According to a study of 2017 college graduates, two-thirds of students graduated with student loan debt at a national average of $28,650 per graduate. Even with scholarships and grant opportunities helping to cover expenses, it can be challenging to keep up with the financial demands to attend college—millions of students and graduates would agree. For many college graduates, the struggle comes monthly when loan payments are due, because, on top of your balance, you may be stuck with interest rates and fees that make your monthly payments incredibly difficult on a recent graduate’s budget.
Refinancing student loans is one option borrowers might turn to in order to lower their monthly payments or get a new loan at a lower interest rate. Sounds great, right? You’re a college grad, and if there’s one thing you learned in class, it’s that critical thinking is key.
Before you refinance your student loan, you’re going to want to consider the risks and benefits, and your true savings upon refinancing. In this post, we’re covering all that and more—including a step-by-step guide on how to refinance your student loans.
Need answers fast? Use the links below to navigate to each topic, or, read the entire piece for a comprehensive view on refinancing student loans.
- What Does it Mean to Refinance Student Loans?
- How To Refinance Your Student Loans
- Student Loan Refinancing vs. Student Loan Consolidation
- Takeaways: Refinancing Student Loans
What Does it Mean to Refinance Student Loans?
If your student loans are getting in the way of paying your other living expenses or savings, refinancing your loan(s) may help to alleviate some of the financial stress of making monthly payments that are too bold for your budget.
Refinancing a student loan essentially means you take your existing loan debt from your current lender and ask a new lender to offer you a different loan agreement. Ideally, this new, refinanced loan would have loan terms and a payment plan that is more manageable than your current one. This could mean a lower interest rate, an extended timeframe to pay off your loan, or lower monthly payments. Additionally, a refinanced student loan can help simplify borrowers’ loan payments by combining multiple monthly bills, instead of having to pay student loans to different lenders.
Federal and private student loans can both be refinanced, but the processes, risks, and benefits vary for each loan type. It’s important to consider the terms of your current loan and new prospective loans before going through the refinancing process.
Does it cost money to refinance a student loan?
Private lenders typically do not charge an upfront fee to refinance student loans, and the federal government allows you to combine loans (consolidate) with a Direct Consolidation Loan at no cost. The U.S. Department of Education says that private companies may offer to consolidate federal loans into a Direct Consolidation Loan for a fee, but consumers should know that the federal government offers this service for free.
How to Refinance Your Student Loans
Now that you know what it means to refinance a student loan, let’s walk through how to refinance your student loan in these five simple steps.
1) Consider the risks and benefits of refinancing your student loans
Before you jump into a refinanced student loan agreement, it’s important to consider the risks and benefits of changing lenders. Depending on whether your original loan was a federal student loan, or borrowed from a private lender, you might expect to see some major differences on your new loan agreement; some might be for the better, while others might not be so appealing. If you originally financed your loan with a federal agency, you might end up losing certain benefits associated with federal loans if you refinance with a private lender.
For step one in our guide, let’s discuss the risks and benefits of refinancing a student loan, according to recommendations from the Consumer Financial Protection Bureau.
Risks of refinancing student loans
- Changes in payment terms and plans
- When you refinance a loan, you’re usually borrowing from an entirely new bank or lender until you pay off the rest of your student loan balance. Like a credit card company, each lender has different terms for how borrowers can repay their loan balance—you might have larger minimum payments stretched over a short period of time, or vice versa. Some lenders, like the federal government, provide options for borrowers who face financial hardship. If you switch from a federal lender to a private bank, you may forfeit the right to access these loan programs that could help lower your loan payments or get you additional time to pay off your debt if you’re affected by financial struggles.
- Ineligibility for certain benefits and loan forgiveness programs
- In addition to offering special loan payment programs, the federal government also has certain benefits and loan forgiveness programs that most private lenders do not include in their student loan services. For example, borrowers who work in education or public service may be able to get loan forgiveness for certain federal loans that they may not have if they had borrowed money through a private lender. Another thing to consider is whether or not a private lender has discharge benefits or loan forgiveness programs in case of death or permanent disability, which may help protect your assets if you are physically unable to resolve your student loan debt.
- Changes to tax deduction
- The Consumer Financial Protection Bureau (CFPB) says some private student loans may not be considered “student loans” for tax purposes. What does this mean for you? This technicality means that if you choose to refinance, you may not be able to deduct the student loan on your tax return. The current deduction rate says you can deduct up to $2,500 in student loan interest.
- Differing loan rates and structure
- Before you refinance your loan, you should check to see how your loan terms will change. You may have a lower variable interest rate at the start, but you may find that your loan payments increase if the lender decides to adjust your interest rate later on.
- The CFPB also warns consumers that a refinanced loan with a lower monthly payment could mean that your interest rate goes up, so it’s important to look closely at the loan’s APR, as this number will give you a clearer perspective of the total amount you can expect to pay for the lifetime of your new loan.
- Changes to SCRA benefits
Under the Servicemembers Civil Relief Act (SCRA), active-duty service members qualify for a discounted interest rate for federal and private loans taken out before the start of their service. If a student loan is refinanced while the service member is serving in the military, they may sacrifice the ability to qualify for the reduced interest rate.
Benefits of refinancing student loans
Although you may be signing away certain loan benefits upon refinancing, the CFPB says there are certainly benefits to refinancing a student loan, which could include the following.
- Consolidating could save money on interest
- One of the benefits of refinancing is that you can filter multiple loans from different lenders into a single loan agreement—meaning you pay a single interest rate, rather than one for each loan. This could help borrowers pay down loans faster by contributing more money toward the actual loan payment, rather than paying toward the interest rate. Combining loans may also make it easier for borrowers to manage their loan payments as they’ll be able to pay to a single lender rather than multiple lenders for each student loan.
- Improve your debt-to-income ratio
- A refinanced loan with a lower monthly payment may help decrease your debt to income ratio, which may translate to a bump up in your credit score. A credit score improvement could increase your odds of being approved for other lines of credit such as a mortgage, or even help you secure a lease to rent an apartment.
- Save money on monthly payments
- Some lenders will negotiate monthly payments for refinanced loans to make payments more manageable for the borrower to pay off. In a 2017 report from The Institute for College Access & Success, research findings showed that graduates from lower-income families were five times more likely to default on their loan payments than higher-income peers, which can lead to damaged credit scores and even consequences as a result of legal action. Reducing monthly payments by refinancing is one way to make affording loan payments easier, and ultimately, help you avoid defaulting on a student loan.
2) Check rates with multiple lenders
After you’ve decided that refinancing your student loan is the right decision for your financial future, you’ll want to weigh your lending options. When you’re shopping for a new, refinanced student loan, you’ll ideally want to find a loan that has better terms, payment schedules, and interest rates than your existing one. That said, you’ll probably want to do some research on rates to compare your options with multiple lenders before signing a new loan agreement.
If you have improved your credit score or were lucky enough to get a great job with a stable income following your college graduation, you may be able to refinance with a significantly lower interest rate.
Does shopping for student loans impact my credit score?
While you’re gathering information and interest rate proposals from different lenders, chances are, the lender will want to conduct a credit check to determine the loan rate they’d be willing to approve you for. The good news is, this type of credit inquiry is typically considered a soft credit check, and it should have little to no impact on your credit score.
Plus, if you’re rate shopping for refinanced student loans in a short period of time, credit bureaus will generally calculate these credit inquiries as a single request. This is because they assume that you are only shopping for a single refinanced student loan, not many.
3) Compare and choose a lender
You’ve been pre-approved for some enticing refinanced loan options, and you’re ready to lower your payments once and for all. But before going the eenie-meenie-miney-mo route to choose a new lender, you should compare your lending options using a student loan refinancing calculator. Use the following details to help guide your decision and find the best refinanced student loan for you:
- APR (annual percentage rate)
- Fixed or variable interest rate
- Loan term
- Estimated monthly payments
4) Prepare your loan paperwork and fill out your refinancing application
Once you’ve found a refinanced loan and lender that makes sense for your finances, you’ll need to fill out an application to get approved. Only after you’re approved will you be able to start making payments toward your new student loan agreement.
You can think of the refinanced loan application process as just like getting any other new loan or line of credit—lenders will evaluate your financial profile and history to help them decide whether to approve or deny your loan application.
Here are a few tips that could help get your refinanced loan approved.
How to get approved for a refinanced student loan:
- Establish Good Credit
- Before applying to refinance your loan, you should focus on improving your credit score, or maintaining your record of good credit behavior. A healthy credit score could help you qualify for a better loan agreement, and increase your odds of getting approved for a refinanced loan. Plus, your credit score will be considered for any other loan opportunities you apply for in the future.
- If you don’t have good credit, you may consider enlisting the help of a parent or spouse to help you cosign your loan. Just make sure this individual has good credit that can help you boost your refinancing application.
- Provide Proof of Income
- Lenders generally want to see that you have sufficient and stable income that enables you to make your monthly loan payments. An applicant with a reliable income is typically a less risky venture for the lender than an applicant who does not have substantial paychecks coming in each month. Being unemployed or underemployed at the time of your application could make it harder to get approved for a refinanced loan. If you’re between jobs, it may be a good idea to wait until your income is more stable to apply for a refinance.
- Limit Your Debt to Income (DTI) Ratio
- Your debt to income ratio is an important component of your financial health. This percentage represents the ratio of your total monthly income, against your monthly debt obligations. In a lender’s eyes, a low DTI generally signifies more capacity to make loan payments—rendering the loan less risky for the lender. Typically, the less risky the loan is, the more likely the applicant is to be approved. Try to limit your DTI before applying for a new or refinanced loan—one way you can do this is by paying down your existing debt on credit cards or other lines of credit.
5) Pay your current student loan until your refinanced loan is approved
Even if you’ve been pre-approved for a student loan refinance, you should still continue to make payments to your current lender as usual until the lender change is official. Failing to pay your student loans could result in a number of consequences that aren’t worth the mix-up. Wait for an official notice from the lender before making changes to your loan payments.
Consequences of not paying student loans:
Skipping a loan payment or two can be tempting when you’re working on a tight post-grad budget, but not making payments according to your student loan agreement could have a big impact on your financial health. TransUnion says for most federal student loans, 9 missed payments (or 270 days) could constitute a loan default.
Defaulting on a federal student loan can translate to a number of consequences for the loan borrower, including:
- Student loan debt may be assigned to a collection agency
- The borrower may lose eligibility for other types of federal student aid
- The defaulted loan will be reported as a delinquent loan, which could damage your credit score
- The lender could seek legal action against the borrower
- Federal and state taxes may be withheld through a tax offset
- The federal government could enact wage garnishment
- Federal employees could have disposable pay offset to repay the loan
In summary: Even if you are waiting for your loan to be refinanced, you should continue to make loan payments as normal to your current lender. After the refinancing process has been finalized, you may make payments to your new lender according to their loan terms.
Student Loan Refinancing vs. Student Loan Consolidation
Oftentimes loan refinancing and loan consolidation are lumped into the same category because they both combine loans into a single account—simplifying monthly payments and sometimes reducing interest rates. But while loan consolidation and student loan refinancing share some similarities, they have some important differences that student loan borrowers should keep in mind. Let’s discuss the major differences between loan refinancing and consolidation to help you make the best decision to manage your student loans.
- Different loans are eligible for consolidation
The Federal Trade Commission (FTC) says borrowers can consolidate their federal student loans with the government at no cost. Typically, private student loans cannot be consolidated with federal loans. Federal loans often offer certain benefits like flexible repayment terms, loan forgiveness programs, and reduced interest rates that do not apply to private loans.
Private loans can be consolidated, just not under the federal government’s Direct Consolidation Loan program, but rather through another private lender, or sometimes your current lender (so long as it’s not the federal government). Consolidating a private loan would basically mean you are combining your loans and simplifying your payments, without much (if any) impact on your repayment terms or interest rate. The main reason a borrower would want to consolidate a private loan is generally to make keeping track of loan payments easier by getting a single monthly bill rather than multiple if you have more than one student loan.
2. How interest rates are impacted
Whether or not your interest rate is impacted after loan consolidation depends on if your loan is at a fixed or variable rate to begin with. Federal loan consolidation doesn’t impact your interest rate, because you are simply combining loans at a weighted interest rate which should not make a difference on how much you’re actually paying on your loan—but rather, simplifying your payment process. When you refinance with a private lender, you are both consolidating your loans, and ideally saving money on a better loan agreement.
In addition to combining multiple loans, both refinancing student loans and consolidating student loans may offer options to change your repayment plan. This could mean you get more time to pay off your loan with lower monthly payments—but keep in mind, prolonging your loan term generally means you will end up paying more in interest than if you paid bigger monthly payments over a shorter period of time.
Takeaways: Refinancing Student Loans
Refinancing your student loans can benefit borrowers in a multitude of ways, including:
- Lower monthly payments
- Saving money on multiple interest rates
- Enabling borrowers to pay off loan debt faster
But before you decide to refinance your student loans, you should also consider the risks of losing federal student loan benefits like loan forgiveness programs or extensions to pay off loan balances. After evaluating whether or not a refinanced student loan makes sense for you, you should take action to improve your financial health by:
- Checking your credit score and establishing good credit
- Minimizing your DTI
- Continuing to make your student loan payments