How to refinance your student loans

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How to refinance your student loans
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When was the last time you took a good, hard look at your student loans? If it’s been a while, now is the time.

Here’s why: you could be saving a whole lot of money without even realizing it.

Why you need to reevaluate your student loans

If you’re facing some pretty hefty loans, just thinking about looking at all of the details can be kind of terrifying, especially if you don’t have the money to pay them off anytime soon. So it’s easy to simply set your monthly payments on autopilot and never look back. But while that’s a good way to make sure you don’t miss any payments, ignoring the big picture may be costing you more than you think.

Many people don’t realize that a big chunk —often the majority — of their monthly payments are probably going toward interest, depending on the interest rate and other factors (we’ll get to that). So even by paying hundreds of dollars each month, you may not even be making a dent in the total cost of your debt. And for a long time, there wasn’t much many borrowers could do about it.

Read more: 5 things to know before paying off student loans

Alternatives to consider before refinancing

If you have federal student loans, there are some options available that you may be able to take advantage of.

  • Income-based repayment: Income-driven repayment plans help borrowers keep their loan payments affordable with payment caps based on their income and family size. There are now four types of these plans available: Income-Based Repayment (IBR), Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE) and Income Contingent Repayment (ICR).After you qualify, your monthly payment may be adjusted each year based on changes in income and family size. You will have to verify your income every year, which means if you start to make more money, your payments may go up.
  • PAYE – Pay As You Earn – Caps monthly payments at 10% of your income; all debt is forgiven after 20 years of on-time payments.
    • Important note: If you took out loans before 2007, your payments are capped at 15% — and you must pay on time for 25 years to have your loans forgiven.
  • Loan forgiveness: In addition to repayment options, there are also ways to have your student loans forgiven. Public service employees can qualify for full loan forgiveness after making 10 years of monthly payments on their federal student loans. Get more details to see if you qualify.

There are also other options like deferment and forbearance, which allow borrowers to postpone their payments — typically for a year or so. The advantage of deferments is that interest does not accrue on subsidized federal student loans during the deferment period. On the other hand, forbearances may be a little more flexible in terms of the postponement period, but interest does accrue during that time.

So by taking advantage of a plan like forbearance, many borrowers were able to put off their payments until they were able to make them — however, if you took out a loan when interest rates were around 6.8%, the interest that accrued during that postponement period added a whole lot more money to the principal of the original loan.

Read more: Student Loan Guide

So what if you’re past the point of being able to take advantage of postponing your payments and you’re making too much money for an income-based plan to do you any good? That’s where refinancing comes in — and it’s helping a lot of borrowers reduce the damage of those high interest rates (on both federal and private loans).

Refinance: New solutions to paying off student loans

Student loan refinancing can be a great way to reduce your payments and decrease the total cost of your debt — while shrinking the time it takes to get it all paid off.

While borrowers didn’t used to have many options, unless their degree or career made them eligible for programs like loan forgiveness, there are now more than a dozen lenders offering student loan refinancing. And the deals they’re offering can save people thousands of dollars.

When you should consider refinancing

If you aren’t sure whether you should refinance your student loans, here’s when it’s your best bet:

1. You want a lower interest rate

If you took out federal student loans when interest rates were high — like 6.8% — or maybe you took out private loans to pay for costs that federal loans didn’t cover, then you should consider refinancing. Refinancing will allow you to take advantage of lower interest rates that weren’t available when you originally took out your loans, and this can mean big savings both now and over time.

Read more: How one couple paid off $55K of student loan debt in 14 months

2. You have great credit (or a co-signer)

Lenders offering student loan refinancing use several factors when determining whether they will give someone a loan, including credit score, income, educational background and employment history. The importance of each factor is different for each lender, but as a general rule, you’ll get better offers — with lower interest rates — if your credit score is in the 700s or 800s. You can still get a great deal even with decent credit, but your offers will depend on a combination of all of those factors.

If you have poor credit, you can use a co-signer to get better refinance offers.

3. You have a solid income

Even if you don’t have stellar credit, having a solid income relative to your debt can help you get a good refinance offer. But it’s important to note that lenders will factor your total debt into their decision — so not just your student loans, but also any credit card debt or other loans you have, like a car loan. So if you’re making $70,000 a year but have $100,000 in total debt, you may need a co-signer to get a really good refinance offer.

But even if you don’t qualify for a good offer now, it doesn’t mean you can’t get one later. If you have other debts to pay off, start paying extra toward those now, in order to reduce them as quickly as possible. Then once you get those down, you can apply for refinance again in a few months.

Who should not refinance student loans?

When you refinance a federal student loan, what happens is the lender pays it off and issues you a new, private loan. So that means once you refinance, you will no longer able to take advantage of programs available to federal student loan borrowers, such as income-based repayment, deferment/forbearance and loan forgiveness (available to borrowers working in public service). So make sure you’ve gotten what you can out of those programs first.

Read more: 40 ways to take control of your money

How to save the most with refinancing

The main reason people refinance is to get a lower interest rate, but there’s another part of the process that can save you even more.

Refinancing to a lower rate will of course save you money over time, but choosing a shorter loan term is what will save you the most. The down side is that it may increase your monthly payments, but with a shorter term, you’ll get your loan paid off quicker — and at an even lower cost.

In fact, about 30% of people who refinance actually increase their monthly payments. So if you can afford the higher amount, you’ll save a lot more money. And if you can’t, you’ll still save with a lower interest rate.

How to apply and get started

When you’re ready to refinance, or just considering the option, you can see estimated rates from lenders without even submitting a full application.

NerdWallet has teamed up with the online refinancing marketplace Credible to make the process pretty simple. All you have to do is fill out one application on Credible’s website and then you will receive offers from all eight of the approved lenders within one to four business days. This is a great way to compare several different offers without having to apply eight different times. Plus, NerdWallet has put together a list of reviews about each lender to give you more information about the various options.

You’ll notice that most of the offers will include both a variable rate and a fixed rate. Variable rates are set by an economic benchmark, which means they can change at any time. So if you don’t plan to pay your loan off pretty fast, then you’re better off going with a fixed rate offer.

More refinance options

There are some lenders not included in Credible’s refinance application that you should consider applying to directly. These lenders are widely known to be very good options for borrowers looking to refinance student loans:

  • SoFi: Offers fixed rates starting at 3.5% and variable rates starting at 2.13%. The minimum loan balance is $10,000. SoFi doesn’t specify a minimum credit score, and it considers other factors like employment history and cash flow when determining each borrower’s offer. Check out NerdWallet’s review of SoFi here.
  • Earnest: Offers fixed rates starting at 3.5% and variable rates starting at 1.9%. The minimum loan balance is $5,000. Earnest doesn’t specify a minimum credit score, and it weighs your credit along with other factors like employment and income. Check out NerdWallet’s review here

Bottom line: If refinancing does make sense for you, it’s a great way to save a whole lot of money.

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Alex Thomas Sadler About the author:
Alex Thomas Sadler is the Managing Editor of Clark.com and Clark Howard Digital Products. Alex is also the host of Common Cents, a new Clark.com series that makes money simple, so you can better understand and take control of your own financial life. Alex graduated from the University of Georgia with bachelor's degrees in ...Read more
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