Many student loan borrowers ask us about whether they should refinance their loans to lower their interest rate. While refinancing can help some borrowers lower their student debt load, there are a number of important factors that you should consider before applying. In this guide, we break down how refinancing works, who is eligible, and the advantages and disadvantages of refinancing.
What is refinancing?
Refinancing is a common financial term that describes changing a loan’s terms, typically by lowering the interest rate––which can reduce the cost of the loan––and sometimes giving the option to change the repayment timeline (i.e. shortening to 5 years or increasing to 20 years, for example).
How does refinancing work?
When you refinance, you often take on a new loan with a new lender. Then, your new lender pays off the loan (or loans) that you owed to your former lender. When you’re done, you only have to pay your new lender. You’ll then have a new lender and potentially a lower interest rate, saving you money.
Anything else I should know?
If you have private student loans, it’s pretty simple: you should refinance if you can get a lower rate.
If you have federal student loans, however, you may not want to refinance your loans if you think you will have trouble making your monthly payments in the future. Federal loans have repayment plans that help borrowers who are in trouble. And if you plan on working in the non-profit or the public sector, your federal loans can be forgiven after 10 years. Refinancing costs you those benefits because it turns your federal loans into a private loan.
Here’s what lenders typically look for when determining your eligibility for refinancing your loans:
Having a higher credit score increases your chances of being eligible to refinance. A credit score of 680 or higher can help you look your best when trying to refinance. To find out where you stand, you can get your free credit score here.
Low debt relative to how much you earn.
A lower debt-to-income ratio also improves your odds, with 45% or lower a general benchmark for eligibility. To calculate your debt-to-income ratio, add up all of the monthly payments you owe on any outstanding debts (like your student debt, car loans, etc.) and divide that by your how much money you make each month before taxes (called your gross monthly income). Note: you’re more likely to qualify for refinancing if you apply with a smaller number of loans. For example, if you have federal student loans and private student loans, you can increase your odds (and preserve your federal loan benefits) by just applying to refinance your private student loans.
A stable income.
You’ll need to have a job and at least a few months worth of paystubs to qualify for refinancing, although lenders have different requirements in terms of how long you’ll need to have been working.
Not all lenders are the same and not all of these requirements are written in stone, so make sure to check with lenders directly to see if you’re eligible for refinancing your loans.
So, what are the upsides of refinancing your loans? Let’s go over how refinancing can help you.
You save money.
You can get a lower interest rate which means you will pay less on your loans.
Refinancing many loans into one makes it simpler to manage your payments. Refinancing means you’ll only need to pay one company each month instead of many.
You can change your repayment schedule.
When you refinance, you can also change your monthly payments and the length of your loan term to make sure it works for you. If you extend your repayment timeline when you refinance, your payments will go down now, but you’ll pay more in total payments overall. If you shorten your repayment timeline, however, you’ll pay more now but less overall.
Now that you know about how refinancing can help you, let’s cover the risks and drawbacks to refinancing your loans.
You’ll lose your federal loan benefits.
The government offers more support to borrowers who are struggling to make payments than private lenders that refinance your loans. If you refinance your federal loan for a private loan, you won’t be eligible for federal repayment programs like income-driven repayment and Public Service Loan Forgiveness (PSLF) that can save you money. Once you’re out, you’re out.
The bottom line.
If you think that your job situation may change in the near future and/or you may need financial assistance in the future, then you should think twice before refinancing your federal loans. If you refinance, you forgo the ability to enroll in federal loan forgiveness programs that could help you out.
Step 1: Know what you’re looking for when getting a new loan.
Calculate your current average interest rate. You should only refinance your loans if a lender gives you an interest rate below your current weighted average interest rate.
Pick the ideal repayment timeline and monthly payment amount for you. Want a lower monthly payment? If you do, you’ll want a longer timeline—but that also means you’ll pay more for your loan in interest in the long run.
Want to lower the total amount you’ll pay over the life of your loan? You’ll want a shorter timeline—but that also means you’ll be paying more each month.
Tip: We recommend picking a slightly longer repayment timeline and then making overpayments (an amount higher than your minimum monthly payment) to pay off the loan faster than scheduled. Why? This maximizes your flexibility so that you’re not locking yourself into high monthly payments that you might be able to do today, but would have trouble keeping up with in the future if unexpected expenses popped up or your income drops for any reason.
Step 2: Apply and compare.
You should compare offers from lenders to see which one offers you the lowest interest rate and best repayment schedule for your needs. Summer helps you aggregate offers in one place from multiple lenders so you can compare rates and timelines to see which option is best for you. If refinancing is indeed right for you, applications are straightforward and take less than 5 minutes to complete.
Tip: If you don’t qualify for refinancing, it could be because your credit score is too low. Adding a co-signer—someone who would be responsible for paying back your loan with you (such as a family member)—could increase your odds of approval. Alternatively, you can reapply with just one or two loans––we recommend your highest interest rate loans––to increase the odds of approval.
Step 3: Get enrolled.
Enrolling is the easy part—be sure to follow the instructions with your new lender to transfer your debt.
Also make sure you keep copies of all documentation and set up calendar reminders for your new monthly payments.
If you are confident about your monthly cash flow, you can also set up auto payments, which automatically deduct the payment from your bank account each month. You can add an overpayment above the minimum monthly payment if you wish you pay off your load ahead of schedule and realize additional savings on your loans.