Should You Refinance Your Student Loans?

Student loan debt has surpassed $1.2 trillion, ticking up several thousand dollars per second, according to FinAid.org. For recent graduates entering the workforce, the average loan for a bachelor’s degree amounts to more than $35,000. Failure to repay can lower credit scores and lead to garnished wages and legal action; this debt can’t be eliminated through bankruptcy. One way to make loans easier to manage, and potentially decrease the financial burden, is to refinance.

Refinancing is when a lender pays off the outstanding loans and issues a single new one, often based on an applicant’s credit score, debt-to-income ratio, and income. The process is often similar to applying for a new student loan, except this time around the borrower’s circumstances, or the global markets, may have changed. Former students in a better financial situation than they were when they took out the loans may be eligible for lower rates through refinancing.

Owen Karssiens, an accounting and payroll specialist, refinanced his student loans and now stands to save thousands. After earning an MBA, Karssiens had accumulated $35,000 in federal loans. Between the principal and interest (6.8 percent), the 10-year repayment plan would have cost him a total of $48,000. He stuck to that path for three years before refinancing with Earnest, a private lender. His new loan has a fixed 5.87 percent interest rate, and if he maintains the same $450 monthly payments at the lower rate, he’ll repay the loan 14 months early, saving $6,300.

Refinancing isn’t necessarily a good deal, though — in some cases monthly payments get smaller but the life of the loan gets longer, costing the student more in the end. The long-term financial impact isn’t always easy to determine, especially when dealing with multiple loans with different interest rates. Student Loan Hero, a free online resource that helps borrowers organize and understand their loans, provides a calculator that shows estimated monthly payments and total interest costs before and after refinancing.

Keep in mind that special arrangements with previous lenders, such as discounts for consistent on-time payments or automatic payments, won’t be honored after refinancing. The new lender may also have different rules or fees when it comes to repaying loans. Some private lenders charge several percent of the amount being refinanced in origination fees, which can offset potential savings.

Federal Loans vs. Private Loans

Federal loans (there are several types) are somewhat flexible. Borrowers are eligible for special repayment terms, such as income-based repayment or an extended repayment plan. The loans also can be forgiven if the borrower makes 120 payments (10 years’ worth) while working full-time in a public service job. Payments can be temporarily reduced or frozen if the borrower returns to school, loses a job, or faces financial hardship. While some lenders refinance only private loans, others also take on loans from the federal government. Refinancing replaces the federal loans with a single private loan. Borrowers who initially owed money to the federal government are no longer eligible for any of the associated repayment or forgiveness programs.

There is one way for students with federal loans to combine several loans into one and still hold on to the special repayment terms: a federal Direct Consolidation Loan. Students can consolidate their federal loans after graduating, leaving school, or taking on less than a half-time load of courses (a full list of eligible loans can be found at StudentAid.gov). Everything goes to one lender, which means no more sorting through multiple piles of paperwork or dealing with multiple due dates and interest rates.

As with refinancing, borrowers can potentially wind up with a lower monthly payment but a longer payment term. And with consolidation, the new interest rate is the weighted average of the previous loans’ rates. Borrowers typically don’t save much money, if any. Private loans can sometimes be consolidated with a similar outcome if the borrower has multiple loans from the same issuer. However, refinancing is required to combine private and federal loans.

Some, but not all, private lenders offer flexible repayment programs similar to those provided by the federal government. Online lender SoFi, for one, freezes repayment and offers complimentary career coaching for borrowers who lose their jobs.

More About Refinancing

The ability to refinance isn’t open to every student debtor. According to Student Loan Hero, many lenders require a minimum 680 credit score, a maximum 45 percent debt-to-income ratio, and a monthly income of at least $2,000 to be eligible. Other lenders take a big-picture approach that relies less on credit scores and incorporates other factors such as employers, alma maters, banking history, savings account balances, and even applicants’ LinkedIn profiles. Students who seek private loans often have a relative cosign (federal loans don’t require this), and some lenders are willing to release the cosigner in refinancing. This is more likely if the borrower has a history of consecutive and on-time monthly payments, hasn’t extended repayment terms, and is currently employed. (Still, good luck: The Consumer Financial Protection Bureau found that 90 percent of cosigner release requests were denied.)

Borrowers may be able to choose between fixed and variable rates when refinancing. A variable option with a low starting interest rate can be appealing, but it might wind up costing more in the long run. For example, SoFi offers fixed rates starting at 3.50 percent and variable rates starting at 1.90 percent (for borrowers who enroll in automatic payments), but the latter can climb to 4.19 percent as overall interest rates fluctuate.

Where to Refinance

Those considering refinancing should also read about the customer service experience that a new lender will provide. Karssiens said everything seems less bureaucratic, cleaner, and easier to understand with his new loan servicer. Logging into his account and making an extra one-time payment or changing his monthly payments feels as seamless as using Uber or Amazon. Magnify Money, a free online resource, grades and reviews lenders. A helpful comparison chart shows the longest term length, cosigner release option, fixed- and variable-rate ranges, and largest loan amount the company will refinance. In addition, consider how different private lenders treat borrowers who run into financial trouble.

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