Written by: Livia Neistat
Student loan debt is still a big financial hardship for millions of Americans.
According to statistics released by The Institute for College Access and Success in October 2020, more than six out of ten (62%) Americans who graduated from college in 2019 have student loan debt, with an average debt of $28,950.
There is some good news: federal student loan interest rates have reduced to 3%, and some private student loan rates are even lower. As a result, many people may find refinancing student loans to be an enticing option.
However, it is not as simple as it appears.
Borrowers with good credit histories and high incomes are eligible for the lowest interest rates. Refinancing your student loans may be a terrible idea based on the sort of loans you have.
All payments, interest, and collections on federal student loans held by the government are currently stopped. The federally held student loan forbearance and interest freeze are set to expire on December 31, 2020. So there's no reason to consider refinancing such sorts of loans until then. "You'll never beat a 0% interest rate, so there's no incentive to [refinance federally held student loans] for the time being," says Adam S. Minsky Esq., a student loan attorney.
When Refinancing Student Loans Isn't a Good Idea
Federal student loans may be eligible for a variety of advantages and safeguards, including death or disability discharge, default settlement, and deferral or forbearance alternatives. If you make qualifying monthly payments while working full-time for a qualified job, you may be eligible for repayment plans depending on your income and debt forgiveness.
That's a lot to give up, and you should only do it if you can significantly lower your interest rate or pay off your debts soon. Even so, Minsky advises maintaining a fully established emergency fund as well as enough life and disability insurance to mitigate some of the risks.
You can use the federal student debt consolidation program instead of refinancing your federal student loans. Consolidating federal loans keeps all of the advantages, but the interest rate is a weighted average of the prior loans. It won't lower your interest rate, but it does offer other advantages, according to Mark Kantrowitz, vice president of research at savingforcollege.com.
As you combine your bills, all of your payments are bundled into a single, easy-to-manage payment. Consolidating your debts may also enable you to extend your repayment period while decreasing your monthly payment. Remember that, like extending a private loan, increasing your loan will increase the amount of interest you pay in time.
When Should Your Student Loans Be Refinanced?
If you have a private student loan and can save money on interest or lower your monthly payments over time, refinancing makes sense. Lowering your interest rate by one percentage point on a $37,000 loan might save you $18 each month and $2,200 in interest over the life of the loan. You can save even more money if you refinance higher-interest debt, such as graduate school student loans.
Student loan refinance, unlike other types of loans, rarely include upfront origination costs. However, keep in mind that extending the term of a loan will result in you paying more interest throughout the life of the loan. Adding five years to the loan term would cost nearly $5,500 in interest in the case above.
Refinancing Student Loans: What You Need to Know
Student loan refinancing provides a significant benefit over other forms of debt, such as mortgages, because upfront loan origination costs are uncommon. Comparing offers is straightforward because most lenders do not charge fees for refinancing student loans. It's a matter of determining the best loan term or the lowest interest rate. A refinancing application is simple to fill out, but you'll need to provide supporting documentation to prove your income and identification. You'll also need a good credit score (generally 650+) and a debt-to-income ratio (DTI) of 50% or less to qualify for refinancing, though these figures can vary by lender.
A lower DTI and a higher credit score may help you qualify for cheaper loan rates when your financial situation improves. "Your credit score isn't the only factor that determines whether you'll be approved for a private loan. They'll also look at the information that isn't on your credit report, such as your work history "Kantrowitz goes on. Lenders will want to know the amount you make and how long you've been employed at your present position.
Student debt refinancing can be a catch-22 situation. If you have a high income and credit score, you're more likely to qualify for a cheaper rate. However, those who most need the financial relief that a student loan refinancing might bring are the ones who are least likely to qualify for a fair deal. However, because student loans may be refinanced without incurring any upfront costs, even minor financial benefits might make refinancing beneficial. Just be sure you're not willingly sacrificing the crucial safeguards that come with government loans.