There are various potential benefits and drawbacks to student loan refinancing. So when you're trying to decide if you should refinance your own student loans, there are multiple factors to consider.
The decision will often heavily depend on the type of loan that you have, whether federal or private. If you have federal loans and are currently taking advantage of one or more federal benefits, you might want to avoid refinancing so that you don't lose them.
But even if you aren't currently utilizing any federal student loan benefits, that doesn't necessarily mean that you should rush to refinance your loans right now. Here's how to decide when you should refinance your student loans and how to get the lowest rate when you do.
How Does Student Loan Refinancing Save Money?
For many borrowers, the most important question is whether refinancing their student loans will save them money. Refinancing can generally save you money in two ways:
- Reducing the interest rate you pay on your balance
- Shortening your repayment term to reduce the total interest paid
These two money-savers often go hand-in-hand in that a borrower may need to agree to a shorter repayment term to get a better interest rate. Usually, the shorter the repayment term, the lower the interest rate that a lender is willing to offer.
Borrowers often mistakenly believe that cutting their interest rate in half will also halve their monthly payments. But a halved interest rate will typically only reduce a payment by 10% to 20% since most of the payment goes to principal, not interest. So a 1% percentage point decrease in interest rate is likely to save a borrower just $5 to $6 per month for each $10,000 in student loan debt.
In reality, most of the savings from refinancing will come from moving to a shorter repayment term, not from having a lower interest rate. But it's also important to note that a shorter repayment term may increase your monthly loan payment, even with a lower interest rate.
How Long Will Interest Rates Remain Low?
It's not possible to predict interest rates precisely, as there is a lot of uncertainty. But it seems likely that interest rates will start increasing soon.
The Federal Reserve Board had previously said that it will not increase interest rates until 2023, prioritizing full employment over controlling inflation. But it recently reversed course and announced that it anticipates three rate hikes in 2022, plus two more each in 2023 and 2024.
So interest rates could start rising in the first quarter of 2022, plus or minus a quarter. And by the end of 2023, rates could be as high as 2.125% according to three Fed officials.
Should You Refinance Your Federal Student Loans?
Federal consolidation loans do not offer interest rate reductions. So the only option for decreasing the interest rate of federal student loans is to refinance them into a private student loan.
This might yield a lower interest rate if the borrower (or cosigner, if any) has excellent credit. But refinancing federal loans into a private student loan will cause the loans to lose the superior benefits of federal loans, such as:
There are a few other factors that may influence whether borrowers choose to consolidate or refinance their federal student loans including:
- Expiration of the federal student loan payment freeze: The payment pause and interest waiver was recently extended once again. It's now set to end on December 31, 2022. This may lead to an increase in refinance activity in January 2023 when federal loans no longer have the equivalent of a zero interest rate.
- Potential for new student loan forgiveness policies: If broad forgiveness of federal student loans occurs, it's most likely to happen soon, before the mid-term elections. So borrowers may hesitate to refinance federal loans into a private loan before then due to the fear of missing out.
- The Limited Public Service Loan Forgiveness (PSLF) Waiver: The Limited PSLF waiver is available through October 31, 2022 and could give credit for past periods of repayment to millions of borrowers who work (or have worked) for qualifying employers.
In general, federal loan borrowers should only refinance their student loans if (A) they don't qualify for PSLF and if (B) their incomes are high enough that they won't benefit from joining an IDR plan and are unlikely to be targeted by future student loan forgiveness policies.
Should You Refinance Your Private Student Loans?
There are no prepayment penalties on private student loans. So nothing stops a borrower from refinancing their private student loans if they can qualify for a lower interest rate. Some borrowers have refinanced their private student loans multiple times, each time to get a lower interest rate.
Refinancing is a good option for borrowers who have an excellent credit score or who have student loans from several years ago, when interest rates were higher. Also if the borrower's credit score has improved since they last applies, they might qualify for a lower interest rate.
A potential drawback of refinancing any student loans, including private loans, is that it replaces multiple loans with a single loan. This might streamline repayment, but it also prevents the borrower from targeting the loan with the highest interest rate for quicker repayment.
Accelerating repayment of the loan with the highest interest rate, instead of refinancing, can save money by reducing the average interest rate paid by the borrower. But if you decide to go this route, just be sure to tell the lender that the additional money you pay should be counted as an extra payment and not an early payment of the next installment.
How Can You Qualify For A Lower Refinance Rate?
The interest rate you're offered on a private refinance loan will depend your credit score. And if you have a cosigner, their credit score will impact your interest rate as well.
Interest rates can vary from about 2% to about 12%, depending on credit scores and lenders. Here are a few things you can do to increase your chances of qualifying for a refinance rate that's on the lower end of this scale:
- Graduate from college. Students who drop out of college are less likely to be approved for a private refinance loan because they're statistically more likely to default on their student loans.
- Pay your bills on time. Making your monthly payments on or before their due dates will contribute to a better credit score, which will help you qualify for student loan refinancing.
- Pay down debt. Don’t carry a balance on your credit cards. A low debt-to-income ratio will increase your likelihood of being approved for private refinancing.
- Maintain steady employment. Lenders love to see income stability. That's why borrowers who have worked for their current employer for at least 2-3 years are more likely to qualify for refinancing.
- Add a creditworthy cosigner. Applying with a creditworthy cosigner can yield a lower interest rate, even if borrowers could qualify for refinancing on their own. Just know that cosigners take on risk as their credit scores are impacted (positively or negatively) by the loan's payment activity.
Most importantly, it's important to shop around with several of the best refinancing lenders to find the lowest interest rate available to you. You can also use a lender marketplace like Credible to get quotes from multiple lenders in minutes.
When Is The Best Time To Refinance Student Loans?
While refinancing activity occurs throughout the year, it often peaks in November and December. That's because the six-month grace period after students graduate expires around that time.
Refinancing so soon after college graduation, however, may not be optimal because credit scores decrease with each year in school as credit utilization increases. It takes several years of steady employment and on-time bill payment for credit scores to improvement.
That being said, interest rates on private student loans are currently at or near record lows. So even with a less-than-stellar credit record, borrowers may qualify for a lower interest rate, especially if they apply with a creditworthy cosigner.
When weighing whether to refinance your student loans, it's important to consider the total cost of the loan. Compare the the total loan payment before and after refinancing the loans. This is especially important if the refinance has a different repayment term.
A longer repayment term might reduce the monthly loan payment but actually increase the total amount paid. And while a shorter repayment term might raise your monthly loan payment amount, it could save you a lot of money overall.
Finally, keep in mind that private lenders can vary widely on the benefits they offer to borrowers such as the option to place loans in forbearance during periods of economic hardship or in deferment if you decide to go back to school. You can compare our top refinance refinance companies here to help you find the right lender for your needs.
Editor's Note: This article was updated to reflect the updated extension date of the student loan pause.
Mark Kantrowitz is an expert on student financial aid, scholarships, 529 plans, and student loans. He has been quoted in more than 10,000 newspaper and magazine articles about college admissions and financial aid. Mark has written for the New York Times, Wall Street Journal, Washington Post, Reuters, U.S. News & World Report, MarketWatch, Money Magazine, Forbes, Newsweek, and Time. You can find his work on Student Aid Policy here.
Mark is the author of five bestselling books about scholarships and financial aid and holds seven patents. Mark serves on the editorial board of the Journal of Student Financial Aid, the editorial advisory board of Bottom Line/Personal, and is a member of the board of trustees of the Center for Excellence in Education. He previously served as a member of the board of directors of the National Scholarship Providers Association. Mark has two Bachelor’s degrees in mathematics and philosophy from the Massachusetts Institute of Technology (MIT) and a Master’s degree in computer science from Carnegie Mellon University (CMU).
Editor: Robert Farrington