Determining if and when to refinance your student loans is a personal decision with several factors to consider.
While student loan refinancing can be a powerful tool to strengthen your financial situation, it’s not always the best choice. There are a few one-size-fits-most scenarios to help you determine when refinancing does (or doesn’t) make sense.
- When to refinance student loans
- When not to refinance loans
- Are you eligible for refinancing?
- Is now a good time to refinance?
- How to refinance your student loans
When to refinance student loans
Student loan refinancing refers to combining one or more of your student loans into a completely new loan with different repayment terms. That means you could qualify for a different interest rate or change the length of your loan term. In the following five instances, refinancing your student loans could work in your favor.
- You have the credit and income to score a low APR
The best reason to refinance your student loans is to save money on interest and the overall amount you’ll pay on your loans. You accomplish this by using your good to great credit score (among other financial markers) or a cosigner’s to qualify for a lower interest rate.
Once you’re quoted potential APRs (rates that account for lender fees) for refinancing, use a student loan refinance calculator to determine how much you could save on your monthly payment as well as on your overall interest. Input your latest loan balance as well as your current terms, including interest rate, monthly payment, and the remaining term. Then add your estimated new interest rate and term length to see the changes in your monthly payment and total interest paid.
| For example: Let’s say you have a $20,000 loan balance with a 10.00% interest rate, a 10-year term, and a monthly payment of $264. If you were to refinance that loan with a new interest rate of 4.25% and the same term, your monthly payment would be $205, and you would save $7,131 over the life of the loan. |
- You can get a lower monthly payment
If you can save money in the long run, it’s almost always a good idea to refinance your student loans. But sometimes you need some short-term financial relief and want to lower your monthly payment — even if it means paying more interest overall.
Refinancing to a longer loan term spreads out your existing balance over a longer period. Although it results in more interest payments, this strategy does help reduce your budget each month.
| For example: Let’s say you have the same $20,000 loan balance with a 10.00% interest rate, a 10-year term, and a monthly payment of $264. If you were to refinance that loan with the same interest rate but a 15-year loan term, your monthly payment would decrease by $49 to $215, but you would send $6,924 over the life of the loan. (If you have the credit to also bring your refinancing rate into the single digits, down from 10.00%, your monthly savings would be even greater, and your total cost of repayment wouldn’t be as high.) |
- You can ditch a high variable APR for a lower fixed rate
Student loans come with one of two types of interest rates: variable or fixed.
- Fixed interest rates stay the same throughout the life of your loan, meaning that your payment amount is also static.
- Variable interest rates change depending on market conditions, meaning that your monthly dues could increase or decrease.
Interest rates have been on an upward trajectory and are expected to keep climbing in 2023. So if your student loan has a variable APR, your rate — and consequently, your monthly payment — will also increase. It could make sense to refinance and lock in a fixed rate to have predictable monthly payments. That could make budgeting an easier exercise, particularly during uncertain economic times.
- You have private student loans and good credit
When you have a good credit score (or a cosigner), you have the best chance of qualifying for a lower interest rate via student loan refinancing. You may even be able to pay off your loan faster by speeding up your payoff date or making extra payments with the savings on interest.
Also, if your student loans are already private, you have much less to lose by refinancing. After all, you’d be taking private loans from one bank, credit union, online lender or other financial institution and refinancing them with another (though you might have the option of refinancing with your current lender, too). (It gets much trickier when considering refinancing federal loans with a private lender, which we’ll discuss below.)
- Your debt-to-income ratio has recently improved
Your debt-to-income ratio (DTI) is another important factor in qualifying for a lower interest rate during a student loan refinance. Your DTI refers to the amount you pay toward debt each month, compared to your gross monthly income.
Your debts include credit card, mortgage, and auto loan payments as well as any other student loans you have. This total is divided by your gross (pre-tax) earnings. The lower your DTI, the better chance you have of getting approved and snagging a low interest rate.Â
When not to refinance student loans
When should you skip — or at least delay — the refinancing process? There are a few scenarios in which you should think twice before starting your application.
- You value federal loan protections
If you have federal student loans, refinancing them automatically — and permanently — converts them into private loans. This removes all of the protections that come with federal student loans.
It’s wise to consider other alternatives before refinancing. You never have to worry about prepayment penalties, which are sometimes present with private loans. Additionally, you have access to forbearance, deferment, and student loan forgiveness programs.
Some alternatives to refinancing federal loans include:
- Switching to an income-driven repayment plan
- Consolidating your federal student loans into a Direct Consolidation Loan
Neither of these strategies change your interest rate, but a Direct Consolidation Loan can combine multiple loans into one easy payment and change the term length. Plus, you retain all of the perks that come with federal student loans.
- You’re pursuing loan forgiveness or repayment assistance that could be affected by refinancing
As mentioned, federal student loans come with additional benefits that are lost when refinanced. One of these benefits is access to Public Service Loan Forgiveness, which eliminates the borrower’s student loan balance by meeting certain career requirements. Eligibility starts by working for eligible employers (including government and nonprofit entities) while making 120 payments in the program.
Most federal student loans are also eligible for multiple income-driven repayment programs. These programs may reduce your monthly payment if you meet the income requirements — but they’re non-transferrable when you refinance to a private loan.
- Your application isn’t strong enough to qualify for a lower rate than you currently have
In some cases, refinancing doesn’t make sense simply because it doesn’t offer any savings. If your credit score is too low, you recently experienced a loan default, or rising interest rates don’t compete with your current rate, you may not qualify or have any incentive to make a change.
| Tip: If good credit is all that’s holding you back from refinancing, you might consider adding a cosigner to your application. By piggybacking onto a cosigner’s stronger credit profile, you could improve your chances of lender approval — and getting a lower interest rate. Just be aware that a cosigner is legally responsible for repayment if you can’t pay off your debt independently. |
Evaluate what you were hoping to achieve by refinancing and look for other strategies to get there. For instance, if you were hoping to shorten your loan term, consider making extra principal payments to pay off your loans faster.
- You can’t afford your new monthly payment
When you receive a student loan refinancing quote, you may not feel comfortable with the new monthly payment. Use a loan repayment calculator to make sure you fully understand any savings opportunities — or realize that there aren’t any. In the event it doesn’t make financial sense, look at your monthly budget to find other ways to save money.
- You’re already behind on your bills
It may not be a good idea to refinance your education debt if you’re already struggling to keep your head above water financially. In addition to finding other areas in which to save, also evaluate your earning potential. Look for growth opportunities at your job that come with better pay, or start a side hustle or part-time job to help meet your immediate cash-flow needs.
Are you eligible for student loan refinancing?
Lenders look at the following criteria to evaluate applications for student loan refinancing.
- Positive credit score
- Consistent income
- Low debt-to-income ratio
- Completed degree program
- U.S. citizenship or permanent resident
Is now a good time to refinance?
Interest rates are on the rise, which means it’s important to explore today’s rates compared to your current student loan APR. If your credit score has improved or you want to drop a cosigner from your existing loan agreement, it could still make sense to refinance.
Currently, there’s disagreement on how rates are expected to fare in the next year or two. The Federal Reserve has stated its commitment to wrangling inflation to 2%. While inflation is slowing, it hadn’t reached that threshold by January 2023. How aggressive the Fed plans to be is unknown.
For student loan borrowers, that means there’s uncertainty on what to expect in the months ahead. If you have a variable rate loan that’s already increasing, it may be worth exploring a refinance sooner rather than later.
| Remember: If you have federal student loans, it’s best to wait until 60 days after June 30, 2023, when the payment pause ends. Interest rates are currently set to 0% because of the CARES Act, and if you refinance now, you’ll have to start paying at whatever interest rate you switch to. |
How to refinance your student loans
If you determine that student loan refinancing is right for you, follow these steps to find the best option.
- Compare lenders. Not all lenders offer the same rates and terms. Look at multiple options to compare rates, fees, and terms that help achieve your goals. Review APRs to ensure apples-to-apples comparisons among lenders competing for your business.
- Choose a refinance option. After reviewing different refinancing options, choose the one that makes the most sense for you. You might be after a lower rate on a shorter term (to quicken your repayment and save), you might prefer a lower monthly payment on a longer term (to make room in your budget). Confirm that your refinancing offer helps you achieve your individual goal.
- Fill out your application. The next step is to fill out the full application. You’ll need to submit some supporting documentation, such as pay stubs, tax returns, and your current student loan information.
- Manage the change in payments. It takes time to switch from one lender to another. Keep up with payments to your existing loan servicer until you receive notice that the refinance process is complete. Then begin making payments on your new loan once it’s disbursed to ensure you hit the ground running.