Should You Refinance Your Student Loans?
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Student loan debt remains a huge financial burden for millions of Americans.
More than six in ten Americans (62%) who graduated from college in 2019 have student loan debt and owe an average of $ 28,950, according to one October 2020 Report published by the Institute for College Access and Success, a nonprofit group.
Not all bad news: Federal interest rates dipped below 3% – and some private student loan rates are even lower. This could make student loan refinancing an attractive option for many.
But it’s not as easy as it sounds.
The best interest rates are only available for borrowers with a strong credit profile and high income. And depending on the type of student loans you have, refinancing could be a bad decision.
At the moment, everything payments, interest and collections have been suspended for federal student loans held by the government. The forbearance and interest freeze for student loans held by the federal government is currently scheduled to end on December 31, 2020. So, until then, there is little reason to consider refinancing these types of loans. . “You’re never going to beat a 0% interest rate, so certainly for now at least there’s no reason to [refinance federally held student loans], ” Adam S. Minsky Esq., who is a lawyer specializing in student loans.
When refinancing student loans doesn’t make sense
“I’m very careful to recommend that people refinance any federal loan to a private loan because of what you’re giving up,” Minsky says.
There are a number of benefits and protections that federal student loans may qualify for: death or disability leave, default resolution, and deferment or forbearance options. Federal student loans may be eligible for repayment plans based on your income and loan forgiveness if you make qualifying monthly payments while working full-time for an eligible employer.
That’s a lot to give up – and going this route would only make sense if you can dramatically lower your interest rate or pay off loans quickly. Even so, Minsky recommends mitigating some of the risk by having a fully funded emergency fund and adequate life and disability insurance.
Instead of refinancing federal student loans, you can take advantage of the federal student loan consolidation program. When you consolidate federal loans, you keep all the benefits, but the interest rate is a weighted average of previous loans. It won’t lower your interest rate, says Mark Kantrowitz, vice president of research at saveforcollege.com, but it has other advantages.
When you consolidate, all of your loans come together into one easy-to-manage payment. You may also be able to extend your repayment term with a consolidation and reduce your monthly payment. Keep in mind, just like with a private loan refinance, when you extend your loan, you will increase the amount of interest you pay over the long term.
When to refinance student loans
If you have a private student loan, refinancing is usually a good idea when you can save on long-term interest or lower your monthly payments.
Reducing your interest rate by just one percentage point on a 10-year $ 37,000 loan could you save around $ 18 per month and $ 2,200 in interest over the term of the loan. And you have the potential to save a lot more if you refinance higher-interest debt, like graduate student loans. Even if you can’t get a lower interest rate, refinancing that same loan over 15 years would save you around $ 100 per month.
Unlike other types of loans, student loan refinances usually do not come with an upfront origination fee.
But a word of warning: every time you extend the term of a loan, you will end up paying more interest over the term of the loan. For the example above, you would pay over $ 5,500 more in interest by adding five years to the term of the loan.
Since it is easy to refinance student loans without paying an upfront origination fee, there are many other situations where it makes sense. You can refinance to convert an adjustable interest rate into a fixed rate loan. Refinancing is also a way for a borrower to remove a co-signer from the loan.
Mary Hobbs, Founder of Personal Finance Site Pennies not perfection, was able to refinance her mother’s federal parents PLUS loans and transfer them to her name. “I didn’t want my mom, in particular, to end up on a fixed income with this huge pile of student loans. So I decided that since I could pay them back, I would, ”says Hobbs. By refinancing these loans in his name, Hobbs was able to lower the interest rate from 8.5% to a floating rate of 2.57%. Hobbs plans to pay off the loan in two to three years – so the lower variable rate allows him to pay off the loans a bit faster.
How to refinance student loans
Refinancing student loans has a big advantage over other types of debt, such as mortgages, because the initial loan origination fees are very rare.
Since most lenders don’t charge a student loan refinance fee, comparing offers is straightforward. It’s about finding the lowest interest rate or the ideal length of the loan.
Completing a refinance application is fairly straightforward, but you will need to include supporting documents to verify your income and identity. And to be eligible for refinancing, you’ll need good credit scores (usually 650+) and usually a debt to income ratio (DTI) of 50% or less – although these numbers vary by lender. As your financial profile improves, a lower DTI and a higher credit score can help you qualify for lower interest rates.
“It’s not just your credit scores that affect your eligibility for a private loan. They will also review information that is not in your credit history, ”says Kantrowitz. Lenders will want to know your income and how long you have been in your current job. “Typically, the lender will want to see that you’ve been with the same employer for at least two years,” he says.
This can be a dilemma for new graduates without a strong credit history or high income.
Samantha Sands, 22, of San Diego, Calif., Secured $ 120,000 in private student loans with interest rates ranging from 7% to 10.5% and struggled to find a lender willing to refinance her debt. “It’s been a real nightmare,” says Sands. She says she didn’t earn enough money to qualify for refinancing and had to add her mother as a co-signer. Even then, she could not benefit from a lower interest rate. She was able to reduce her monthly payment by $ 600 by refinancing a longer-term 15-year loan.
If you need a co-signer to refinance your student loans or get a better interest rate, it is important that the co-signer understands the commitment. “The co-signer is legally responsible for the entire loan just as much as the borrower,” says Minsky. “If the borrower stops paying, the co-borrower is a prisoner.”
At the end of the line
Refinancing student loans can be a bit of a trap. You are more likely to get a lower rate if you have a high income and a high credit score. But the borrowers who need the financial help the most that a student loan refinance can provide are the least likely to qualify for a good deal. However, since you can refinance student loans without paying an upfront fee, even small financial gains can make refinancing a worthwhile decision. Just make sure you don’t give up the valuable protections that come with federal loans without serious consideration.