Consider refinancing your federal student loans if doing so will get you a lower interest rate. Even if the interest rate isn’t lower, refinancing may still make sense if it allows you to consolidate multiple existing loans into a single loan.
Overview
The federal government doesn’t refinance student loans, so you’ll have to use a private lender4. This can include traditional lenders such as a bank or credit union, but you can also use lenders that specialize in refinancing student loans.
Refinancing federal student loans through a private lender requires you to consider the differences in terms between government and private lending, which can be significant. As when considering any financial product or service, it pays to shop around before choosing a private lender.
Qualifying for a refinance is often the most challenging part of this process because private lenders generally have stricter criteria than the U.S. government. Your income and credit rating are more important when applying for a private loan, so you may need to wait until you reach a certain level of financial stability before refinancing your federal student loan.
If you qualify for the refinance, you’ll provide the lender with information about the loans you want to refinance. Your new lender will then contact the lenders that have been servicing your federal loans. The next step for the new lender is to obtain terms from those lenders and to use your new privately obtained loan to pay off the federal loans in full.
Should I refinance?
The decision to refinance requires you to consider some pros and cons. The biggest advantage of refinancing your federal student loans through a private lender is that you often can get a lower interest rate, especially if your financial situation improves after you graduate. However, you will lose some benefits of federal loans when you refinance through a private lender. Federal loans have much looser standards for debt forgiveness, and payments are based on income. Once your new lender pays off the old loan or loans, the federal loan and its perks will be gone.
You need to be sure of your decision before you go through with it, because there’s no way to undo a refinance. That makes it essential to consider your future financial picture as well as your current one.
Should I shop around?
Shopping multiple lenders is essential for getting the best terms on a refinance. The interest rate is typically the most important factor, but you should also consider customer service when selecting a lender. Many websites rank lenders that refinance student loans, providing an opportunity to learn more about them and their products. Making direct contact with lenders will enhance your understanding, which is crucial since you’ll need to trust your own judgment when making a decision.
Shopping around will give you an idea of the lowest interest rate that lenders offer, but you will need to know the lowest rate for which you qualify. Lenders routinely advertise low interest rates, but the interest rate for individual borrowers can be much higher depending on their perceived level of risk. If you’re not a high earner with a good credit score, it’s even more important to get competitive rate quotations from multiple lenders.
Develop a refinancing plan before you start your applications. The best practice is to develop a list of possible lenders and to submit all your applications at once. That’s because credit reporting agencies usually treat multiple applications as a single inquiry provided they fall within a certain window, typically 30 days. They understand that consumers shop around for lenders and want to encourage this behavior. If you submit new loan applications every couple of months, they will be treated as multiple credit applications, meaning your credit rating is likely to suffer, making it harder for you to qualify.
When should I refinance?
You should consider refinancing when you can get an interest rate that is lower than the rate on your original student loan, which depends on three basic factors:
First of all, lenders generally base their rates on market conditions. They typically start with a leading economic indicator such as the prime lending rate and add a fixed amount to it based on the borrower’s risk. You can’t do anything about market conditions other than to monitor them and wait for rates to go down.
Your income is important in determining your creditworthiness. Since you probably didn’t have an appreciable income while in college, it’s quite likely that your income has increased significantly since you graduated. If this is the case, you should strongly consider refinancing, since income is one of the first things lenders look at when considering your application. Don’t worry about the possibility that your income will increase in the future, giving you an even lower rate. You can always refinance again if this occurs.
Your credit rating is also a major factor in the interest rate you’ll get when refinancing a loan. Even if the credit inquiry from your loan application does slightly lower your credit score for a short period, it will almost certainly be worth the savings resulting from a reduced interest rate. Again, you shouldn’t be too concerned about the possibility that you could get a better rate in the future when your rating improves. However, if you know you’re going to pay off a debt in the next few months that would improve your rating, it might be better to wait until then to refinance.
