Each year, there’s an increase in refinancing and consolidation of student loans in November and December, perhaps because of the end of the 6-month grace period after graduation.
A private student loan refinance is a new loan that pays off the old student loans. As a new loan, it has a new interest rate and new repayment terms, not just a new lender and loan servicer.
Why Should You Refinance Your Student Loans?
Popular reasons for refinancing student loans include the opportunity to save money with a lower interest rate and shorter repayment term. Borrowers can also choose a longer repayment term to reduce the monthly loan payment, but this often increases the total cost of the loan. Other reasons for refinancing include switching to a different loan servicer and cosigner release.
What Are the Best Interest Rates?
Current interest rates on a private refinance are as low as 2.80% fixed and 1.34% variable. These interest rates assume that the borrower qualifies for an AutoPay discount by agreeing to have the monthly loan payments automatically transferred from their bank account to the loan servicer.
A fixed rate remains unchanged over the life of the loan. A variable rate can change periodically, such as monthly, quarterly and annually. Given that interest rates are currently at or near record loans, a variable rate has nowhere to go but up. However, a variable rate can save you money if you are able to pay off the loan in full in just a few years, before interest rates increase too much.
How to Qualify for the Lowest Interest Rate
Your actual interest rates may be higher than the lowest advertised interest rate, since the interest rates you get depend on your credit score. A higher credit score yields a lower interest rate.
Lenders also require a low debt-to-income ratio and that you have worked for at least 2 years with your current employer. You must also have graduated from college and not be delinquent or in default on your student loans.
Qualifying for the lowest fixed rate may also require choosing the shortest repayment term. Typical repayment terms range from 5 to 20 years.
Shop around for the lowest interest rates using a student loan comparison tool and by applying for several loans.
Applying for several loans within a short period of time will have a minimal impact on your credit score because the credit bureaus now recognize shopping-around behavior. Also, many lenders do a soft credit check instead of a hard credit check when giving you an initial estimate of your interest rate.
How to Choose a New Student Loan
Cost is the most important criterion for choosing a student loan.
Compare both the monthly payment and total payments to find the lowest-cost loans. Generally, a lower monthly payment increases the total payments over the life of the loan. A higher monthly payment will reduce the total interest you pay.
Cutting the repayment term in half has about the same impact on total payments as cutting the interest rate in half. When you do both, about two-thirds of the savings come from the shorter repayment term, not the lower interest rate.
You don’t need to refinance to save money on your student loans. Since student loans do not have prepayment penalties, nothing stops you from paying extra on the loan. When you pay more each month, it is like being in a shorter repayment term.
Be Careful about Refinancing Federal Loans
Federal student loans provide better benefits than private student loans.
- Federal student loans held by the U.S. Department of Education, including all Direct Loans and some FFELP loans from 2008-09 and 2009-10, are eligible for an automatic payment pause and interest waiver.
- Federal student loans have lower fixed rates.
- Federal student loans offer longer deferments and forbearances. The federal government pays the interest on subsidized loans during a deferment.
- Federal student loans offer death and disability discharges.
- Federal student loans have better repayment terms, including income-driven repayment plans.
- Federal student loans may qualify for loan forgiveness for working in particular occupations, such as teaching and public service.
However, borrowers may want to refinance older federal loans, which may have higher interest rates and may not be eligible for all of these benefits.
Do This Before Your Refinance Your Student Loans
Check your credit reports and correct any errors before refinancing your student loans. Errors in your credit reports can affect your credit score, which will then yield a higher interest rate.
You can check your credit reports for free at www.annualcreditreport.com. You can check all three once a week through April 2021. (Normally, you can check your credit reports once a year for free, but this was expanded to weekly during the pandemic.)
You can correct errors by disputing them. Creditors have 30 days to confirm the accuracy or remove the incorrect information from your credit reports. Wait until the errors have been corrected before applying for a private refinance of your student loans.
How to Improve Your Credit Scores
Aside from disputing incorrect information, there are other ways to improve your credit scores to qualify for a lower interest rate when you refinance your student loans.
- Continue to make on-time payments on all your debts. It is particularly important to have no delinquencies during the last two years.
- Pay down debt, especially credit card debt. This will reduce your debt-to-income ratio.
- Once you’ve paid off a credit card in full, do not cancel it. Cut up the card, so you won’t be tempted to spend more money, but don’t cancel the account.
- Don’t switch jobs. Lenders consider the duration of employment with your current employer when deciding whether to approve a private refinance.
- Apply for the private student loan with a creditworthy cosigner, even if you can qualify for the private refinance on your own.
Some credit bureaus will count your utility, telephone and rent payments toward your credit scores, boosting your credit scores a little. Experian Boost and UltraFICO will need access to your bank account so they can identify and track the rent, utility and telephone payments.
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