Thanks to companies like SoFi and Credible, refinancing student loans has become more popular than ever. Yet, many folks aren’t quite sure whether they should stick with their existing federal student loans, or refinance over to a private loan. Let’s take a look at a few questions you should consider, in deciding whether to refinance.
How Does Student Loan Refinancing Work?
When you refinance a student loan, your new lender will pay off the remaining amount owed (plus interest, as of the date of refinance), for the loans you originally signed up for. Those loans will now be treated as paid and closed.
Let’s say you owe $40,000 in graduate school loans. If you refinance these loans, then you’re basically asking the new lender to pay off these loans, and issue a new loan.
After you’re approved for the new (refinanced) loan, you will start making payments on that loan. Typically, payments begin just 1 month after the new loan has been opened.
What Is The Total Remaining Cost Of Your Current Student Loan?
The first thing to consider is how much you are currently spending on your student loans. This is decided by the amount of your principal, as well as your APR (annual percentage rate), and the length of your loan.
Your principal refers to the amount you borrowed (i.e. the amount of your loan). If you’ve already started repaying the principal, simply look at the principal still remaining.
Your APR includes not only your interest rate, but also, any additional fees, such as loan origination fees, or time the loan spent in forbearance (discussed below). Lastly, the length, or term of your student loan, refers to the number of years you’ll spend repaying the loan.
Why are these numbers so important? Your principal, APR and loan term determine how much you’ll end up spending, in total, to repay the loan. Once you know these numbers, you can use a student loan calculator to figure out how much you’ll end up spending, in total, on your current loan.
You’ll want to compare this number to any student loan refinancing option you might be offered. Make sure that the overall cost of the refinanced loan is lower than that of your current federal loan (after all, your goal is to save money).
How do you find out these numbers? You can contact your student loan provider by phone, or login online, and request this information.
How Stable Is Your Job & Income?
One crucial consideration when refinancing a student loan is your employment and income situation. With federal student loans, if you have trouble making payments, there are a variety of options, to help you avoid defaulting on the loan – and damaging your credit.
You can apply for a repayment plan based on your income, whereby your student loan payments will be adjusted based on your income and family size. You could request deferment (where your student loan payments will be put on hold for a while, without accumulating interest), or forbearance (which is similar to deferment, except that in forbearance, you’ll continue accruing interest on the loan). If you work in a public service job (such as for the government, or certain types of non-profit organizations), you might also be able to have part of your loan forgiven.
With private student loans, these options are considerably more limited. Deferment and forbearance might be possible in some cases, but only if the lender agrees to it. Income-based repayment plans are rare, and public service loan forgiveness doesn’t apply. Therefore, if you run into trouble with paying a private student loan, your options are somewhat more limited, as compared to federal student loans.
For this reason, we suggest refinancing your loan only if you’ve been with your current employer for at least 12 months. If you are a freelancer or run your own business, we suggest at least 24 months in that role, while earning a steady salary / income.
If you are in any kind of contract or temporary position, avoid refinancing your student loans. If you work in a job or industry which is heavily commission based (like sales), you’ll want to make sure that even if you earned less than expected, you’ll be able to make payments on your new loans
No matter whom you refinance your student loan with, make sure you understand your options are in terms of deferment and forbearance, especially in cases of unemployment. Life happens, and you don’t want to needlessly place yourself in a tough position.
How’s Your Credit Score?
Federal student loans don’t consider your credit score. If you want to refinance to a private student loan, however, credit will be an important factor.
While most private lenders do work with folks whose FICO credit scores are as low as 670, to refinance a student loan in order to qualify for the lowest interest rates and overall costs, you’ll typically want to have a score of 700 or higher, ideally, over 740.
If you aren’t sure of your current FICO score for free with Discover (you don’t have to be a customer), or through freecreditscore.com (where you’ll also recieve your Experian report). A strong credit score greatly increases your chances of refinancing into a better loan. If your credit score isn’t as strong as you’d like, you might want to work on improving your score, or consider finding a cosigner for your loan.
Can You Afford The Monthly Payments?
This might seem like a strange question. After all, why would you refinance your student loans, in order to pay more? However, it isn’t quite so simple.
Some refinancing offers might cost less overall, and offer a lower APR, yet monthly payments are higher. Why? These loans carry shorter loan terms, with larger monthly payments. You have a shorter period of time in which to repay the money. They save you money in the long run (since you are paying lower interest, for less time), but to make that happen, your monthly payments increase.
A good rule of thumb to follow, is that you should spend no more than 10 to 15% of your monthly income, on repayment of your loans (this is the same amount used in many of the income-based repayment plans mentioned earlier). Spending more than that is risky, especially if you run into a financial emergency.
Is This The Best Deal You Can Get?
Suppose you’ve been approved for refinancing with a particular lender. Should you stop there?
In most cases, no. There are a number of banks and independent lenders who refinance student loans. It’s possible that you were offered the best deal – but you won’t know unless you research some other options.
For this reason, we suggest researching and/or prequalifying with multiple lenders, before signing up for any loan. You can review interest rates and terms by inputting your loan amount, income, credit score and other information into NerdWallet, which will display offers from various lenders. Otherwise, we suggest contacting SoFi, Credible, Common Bond and Earnest, to see if you can recieve a better offer than what you’ve got on hand.
One question we often recieve, is how applying for multiple student loans will affect your credit score. Some lenders and marketplaces, like Credible, only conduct a “soft pull” (which doesn’t affect your credit score), during the preapproval process.
Other lenders might run a “hard pull” or “hard inquiry” which does impact your FICO credit score. You thus want to be mindful to only apply for loans once you have researched your chances of being approved, and are fairly confident that you can qualify for the loan.
The Final Word
Refinancing student loans can be a great way to save money, reduce debt, and ultimately, grow your wealth. Every dollar you aren’t paying in student loans can be invested, or applied towards reducing other debts.
However, as great as student loan refinancing can be, they aren’t for everyone. Follow the tips detailed above, and you’ll recieve the best deal possible.
