What is student loan refinancing?

May 15, 2023

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Refinancing a student loan means applying for a new loan to pay off your current student loan, usually to reduce the interest rate or extend the repayment period. If you have a federal student loan, you must refinance it with a private lender. If you have a private student loan, you can refinance with the same lender or choose another one.

Refinancing a student loan replaces the existing loan with a new one. Most borrowers use this strategy to get a lower interest rate and, therefore, a more affordable loan.

How does student loan refinancing work?

If you decide to refinance your student loans, you must choose the student loans you want to refinance. You must then check the lenders' websites to see what rates and terms they offer. Refinancing is only possible through private lenders, which is important if you have federal student loans. By refinancing, you lose federal protections, such as specialized repayment plans and the ability to forgive debt.

Many lenders offer pre-qualification, which is the inclusion of basic information about you and your existing loans in exchange for a rate offer. Unlike a formal application, pre-qualification does not affect your credit rating. It is therefore the best way to compare rates offered by lenders.

Best student loan rates for May 2023

Once your loan application is approved, the funds will be used to pay off your existing student loans. You will then begin paying off your new refinanced loan. With a lower interest rate or shorter repayment period, you will pay less over time on your refinanced loan than on your previous loans.

If you have bad credit or low income, you may not be able to refinance your student loans. If you are denied refinancing, the lender is required to explain why. You may need to seek a co-signer to improve your credit situation.

Refinancing and consolidation of student loans

Student loan consolidation is a federal program that consolidates all federal student loans into a single direct loan. Borrowers often consolidate to simplify the debt repayment process because it is easier to manage one loan than many. Borrowers who consolidate their student loans can take advantage of some income-driven repayment plans and debt forgiveness programs for which they would not otherwise qualify. Under these programs, the interest rate does not change.

Student loan refinancing, on the other hand, is offered only by private lenders, with the main purpose of saving on interest or extending the term of the loan. Unlike student loan consolidation, refinancing is available for both federal and private loans, and the interest rate and terms almost always change.

Timing can also play a role in student loan savings when deciding to refinance. Although it is possible to refinance while you are still in school, it may not be the best option because your finances or credit rating may be strong enough to allow you to get the most competitive interest rates or loan terms.

To maximize the savings from refinancing and get a lower interest rate, it may be wise to refinance earlier rather than waiting years after graduation. Once you graduate, with a stable income and a good credit score, you can start looking for a better interest rate on your student loans.

Are student loans worth refinancing?

There is no single answer to the question of whether refinancing student loans is a good decision. It depends on your particular financial situation and the conditions for getting a new loan. Factors to consider include your credit rating, the interest rate on your existing student loans, and the current interest rate environment. The type of student loan-private or federal-is another important consideration.

More competitive applications may have more favorable loan terms or interest rates. But it is important to assess one's personal financial situation and all the implications of refinancing before proceeding.

Who benefits from refinancing?

Borrowers with high interest rates on private loans are the best candidates for refinancing because they are more likely to save money.

For example, suppose you have a $50,000 debt with a 12 percent interest rate and a 10-year term. In 10 years you will have paid $36,082.57 in interest. If you refinance with a 6 percent interest rate and a 10-year term, you will pay only $16,612.30 in interest over the life of the loan. You can use a student loan calculator to estimate how much you might save.

Others may consider refinancing their student loans:

Borrowers who want to consolidate multiple loans into one.
Borrowers with high monthly payments who may benefit from a longer repayment period.
Borrowers who wish to release their cosigner from an existing loan.
Borrowers who have a higher income or better credit rating than when they signed the original loan.

Who is not affected by refinancing?

Refinancing is not the best option for everyone. Federal student loan borrowers, in particular, need to think carefully about the disadvantages. Refinancing a federal student loan eliminates many of its advantages. For example, you will no longer be able to take advantage of the payment suspension implemented during the pandemic, and you will no longer be able to apply for loan forgiveness through programs such as income-driven repayment plans or Public Service Loan Forgiveness.

You should also think twice about refinancing your loan if you are offered higher interest rates than you are currently paying or if you are offered a longer term. In either case, you will pay more over the life of the loan. It is therefore important to weigh the benefits of the new terms against the total cost. This is especially true if you are nearing the end of your loan term. If you only have a few years left to pay, most of your monthly payments will go toward principal payments, so refinancing may not be worth it.

Eligibility requirements for student loan refinancing.

There is no minimum standard for refinancing; each institution has its own idea of what constitutes an eligible borrower. That said, there are some commonalities:

Credit score. Creditworthiness is the most important factor in obtaining a student loan refinance. The higher the credit score, the more likely you are to be approved and get the lowest interest rate. Most lenders require a credit score of at least 650 and a credit history with no late payments.
Debt-to-income ratio. The more debt you have, the riskier you appear in the eyes of lenders. This shows that you are less likely to make payments in an emergency. Before applying for refinancing, make sure your debt-to-income ratio is less than 50 percent.
Your job. You must show that you have a steady income and can afford the payments. Many lenders require a minimum income of $25,000.
Your loans. Lenders set a minimum amount you can refinance. If you have less than $5,000 to pay, you may have difficulty finding a lender willing to refinance your loan.
Degree. Some lenders will allow you to refinance your loan even if you have not yet graduated, but most lenders require that you have completed a program before you can refinance.

When refinancing, the best thing you can do for yourself and your finances is to get quotes from different lenders, since all lenders evaluate eligibility factors differently. It is almost always possible to get quotes without having to check your creditworthiness. By getting a pre-qualification, you will be able to see where you qualify and at what rate, giving you a better idea of which lending institution is best for you.

Refinancing student loans can help some borrowers save money by allowing them to exchange their existing loans for a new private loan at a lower rate. If you have federal student loans, be aware that refinancing involves waiving benefits such as federal debt forgiveness and debt relief programs. If you think refinancing is right for you, compare rates, terms and fees from as many lending institutions as possible.

Frequently asked questions.

Is it worth refinancing a student loan?
The answer depends on your specific situation. For example, refinancing may make sense if you can get a lower rate and save money. Conversely, refinancing does not make sense if you cannot get a lower rate than you currently have.
Is it possible to refinance a federal student loan?
Yes, it is possible to refinance a federal student loan. To do so, you must take out a private student loan to pay off your existing federal student loan. However, before you refinance your federal student loans, be aware that you will lose access to federal benefits, such as access to income-driven repayment (IDR) plans and student loan forgiveness programs.
How often can student loans be refinanced?
If you meet the requirements, you can refinance your student loans as often as you want-there is no fixed limit. However, keep in mind that refinancing too frequently can hurt your credit rating. When you apply for a private student loan, the lending institution usually performs a credit check to assess your financial health, which results in a temporary drop in your credit rating.
When is the best time to refinance a student loan?
The best time to refinance depends on a number of factors, such as your credit score and income. Refinancing may be a good idea if you have a stable income and your credit has improved since the original loan.

Written by

Irene Scott

Insurance

I’ve worked for more than 5 years as a Credit Analyst and more than 4 years as an Internal Auditor for one of the leading global financial institutions. I have been exposed to the credit review process, various banking products, financial security topics, corporate governance, operational risk, and the internal control framework of a complex, multinational organization.