If you have federal student loans, you probably know that interest rates have temporarily been set to 0% and payments have been suspended because of the economic hardships imposed by COVID-19. But those measures are scheduled to end Dec. 31.
Refinancing some or all of your student loans is one way to potentially reduce your monthly payment. But is it worth it and is now a good time?
Why You Should Consider Refinancing
In 2020, interest rates for most types of debt have fallen dramatically, largely because of actions taken by the Federal Reserve to stimulate the economy. In response to the COVID-19 crisis, the Federal Reserve has set the benchmark interest rate near 0%. As a result, both mortgage and student loan refinance loan rates are at unprecedented lows.
This presents an opportunity for some qualified borrowers to refinance their student loans and secure a low interest rate for years to come. But there may be tradeoffs.
- Student loan rates are at historic lows
- Borrowers give up benefits if they refinance federal student loans
- Lenders have tightened standards on borrower eligibility
- Borrowers can potentially save thousands by refinancing
Federal vs. Private Student Loan Refinancing
When considering whether to refinance, know that sometimes a lower rate doesn’t justify losing key benefits.
Federal Student Loans
If you have federal student loans, the Department of Education has a range of options for you to lower your payment, but refinancing isn’t one of them. In other words, if you want to get a lower interest rate on federal student loans, you have to refinance with a private lender.
But doing so is almost always a bad idea because private loans don't have the borrower-friendly features federal loans do. By refinancing into a private loan, you lose income-driven payment options; the flexibility to change payment plans; broad options for forbearance and deferment; and the possibility of loan forgiveness.
Private Student Loans
If you have private student loans and can qualify for better terms by refinancing, there are fewer downsides to doing so. In addition to seeking a lower rate, consider lender-specific features like flexible repayment terms or the ability to release a co-signer.
Bear in mind that some lenders charge an origination fee (based on a percentage of the amount you refinance). The origination fee is reflected in the APR, so make sure to compare APRs between lenders and not just interest rates.
If you are switching from a fixed to a variable rate loan, be aware that your interest rate, and thereby monthly payment, can change over time. Be sure to compare student loan refinancing companies to get the best deal for you.
The shorter your loan term, the higher your monthly payment, but the less total interest you'll pay. When refinancing, it's often a good idea to keep your repayment timeline the same or choose a new loan with a shorter repayment period.
While some borrowers can get very low rates for refinancing student loans, they must qualify to do so based on their credit and other financial credentials, such as how much income and debt they have.
Many lenders have tightened lending standards, according to the Fed’s most recent Senior Loan Officer Opinion Survey on Bank Lending Practices. This means the application process is more rigorous and approval may be more difficult—especially for those who have lost jobs or income, and have accumulated debt due to the pandemic.
If you don’t qualify to refinance on your own, consider asking someone with good credit, good income, and a generous nature to be your co-signer. Co-signers can make it easier to get approved, as lenders consider the co-signer’s financials in the lending decision. But lenders can also collect payment from co-signers if you fail to make payments or default on the loan, so it’s not a request to make lightly.
Some student loan lenders offer co-signer release. If you need a co-signer to get approved, get rate quotes from these lenders and let your potential co-signer know they can be removed from the loan after a certain number of on-time payments.
How Much Could You Save?
The amount you can save by refinancing will vary depending on your current interest rate, the new rate you qualify for, and the repayment term you choose.
In 2018, the average interest rate on a private loan with a fixed rate was just under 10%. Some of the best student loan rates currently available are below 3% for the most qualified borrowers and for shorter repayment terms.
If you were to refinance a $20,000 10-year loan you took out in 2018 at 10% interest into a new 10-year loan at 4%, you could reduce your monthly payment from $332 to $202. This would net you a monthly savings of $130 and save almost $3,600 over the life of the loan. If instead you refinance into a loan with a 7-year term, you would save almost $5,000 over the life of the loan, and reduce your monthly payment by $59.
While variable rates are an option, in such a low-rate environment, it may be wiser to choose a fixed rate, especially if you intend to also choose a long repayment term.
How to Refinance Private Student Loans
- Check your credit report to make sure it's free of errors—your credit is a key determining factor in whether you will be approved for a loan at a competitive rate.
- Shop around and get quotes from several different lenders. If possible, choose lenders that do not perform a hard credit inquiry to check your rate. (Hard credit checks can reduce your credit score.)
- Look at the annual percentage rate (APR), repayment terms, and lender-specific features, such as economic hardship options, to compare loan offers.