Questions to Ask Before Student Loan Refinance
Refinancing your student loans can potentially help you save money, but it doesn’t make sense for all students. Here’s what you need to know.
August 4, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment advisor before making investment decisions.
For many students, taking out student loans is essential in order to pay for the increasingly high costs of a college education. Public university students now borrow an average of $30,030 to obtain a bachelor’s degree, and over 43.4 million borrowers currently have federal student loan debt.
Paying for these loans can be costly. Once students graduate, many are faced with high monthly payments and significant interest expenses.
In some cases, a student loan refinance may make financial sense. But how does refinancing work, and is it worthwhile for everyone?
What is student loan refinancing?
Student loan refinancing involves taking existing student loans and rolling them into a new loan. The student takes out a single new loan, which is used to pay off all the existing loans. This might be done to take advantage of a lower interest rate or to lower the total monthly payment amount.
For example, a student might have three loans at 6%, 7% and 7.5% interest. They could potentially refinance all three loans into a single new loan, at a lower 5.5% interest rate. This would help them save money on interest, and also simplify their repayment process.
Student loan refinancing is done through private banks or lenders. You can refinance federal or private student loans into new private loans — but you can’t refinance private loans into federal loans. It's important to note that refinancing federal student loans into a new private loan will mean losing potential benefits that are available through the federal student loan programs, such as deferment and forbearance periods, income-driven repayment plans and forgiveness programs.
Who should refinance their student loans?
Knowing when to refinance student loans is an important first step toward managing your student debt. It typically only makes sense to refinance if you will be able to get a lower interest rate on the new loan.
Here are some situations in which it may make sense to refinance.
Lower interest rates: If you can get a significantly lower interest rate on your new loan, the cost savings can make it worthwhile.
Improved credit or income: If your credit score has improved substantially, and/or your income is significantly higher, it may be easier to refinance to a lower interest rate loan.
Existing private loans: If you took out private loans while in school, they may have a high interest rate. If you’re now making more income and have better credit, it may make sense to refinance.
The ideal candidate for a refinance might be a professional earning a high salary. For example, someone who graduates from medical school will likely have extensive student debt — but given their high income, they may qualify for a lower interest rate on a new private student consolidation loan.
Who shouldn’t refinance their student loans?
It doesn’t always make sense to refinance. There may be costs involved, such as an origination fee or other fees or penalty charges — so it may only make sense to refinance if you can get a lower interest rate.
In addition, people who are on income-driven repayment (IDR) plans for federal student loans may want to think twice about refinancing. Most private loans do not have the same income-driven plans available, so staying on the IDR plan is not possible when refinancing to a private student loan.
Finally, those who qualify for federal student loan forgiveness should be cautious about refinancing. Federal student loan forgiveness programs allow certain public service workers (like teachers and government employees) to have some of their federal student loans forgiven after a period of time.
What type of loans can be refinanced?
Both private and federal student loans can be refinanced. Most types qualify, although some lenders exclude federal PLUS loans. Check with the lender for details on which loans qualify.
Refinancing is always done via private loans offered by banks and lenders. The federal government does not offer refinancing. However, the federal government does offer a consolidation loan, discussed in detail below.
What is the difference between consolidating and refinancing?
Refinancing involves a private lender. Borrowers can take out a single new loan, which is used to pay off all the previous existing loans.
Consolidating via a Direct Consolidation Loan is done through the U.S. Department of Education. This loan allows students to combine all their existing federal student loans into a new single loan.
Consolidation loans offer a fixed interest rate that is the weighted average of the existing loans' interest rates. So, these loans won’t save you money — but they can simplify your repayment plans. Plus, consolidation loans have no upfront costs. Federal loan consolidation also preserves your ability to utilize IDR plans and loan forgiveness programs offered by the federal government.
Will I qualify for student loan refinancing?
Refinancing is done through private banks and lenders, and each lender has their own qualification standards. You will need to apply with the lender in order to determine if you qualify.
With that said, here are some factors that influence a bank’s decision to approve or deny your loan application:
Income: Federal loans are available to most students, regardless of their income or creditworthiness. Private loans, however, require an income level that is deemed sufficient to cover the monthly payments of the new private loan. There’s no hard-and-fast rule, but you will definitely need to be employed and have reliable income in order to qualify for refinancing.
Credit score: Lenders also look at your credit score and credit history to determine your creditworthiness. Many lenders require a credit score in the high 600s or better — but again, this varies depending on the lender.
Size of loan: Even if a bank is willing to lend money to you, they must be willing to lend enough money to cover all the loans you are trying to refinance. The amount they are willing to lend depends on your income and credit score.
How do I refinance my student loans?
Here are step-by-step instructions on how to refinance your loans.
1. Check your credit and income
First, it’s wise to understand your odds of being able to qualify for a refinance. Checking your credit report is important, as is examining your income. If you have poor credit and/or low income, you likely won’t qualify for affordable refinancing.
2. Compare rates
Next, you can shop around for lenders offering student loan refinancing. Check to see who offers the most competitive interest rates and look at the fine print for any fees or other costs you may have to pay.
3. See if you prequalify
Many lenders allow you to apply for “prequalification.” This process allows you to check if you are likely to qualify and what interest rate the lender would likely offer you. Importantly, this process does not affect your credit score (while actually applying for a loan can).
4. Choose an offer and submit an application
Finally, select an offer from a lender and submit an application. This can usually be done online. You will need your Social Security number, photo ID, proof of employment, and details about your existing loans. Some lenders may only offer student loan refinancing for applicants who have already graduated, so will require proof of graduation or your degree.
If you’re approved, the lender will pay off your existing student loans directly. You’ll need to start making payments towards your new loan following the terms you agreed to.
Note that it can sometimes take a few weeks for the new lender to pay off your old loans. Continuing to make minimum payments on your old loans until you have confirmed that they have been paid off will ensure that you don't inadvertently miss a required payment and incur a fee or penalty.
Student loan refinancing often makes sense if you can qualify for a lower interest rate. But not everyone will qualify — and refinancing can also eliminate your ability to be on an IDR plan or qualify for federal student loan forgiveness programs. It can make sense in some cases, but it’s not for everyone or every situation.
Speaking of refinancing, did you know that you can refinance credit card debt? If you have existing credit card balances, Tally† may be able to help you consolidate them into a lower interest line of credit.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.