One in five Americans are currently paying off student loan debt, but they do not all have the same interest rate on those loans. Even if you only took on federal student loans, which are fixed for all borrowers each year, you might find that you have a different rate than others who graduated five, ten, or fifteen years before you.
Interest rates reflect your creditworthiness and determine how much more than the original debt you will have to repay. Lowering your interest rate even a couple of basis points through refinancing could mean serious savings over the years. That’s when student loan refinancing comes into play.
Refinancing is when you replace your existing loan (or loans) with a new private loan, preferably at a lower interest rate. The loan amount due won’t change, but how much you spend on interest payments may change. Lenders may be willing to offer you a lower rate if they see that your credit profile has improved since you took out the original loan. With the lower interest rate, you may be able to pay off your loan sooner, which may result in paying less interest over the life of the loan, or you may make lower monthly payments, freeing up cash flow for other uses.
Refinancing is done with a private lender, rather than the federal government. This means you can pick the lender who offers you the lowest rate and best repayment options. You might be charged an origination fee when refinancing student loans with a new lender, so make sure to read the fine print before signing.
What is a High Interest Rate for Student Loans?
Federal student loan interest rates are reset annually. The fixed interest rate for Direct Subsidized and Unsubsidized Loans for undergraduates is 4.53% for the 2019-20 school year, and will likely change for 2020-21 student borrowers. This might feel like a pretty low rate, but in 2013-14 interest rates for the same loans were just 3.86%.
For a number of reasons, including if you have maxed out your federal loan options, you might turn to private student loans in order to round out paying for school. Unlike federal loans, private student loans offer an interest rate based on the applicant’s credit profile. The market will determine the rates available for any loan, but your creditworthiness, or rather, credit profile will impact the rate you personally receive for your student loan. Fixed rates are currently ranging from about 4 to 13%, but again, rates are always changing based on the market changing.
Another factor that affects the interest rate of a loan is the type of loan chosen by a student. If you took on a variable rate interest loan from a private lender, your interest rate may change over the life of your loan. While the variable interest rate offered by the private lender may at first be lower than the fixed rate available, that could change over the life of the loan.
What could impact the interest on student loans?
One of the major components of your credit score is your credit history. Often students don’t have a long enough credit history, for example: enough lines of credit diverse credit mix, or simply use of credit to show a lender that they can make payments on their loan. The student also may not have had any form of income when they took on the student loan.
Because of risk, private lenders may ask students to add a cosigner to their application for any of these reasons. Adding a cosigner may give the lender peace of mind and the ability to offer a lower rate than they may have been able to offer the student on their own.
When to Refinance Student Loans
One factor lenders will look at when you go to refinance your loan is your debt-to-income ratio. For this reason, a great time to consider refinancing your loan(s) could be if you have reached a major financial milestone in your life. Did you get a raise or promotion that will impact your monthly income? Did you just graduate with a higher degree and will be reentering the workforce? Did you finish paying off another existing debt? These are only a few examples of situations that could improve your debt-to-income ratio and be the reason to reexamine your student loan interest rates. It is important to remember that in order to refinance your student loan, lenders may require you to be graduated or within six months of graduation.
If you are unsure about whether or not you could get a lower interest rate, many lenders (including Earnest) offer the ability to check what rate you could get with them without performing a hard credit pull. With many options available, you can, and should, shop around for rates with different lenders before signing on with anyone.
Refinancing Parent Plus Loans
Not everyone knows that parents can refinance their Parent Plus Loans as well. As those with adult children often have a much longer credit history and established credit score, lenders will have more information to work with and may be able to offer lower rates than what they are currently paying. For parents thinking about retirement, refinancing can be a great solution for paying off the loans they took on to help their student more quickly.
Refinancing vs Consolidating Your Student Loans
Not sure if you should be consolidating your federal loans into a single Direct Consolidation Loan or refinancing? The main difference is how the interest rate for your loans are calculated. When consolidating your federal loans using the Direct Consolidation Loan, your new interest rate will be the weighted average of your existing interest rates. When financing your loan(s) into a private loan your new interest rate reflects your current financial life.
Direct Loan Consolidation of your federal student loans can be great if you are happy with your interest rates and repayment terms, but want to bundle all of your loans into one payment.
It is important to note that you can also pick and choose which loans you would like to include in your Direct Consolidation Loan or private refinancing, you don’t have to repackage them all.
When Not to Refinance Your Federal Student Loans
Refinancing for a lower rate might not be the right decision for everyone. By refinancing, you will be taking on a new loan with a private lender. If you are utilizing or believe you could in the future benefit from loan forgiveness, flexible repayment plans (e.g. income-based repayment, deferment or interest subsidies associated with your current loan then you would be giving up these benefits. If you are happy with your loan terms and repayment options you may not want to make a change.
If you are in deferment on a federal loan while attending school you might not want to refinance your student loans, as you would start repayment after refinancing. Some federal loans don’t accrue interest while in deferment, which is also a great benefit to hold on to.
Lastly, lenders who refinance student loans will also look for a strong history of making monthly payments. Have you had some trouble making payments, been in default or forbearance with your student loans? You might not see an interest rate that reflects the potential you know you have. Instead, work toward making complete and on-time loan payments, review your credit report to see how you can make improvements, and take steps to show a lender that you are a candidate for refinancing.