Many individuals are now looking into refinancing their student loans to save cash, but if you have a private student loan and have improved your credit score, refinancing may be worthwhile for you. On the other hand, if you have federal student loans and refinance at this time, you could be making a mistake because it typically isn’t in your best interest to refinance federal loans now. In addition, sometimes the best option for you is to simply not do anything at all.
What People Are Talking About When They Talk About Refinancing
When you hear your friends or see commercials or random videos on YouTube raving about low-interest rates, you may think it’s simply hype. You are correct to think that; however, refinancing remains an option for many people. Refinancing means replacing your old loan with a new loan through another lender. The new lender will pay off the old loan and you will now be making payments to the new lender. This is an overall simple concept with potentially life-changing consequences.
People decide to refinance primarily for a number of reasons including Low-interest rates or lower monthly payments (with many cases offering both). Others consider refinancing just as a way of escaping their current lender with whom they no longer wish to be associated.
You Need to Double Check the Numbers Before You Get over-Excited!
Refinancing is not an easy way to obtain additional cash; it can only benefit you if the math makes sense. Three items that are far more important than anything else to consider before refinancing are:
- Your credit score;
- The difference in interest rate between your current lender and the new lender; and
- The length of time until you plan to pay off your student loan(s) in full.
If you don’t pay close attention to credit scores or interest rate spreads when refinancing, you may end up with a refinance that you will question down the road instead of being a good decision.
Credit Score: The Unseen Deal Breaker.
Your credit score represents your reputation when it comes to the business world. Lenders put a lot of stock in your credit score. If you have improved your credit score since you financed your loans, you will be in an advantageous position. Improved credit score usually results in more competitive interest rates, and the lower the interest rate, the more money you’ll save.
As a rule of thumb, if your score is between 661 and 799, then you qualify for refinancing with many lenders. The very best interest rates are offered to consumers with credit scores at the upper end of the scoring range (usually above 760). If your credit score isn’t in that range, moving forward with the refinance may not be a wise investment of your time.
Interest Rate Spread: Lower Number, Greater Benefit.
To most people, 1% difference between two interest rates doesn’t sound like much. However, when you look back over the life of the loan, that difference can add up very quickly. It can also mean thousands of dollars in savings for the life of the loan.
Now consider that if the new loan’s interest rate isn’t significantly different from your current loan, then there may not be enough upside to the refinance to justify the costs involved.
Keep this in mind: refinancing your existing loan should provide you with a different loan that has better rates and terms than your current loan, not simply result in a similar loan with slightly different terms and rates.
Time Is Your Enemy Or Your Friend
The duration of how long you intend to continue making payments is a very important factor. On one hand, if you were to continue making payments on this loan for another 10 years, even a small rate reduction would greatly impact your overall costs. On the other hand, if you plan to pay off the loan within 3-6 months, it is unlikely that refinancing will have much of an effect.
Long-term? Refinancing will save you money. Short-term? The amount saved may be limited to a nominal amount.
Caution With Federal Loans
Unlike private loans, federal student loans offer a variety of benefits such as income-driven reduction options, potential loan forgiveness programs, and a temporary pause on payments. Should you go ahead and refinance any federal student loans, you will lose those benefits permanently.
As such, it is recommended that no one refinance any federal student loans at this time, especially since interest rates are currently at an all-time low and ongoing discussions regarding potential loan forgiveness exist.
You Should Consider Refinancing Non-Federal Student Loans
Unlike federal student loans, private student loans do not have all of the same “safety nets” to help borrowers avoid default. There is no option for income-based repayment, there are no options for
Uh…yeah, you get it right? It’s why a lot of borrowers believe that it makes sense to refinance their private student loans.
For those borrowers that have higher income levels, better credit ratings, or have seen interest rates drop between the time they borrowed and the time they would like to refinance their loans, refinancing a private student loan can represent a significant amount of savings to them–so much so that, in fact, most people that refinance their private student loans see their highest savings from the refinance.
You Can Avoid the Confusion Between Fixed and Variable Rates
If you refinance a private student loan, in most instances, a fixed-rate loan is going to be the safest choice. Variable rates may be low when you outlay them, but they can suddenly and unexpectedly go up later at the worst time for the borrower. When managing your debt, predictability is obviously more important than the occasional surprise!
Loan refinancing is not only considering what you have to pay on a loan today; it’s also about how the loan will fit into your future plans for living. Stability, flexibility and risk are all just as critical to your plan as is the current payment amount on your monthly loan statement.
If you have federal student loans, you may want to take a step back and take a long-term view of what your loans will be in the future. Waiting could be the best thing to do.
If you have private loans and interest rates are currently low, refinancing may be one of the easiest ways to save money on interest in a low-rate environment.
The loans you took out for your education are not going away on their own. However, having the right plan can help you make a difficult situation less painful; this may mean that you decide to refinance, or it could mean that you keep your loans as is.
