The most common reason to refinance a student loan is to get better terms, especially a lower interest rate. Federal loans typically have more favorable terms, so you may have less incentive to refinance these loans. However, the chances of improving the terms on a private loan are much greater. The following steps will help you refinance a private student loan.
1. Do your research
To learn whether refinancing makes sense for you, you must do research. In particular, you need to compare the interest rate on your current loan with the interest rate you would get with a new loan. Bear in mind that lenders typically advertise the lowest rate they offer, but that doesn’t mean you’ll actually qualify for that rate. You also need to consider other terms of the loan such as payment flexibility and forbearance options. If your primary goal is to lower your monthly payments, you may be better off by reducing your monthly expenses or by speaking with your current lender about your difficulties in making payments. All other factors being equal, a lower monthly payment now usually means paying more over the long term.
This example shows how refinancing can save money by reducing your interest payments. Assume for this example that you currently have a $15K private student loan with a loan term of ten years and an annual interest rate of 10%. Your minimum monthly payment is $198.23. You would pay a total of $8,786.80 in interest over the life of the loan. Assume further that you’ve been paying on the original loan for two years, when you find a lender willing to refinance at a rate of 6%. Your current balance is $13,063 with eight years left on the loan. If you refinance at 6% and the same term of eight years, your monthly payments would be $171.67. The total interest you would pay is $6,237.81, resulting in a savings of $2,549 compared with the original loan.
2. Improve your credit
The interest rate you receive will depend on the risk that your loan poses to the lender, as measured by your credit rating. That means you need to begin improving your credit score months before you apply for a loan. Start this process by obtaining a copy of your credit report from www.annualcreditreport.com at no charge. Review the entire report. Ensure that the identifying information is accurate. Identify any errors in your credit history and dispute them immediately.
You also will need to identify any accurate information that could be reducing your score. You should then evaluate ways of countering unfavorable information, perhaps by paying down your debt. If improving your credit score is going to take some time, it may be best to postpone your refinance, especially if you expect to pay off a loan in the near future. In this case, simply waiting to refinance until that negative factor is off your credit record can save you a significant amount of money over the term of your loan.
3. Choose a lending option
The most obvious options for refinancing private student loans are traditional financial institutions such as banks and credit unions. However, mounting student debt also has led to the creation of companies that specialize in refinancing student loans. Established homeowners may also consider using their home equity to refinance their student loans. Each method has distinct pros and cons that you’ll need to carefully consider when choosing a lender.
National banks
Many national banks still offer refinancing on student loans. However, the number has been dropping in recent years. In the meantime, companies that specialize in refinancing student loans have been filling the void. A bank will typically offer loans with either fixed or variable interest rates, although the rates will generally be higher than those of alternative lenders. A fixed rate is better if you think interest rates are going to go up, while a variable rate is preferable if you think rates will go down. Many banks offer discounts for current account holders, although they still require a credit score of at least 650 in most cases.
Specialized lenders
Some lenders specialize in student loans aren’t typically as well-known as national banks, but they may offer more favorable terms. Their basic requirements to qualify for refinancing typically include being a legal adult and employed, or at least possessing an offer of employment. You must also have attended a qualifying school. If you meet these requirements, the lender will review your financial picture, including income, credit score, and debt load, before making a decision on your application.
Summary
Refinancing a private student loan often can save you a lot of money, but you may have to improve your credit rating to qualify and you may have to wait for market conditions to change before you can get a lower rate. Securing a refinance through home equity is another effective method of reducing the interest rate on your loan. You will need to consider the type of lender you want since the terms on a refinance can be highly variable.
