Student loans are a huge burden for many people. You may have heard of refinancing, which involves rolling various sources of debt into a new loan with a new interest rate. Refinancing achieves two key purposes: simplifying your student loan debt into one monthly payment and securing a lower interest rate.
Before making the leap, however, here’s what you need to know to decide whether refinancing your student loans is a good idea.
What are the eligibility requirements for refinancing student loans?
Start by assessing if the option is even available to you. Most loan companies will decide your eligibility based on three things: your credit, your current income, and your debt-to-income ratio.
Generally speaking, your credit score will need to be higher than 650 to qualify. However, the higher your score, the better your chances of snagging a good interest rate (or at least better than your current ones on your student loans).
For your income, it matters less how much it is and more that it is a constant inward flow of cash. You’re less of a risk for loan companies if they know you have money coming in that you can use toward monthly loan payments.
Your debt-to-income ratio (or DTI) is a comparison of what you owe vs. what you earn. Understandably, more debt isn’t as big of a deal if you also make more money, but high debt mixed with low income can signal to loan companies that some of your bills may not get paid every month.
If you’re not sure you meet one of these requirements and you want to refinance your student loan at a lower interest rate, you may need to take some time to improve these eligibility factors to improve your chances of getting a loan approved.
We dive more deeply into what the eligibility requirements are in our article, “Are you eligible to refinance student loans?”
How could refinancing student loans affect your credit?
Once your loans are refinanced, your credit should not be affected. In fact, with a lower interest rate and one simple monthly payment, your credit will improve as you work toward paying your loan back in full.
However, credit scores can take a hit during the application process. You’ll want to approach the application process understanding the types of inquiries that can hurt your credit and how best to mitigate the damage.
Not all inquiries are created equal. A hard inquiry on your credit report, which happens when you apply for credit (like a loan or credit card), can affect your credit score, and many of them at once will raise a red flag to lenders.
Soft inquiries are a review of your credit report, either by you or someone you grant permission to for the purposes of preapproval. Soft inquiries aren’t visible to most lenders (with the exception of some types of insurance companies), and they do not affect your score.
In order to minimize the number of hard inquiries on your credit report, shop around, and compare rates from different lenders before submitting applications.
Shopping around will only trigger a soft pull of your credit report. A full application, though, will result in a hard inquiry, so only submit full applications after narrowing your choices to a few select lenders.
Find out more about how refinancing student loans could hurt your credit in our article, “Can refinancing student loans affect your credit?”
What are the current student loan refinancing interest rates?
Securing a lower interest rate on your student loans is one of the major benefits of refinancing. Most borrowers want to get the lowest interest rate possible. Since lenders’ interest rates vary, you should understand how they are determined before applying for refinancing.
Your interest rates depend on the types of loans you have. If you have federal loans, your interest rates are likely fixed. Fixed rates are determined at the time the loan is issued and will remain the same for the life of the loan.
Private loans, however, could have fixed or variable rates. Unlike fixed rates, variable rates fluctuate with the market, so they can change frequently. A variable interest rate is often lower than a fixed one, particularly at the beginning, but it is a risk.
Ultimately, the interest rate you are offered on your refinanced student loan depends on your credit score (better credit scores get lower interest rates) and whether you choose fixed or variable.
Find out more about current interest rates and some reputable lenders in our article, “How to find student loan refinancing interest rates.”
Is refinancing your student loans worth it?
Deciding whether to refinance your loans is a big decision. Although there are a lot of potential benefits, including securing a better interest rate and saving money, there are some drawbacks as well.
For instance, since you can only refinance with a private lender, any federal student loans you have will turn private. This could mean losing out on federal programs like income-based repayment plans, grace periods, and even forgiveness.
Private lenders may offer some flexible repayment options, but these depend on the lender, and they are unlikely to be nearly as generous as whatever the government offers.
Further, depending on the refinancing term you settle on, you could potentially end up paying more in the long run. Choosing a lower monthly payment, for instance, means paying it for a longer period of time, which leads to paying more in interest.
Unless you are financially able to choose a refinancing option that doesn’t extend the life of your loan, refinancing might not be worth it.
Knowing whether your current loans are federal or private and how refinancing compares to the terms and interest rate you have now can help you determine if refinancing your student loans is right for you.
We discuss these and more pros and cons of refinancing student loans in our article, “Is refinancing your student loans worth it?”
What are other options if refinancing student loans isn’t for you?
Don’t worry. There are lots of other options for managing burdensome student loan debt.
If your student loans are federal (most are), you can look into income-based repayment options, consolidation, and even forgiveness. Consolidation is a particularly helpful tool to manage your federal loans.
Consolidating has all the benefits of refinancing, including rolling your student loan payments into one monthly payment, while also keeping your federal loans.
If your loans are private, there are still some options for managing your debt if you are having trouble. The first step is to contact your lender.
You could ask about consolidating (instead of refinancing). Not all lenders offer this option, but it’s worth asking. If your monthly payment is too high, you could ask what programs they have available for negotiating a lower monthly payment or interest rate.
Refinancing isn’t always the best option for everyone, but thankfully, there are alternatives. In fact, some alternatives may even be better. Find out more in our article, “Can’t refinance student loan? Explore your alternatives.“
Refinancing vs. consolidation: What’s the difference?
As you explore options for repaying student loan debt, make sure you understand the difference between refinancing and consolidating. Knowing the difference can help you decide if one makes more sense for you than the other.
The term refinancing generally describes moving your federal student loans to a private lender. You cannot go the other way around—refinancing private loans as federal loans is not possible.
The term consolidating generally refers to federal student loans. One of the most common types of federal loan consolidation is a Direct Consolidation Loan, which combines multiple federal student loans into a loan with one monthly payment. This loan is sometimes the best option for borrowers who have multiple federal loans.
We discuss the differences in more detail in the article, “Refinancing vs. consolidating student loans: What’s the difference?”
The bottom line
Deciding whether to refinance your student loans is a tough decision and definitely involves a lot of consideration. So if you’re trying to decide if refinancing your student loans is right for you, here it is in a nutshell:
DO refinance if you:
- Have good credit
- Earn a steady income
- Are ineligible for federal repayment forgiveness programs
DON’T refinance if you:
- Are eligible for federal repayment forgiveness programs
- Have poor or average credit
- Have a limited or unpredictable income