What Is Student Loan Refinancing And How Does It Work?August 27, 2018
Updated August 25, 2020
If you’re an adult with student loan debt, you may have heard of a process called student loan refinancing. In this post, we’ll walk you through everything you need to know about refinancing student loans, such as what student loan refinancing is, how to refinance student loans, how to compare lenders and rates, the eligibility requirements to refinance, how you can tell whether now is the time to refinance, and more.
What Is Student Loan Refinancing?
Student loan refinancing is the process of obtaining a new loan with a private lender. That new loan pays off your old loan and typically sets you up with a new loan servicer, new interest rate, and new repayment term. People usually refinance their student loans with the goal of lowering their interest rate, lowering their monthly payment, or shortening their repayment term to pay off their loans faster.
The interest rates and terms available vary by lender, and the rates you are provided typically depend on your personal financial situation, including factors such as your credit score, credit history, and debt-to-income ratio. It’s normally best to refinance when you have the opportunity to lower your interest rate, make repayment more manageable, or save money over your loan term.
For example, maybe you have a mix of private and federal student loans that are higher interest than what you can currently get with a private lender. So if you have $25,000 in loans and you’re paying anything from 5% to 8.75% interest, if you can get them refinanced at 4%, then you can save a lot of money in interest over the life of your loans. Watch this video for a breakdown of how student loan refinancing works.
How to Refinance Student Loans
When preparing to refinance student loans, you may wonder how long the process takes, or how many steps are involved. Here are the main steps in the refinancing process, so you can know what to expect from the start:
- Compare Lenders & Rates
- Consider Loan Terms & Payment Options
- Choose a Lender and Apply
- Sign the Refinancing Agreement & Pay Off Your Student Loans
Compare Lenders & Rates
The first step in your journey to refinance your student loans should always be to shop around for the best lenders and interest rates. If you’re not going to save money (either your monthly payment or the amount you’ll pay over your loan term) then it usually doesn’t make sense to refinance. That’s why most people look first to interest rates to understand whether they should refinance or not. If you qualify for significantly lower interest rates than what you currently pay, then take a look at how much you’ll save and see if it makes sense to move forward. An online student loan refinancing calculator can give you an idea of how much you could save by refinancing.
It’s also important to compare lenders when refinancing. When you check what rates you qualify for with a lender through a process called prequalification, they will generally require a soft credit check. However, this is nothing to worry about, as soft credit checks will not impact your credit score. Also worth noting is if you would prefer a fixed or variable interest rate. If interest rates are currently low, then a fixed interest rate may be your best option. These are generally best for borrowers, but if interest rates may go lower and stay lower, a variable interest rate could be a good option.
In the case that multiple lenders offer you similar rates and terms that can save you money, it’s also important to compare lender benefits and their reputations. Look into student loan refinancing reviews of each lender you’re considering. Additional factors could include the lender’s customer service and forbearance options in the case of an emergency. A lender with great customer service could be very helpful during your first time refinancing.
Consider Loan Terms & Payment Options
Briefly mentioned above, another factor for student loan refinancing can be the terms of your loans or the amount of time that you’ll continue to pay these loans before they are paid off. When you refinance, you can typically choose loan terms of 5, 7, 10, 15, or 20 years, but these terms can vary by lender. Shorter loan terms typically come with lower interest rates, and the rate rises with the length of the repayment term.
By choosing a shorter student loan repayment term, you will likely receive a lower rate than a longer term loan, saving you in interest over time and allowing you to pay off your student loans faster. However, depending on how much your interest rate is reduced, your monthly payment may be the same or higher. The main benefit of a shorter repayment term is saving in interest and paying off your loans faster.
By switching to a longer repayment term, you can lower your monthly payment to make repayment more manageable. Depending on how much your interest rate is reduced, you may still save money in interest over the life of your loan term. A third option is to choose the same repayment term, in which case you will save money in interest if you acquire a lower rate, and your monthly payment will also be lower.
Choose a Lender and Apply
After you’ve weighed the options above, it’s time to choose your lender and apply. Several documents are required for applying for student loans, and they will likely be some combination of the following:
- Loan verification statements
- Proof of employment (in the form of a W-2, pay stub, or tax returns)
- Proof of residency
- Proof of graduation
- Government-issued ID
When you submit your student loan application completely, it’s important to remember that this will likely incur a hard credit check which could affect your credit score by several points. Only fully submit your application when you’re completely ready.
Sign the Refinancing Agreement & Pay Off Your Student Loans
It will likely take some time before your application is approved, and while you are waiting you should continue to pay off your student loans. Once you are approved, your lender will pay off your original loans, and from then on, you will make your loan payments to them or their associated servicer. If you’re having second thoughts, you have several days, known as the rescission period, to cancel your refinanced loan.
Student Loan Refinancing Approval Criteria
There are a number of student loan refinancing requirements that play a role in whether or not you are approved for student loan refinancing, such as your credit score, credit history, and debt-to-income ratio.
Possibly the most important requirement is your credit score. Traditionally a “good” credit score is about 680 or higher. Most lenders won’t qualify you for refinancing if your credit score is below 660, but that’s not always the case. The better your credit score, the better rates you’ll receive from lenders. Additionally, your credit history plays a role in your ability to refinance. If your credit score isn’t above the minimum, another option you have is refinancing with a consigner who meets the eligibility requirements. However, it’s important to remember that your consigner will also be responsible for the loan.
Best Ways to Refinance Student Loans
The benefits of refinancing student loans differ by loan type, and there are several factors to consider before moving forward with refinancing.
When considering refinancing private loans, it usually comes down to the math of how much you’ll save. Because there are so many private student loan options, you should compare your specific interest rate, terms, and borrower benefits offered by your lender before refinancing private student loans. Unlike in the case of refinancing federal student loans, you probably aren’t losing any benefits or borrower protections by moving from one servicer to another. Calculate how much you’ll save by refinancing in order to help make this decision.
Federal student loans can also be refinanced with a private lender. These are some of the most common loans to refinance because many people can receive better interest rates than they received when they originally took out their loans. Refinancing federal student loans also allows borrowers to shorten their repayment terms to save additional interest costs and pay off their loans faster.
One reason to think twice about refinancing federal student loans is that when doing so, you lose access to certain benefits that the federal loan program offers. These benefits include the options of Income-Driven Repayment plans and the option of Public Service Loan Forgiveness (PSLF).
You can also refinance other kinds of student loans like Parent PLUS loans. Parent PLUS loan refinancing can be done by the parent who holds them or can be transferred to the student/child from whom the money was borrowed, so either can refinance them.
Keep in mind that you don’t have to refinance all loans of either type. You might have one or two private or federal loans that are at a higher rate and you want to refinance those, but you keep others as-is because the rates and servicers still fit your needs. The loans you choose to refinance are up to you.
Student Loan Refinancing Alternatives
While student loan refinancing offers many benefits, there are alternatives for individuals who have a variety of needs. Here is a list of refinancing alternatives:
- Income-Driven Repayment Plans – These repayment plans offered by the federal government allow borrowers to adjust their repayment terms and monthly payments based on their income and family size. The federal government offers fours types of income-driven repayment plans for different needs.
- Deferment – Another option provided by the federal government, deferment allows you to delay making payments on your student loans for a period of time. Beware, however, that interest may still accrue.
- Forbearance – Forbearance allows you to either forgo making payments on your student loans or pay them at your leisure for a period of time. During this time, interest is not accrued. Forbearance is typically offered in the event of economic hardship.
- Consolidation – Consolidating your student loans simply means combining several loans from different servicers into one loan. The interest rate you get from consolidating is based on an average of your combined loans, or a weighted average. Through the federal consolidation program, your loans will be rounded up to the nearest 1/8th percent. Learn about student loan consolidation vs. refinancing.
When is it time to refinance your student loans?
Deciding when to refinance student loans at the perfect time is different for everyone. The decision is largely personal. Your best bet is to have a firm grasp on where you are financially and how you will benefit from refinancing. For instance, if you plan on taking advantage of federal student loan programs, or your credit score and history aren’t in the best shape, refinancing may not be right for you. However, for many, refinancing can save significant money on interest and on loan payments over time, due to lower interest rates, shorter loan terms, and lower payments. Alternatively, refinancing can serve to alleviate some financial stress by lengthening your repayment term and thus lowering your monthly payments. If you’re interested in refinancing, you can prequalify with ELFI in minutes to see your rate, without affecting your credit score. If you have questions, contact us to speak with one of our Personal Loan Advisors.
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