Refinancing your student loans to a lower interest rate is a great way to save money, especially if your credit score has improved from a few years ago. However, if your loans are federal, refinancing may not be the best option for you at this time. In addition, sometimes doing nothing is an even better financial decision than refinancing your loans.
You’ve probably heard about low interest rates being advertised by friends, on social media, or even through YouTube videos. Well, while this hype isn’t completely unfounded, there is an actual reason behind the excitement surrounding refinancing. Essentially, when you refinance your student loans, you are replacing one lender with another, which means that you will now owe the new lender money. This may seem like a very uncomplicated transaction but can result in substantial savings over time.
So why do people choose to refinance? To obtain a lower interest rate, lower monthly payment, or both. In fact, some people may also choose to refinance to eliminate a lender they dislike working with.
You can not “get” free money from refinancing student loans. If you do not have a strong understanding of how student loans work or do not have any solid numbers to support why you want to refinance, refinancing could become a “mistake” rather than a positive financial move.
Therefore, it is essential to have knowledge of three crucial factors associated with refinancing student loans:
a) Your credit score,
b) How much lower your new interest rate is going to be, and
c) How long you plan on being in debt.
If you disregard one of these three important factors, refinancing could quickly turn from a “good idea” into a “bad decision.”
Credit Score: The Untold Deal Breaker
Lenders really care about your credit score, as it represents your financial reputation. If your score has gotten better since the time you took out your loans, you are likely to be in a good place, and generally speaking, high scores lead to better interest rates and the possibility of saving real money.
Questions to ask yourself? Generally, above mid-600s helps qualify for loans but usually, the best deals are given to people with scores closer to the high-700’s. If you are not close enough to a high-700 score to qualify for a loan, chances are, refinancing your loan will simply take up too much time with little reward for doing it.
Small Differences, Big Savings – Interest Rate Differences
A small percentage difference does not sound too exciting; however, over the course of multiple years, the total amount of money saved by making that small change adds up very quickly! A significant drop in interest rate will save you hundreds of dollars every year and may end up saving you thousands of dollars throughout the course of your loan.
Conversely, if your new interest rate does not differ greatly from your existing interest rate, all the time and effort you put forth to refinance May not be worth it.
Your relationship with time can either help you or hurt you.
The length of time you will be making payments substantially alters how much impact a rate cut has on you. If you will be paying on the loan for another ten years, then a small reduction in the interest rate will have a considerable impact, while if you plan to pay off the loan in three months, then refinancing will likely have little effect.
Extensive timeline? Tremendous savings through refinance.
Short timeline? Maybe disappointing savings.
Federal student loans must be treated very carefully.
Federal student loans carry features and benefits that private student loans do not provide. Federal loans provide borrowers with income-based repayment plans, allowable loan deferral periods, and possible forgiveness programs. When a borrower refinances a federal loan, all of these options are lost irrevocably.
Due to the significant amount of benefits available to borrowers who currently hold federal loans, it is advisable for people who are considering refinancing their federal loans not to do so at this time, as interest rates are currently 0% and forgiveness discussions are ongoing.
Refinancing private student loans usually offers the most benefit — they don’t have the same protections that federally funded loans do: they don’t offer income-based repayment plans; there’s no guarantee of forgiveness or relief — therefore, refinancing private loans typically makes sense.
Anyone with a lower credit score, lower wages, or who has significantly more debt than they did before (when they took out the loan) can benefit from refinancing, as they will likely qualify for a lower interest rate. The main reason to refinance private loans is to save money.
In addition to having better credit and/or higher wage, if you’ve had an increase in your interest rate since you took out your loan, it may make sense to refinance at a fixed-rate loan. In fact, interest rates will generally be lower on fixed-rate loans than on variable-rate loans, even if you refinance just for that reason. You will always have a better idea of what your payment will be if you do this than if you go with a variable-rate loan. There is more certainty with a fixed-rate loan than with a variable-rate loan.
Refinancing is not simply about what you owe today. It is important to consider how your loan will affect your goals for the future, thus stability, flexibility, and risk should also factor into your decision-making (as well as what you see on your most current statement).
If your loans are federal, take a step back and consider the long game. Waiting may actually save you a significant amount of money by the time you do refinance.
If your loans are private, refinancing may be one of the most efficient ways to lower your monthly payments in a low interest rate environment.
Student loans do not disappear overnight; however, selecting the right strategy can reduce the amount of stress and anxiety associated with them. In some cases, refinancing may be the best option; in others, it may not be necessary to change anything at all.
