're allowed to refinance both federal and private student loans, though refinancing is a more common practice in the latter scenario, which we'll discuss in a bit. You can't refinance federal loans through the U.S. Department of Education -- the entity that issued that debt in the first place. Rather, you'll need to go through private entities for a refinance. Similarly, you can't refinance private student loans into federal ones.
There's no set timeframe on when you're allowed to refinance student debt. Some lenders won't allow you to refinance your loans while you're still in school, but some will.
Keep in mind that you're allowed to refinance your student loans more than once, too. You might refinance at one point to a lower rate, only to find yourself eligible for an even better rate down the line. At that point, you're free to refinance again.
Unlike other loan types, like mortgages, you can generally refinance your student debt for free and avoid loan origination or application fees. As such, it certainly doesn't hurt to look into refinancing, especially if the following circumstances apply to you.
1. Your loans have a high interest rate
The purpose of refinancing your student loans is to snag a lower interest rate in the process. Therefore, the higher the interest rate attached to your loans, the more likely it is that refinancing will make sense.
Generally speaking, private student loans come with higher interest rates than federal loans -- often, much higher rates. That's because federal student loans' interest rates are regulated and capped at a certain level, whereas private lenders are free to charge borrowers whatever interest they want.
For example, for the 2018–2019 school year, the interest rates for federal student loans are as follows:
- 5.05% for Undergraduate Direct Subsidized and Unsubsidized Loans
- 6.6% for Unsubsidized Graduate Direct Loans
- 7.6% for PLUS Loans for parents and graduate students
Meanwhile, you might easily pay between 10% and 15% interest, if not more, when you take out private loans. If you're able to shave several percentage points off of your existing rate, your monthly savings could be huge. Additionally, you could save yourself thousands of dollars in interest over the life of your repayment plan.
Imagine you have $20,000 remaining on your student loan balance, and that $20,000 has a 12% interest rate attached to it. Let's also assume you have another 10 years left on your loan repayment period. If you were to refinance to a new 10-year term at a 7% interest rate, you'd lower your monthly payments by $55. Now that may not seem like such a big deal, but after all is said and done, you'd save yourself $6,567 in interest over the life of your loan. That's huge! Therefore, if you're stuck with a relatively high interest rate, it pays to see what sort of lower rate you qualify for.
2. Your loans have a variable interest rate
Another key difference between federal student loans and private student loans is that federal loan interest is fixed. That means you'll have the same interest rate attached to your loans for as long as you pay them off. Private student loan interest, however, is often variable, and that can be problematic.
First, variable interest rates can climb several percentage points above their starting point. This means that if you take out private loans with an 8% interest rate attached to them, you could one day see yourself paying 13% interest. Not only can this cost you more money on a monthly basis, but it could also make working your student loan payments into your budget very difficult.
Therefore, if you're dealing with a variable interest rate on your loans, it could pay to refinance that debt to a new loan with a fixed rate. That way, you'll know exactly how much you'll need to pay each month on your student debt.
3. Your credit score has improved since you took out your loans
When you apply for federal student loans, there's no credit check involved, but when you borrow privately, your credit score plays a huge role in determining what sort of interest rate you're able to snag. The worse off your credit is, the higher an interest rate you're apt to get stuck with, and since many college students apply for loans at a time when they don't have a particularly robust credit history, it's not unusual for that factor alone to result in a higher rate.
On the other hand, if your credit score has gone up since you took out your student loans, then it pays to see what sort of interest rate you're eligible for. And if you're refinancing after already having graduated college and gotten a job, then chances are your credit will be better than it was when you first applied -- especially if you've established a history of paying your various bills on time.
If your credit score isn't in great shape, you can always work on improving it and then refinancing your student debt. A good way to boost your credit score quickly is to pay off a chunk of your existing credit card debt, if you're carrying a balance. That will lower your utilization rate, which measures the amount of credit you're using at once, thereby helping to lift your score.
4. You're not eligible for borrower protections anyway
The benefit of taking out federal loans for college is that you'll have the option to capitalize on certain borrower protections should the need arise. For example, if you find that you're having difficulty making your monthly loan payments, you'll have the option to get on an income-driven repayment plan, which will recalculate those payments as a percentage of your earnings. There's also the option to defer federal loans for a period of time, and often you can do so without incurring additional interest on your debt.
Private loans, however, don't offer these borrower protections, which means that if you're able to snag a lower interest rate on your debt, you really have nothing to lose by refinancing. On the other hand, if you were to refinance your federal loans, you'd then lose the option to take advantage of the borrower protections that come with them.
Refinance your student loans strategically
If you're convinced that refinancing your student loans is the right move, then be sure to shop around for the best interest rates out there. Each lender has its own criteria for determining interest rates, so don't settle on the first offer you get.
That said, each time you apply to refinance your loans, the lender in question will perform what's called a hard inquiry on your credit record. Too many hard inquiries could drive down your score, so do some preliminary research before you reach out to lenders, and also, aim to do your loan shopping within a limited period of time -- ideally a week or less. If you do, your multiple inquiries may be treated as a single hard inquiry, thereby limiting the damage to your credit.
If you're looking to lower the interest rate on your student loans and save yourself money in the process, refinancing could be just the thing that makes that happen. But remember, there are other ways to lower your monthly student loan payments. You could explore your borrower protections under your federal loans, or reach out to your private lender and negotiate your loan's terms. Both are viable options to pursue, but if they don't pan out, then refinancing is likely your next best bet.