If you have student loans, have you considered refinancing them?
Student loan debt can be a crushing burden on many fronts. Not only can it eat up a bunch of your current income, it can greatly affect your ability to save for your future.
Consolidating student loans into one with a lower interest rate won’t immediately solve those problems, but it can ease some of the pressure on you financially.
But student loan refinancing isn’t a one-size-fits-all proposition. In this article, we’ll look at whether or not you might be a candidate for refinancing, how to go about it if you are, and what money expert Clark Howard has to say about it.
Should You Refinance Your Student Loans?
Many people don’t realize that a big chunk — often the majority — of their monthly student loan payments are likely going toward interest. Even if you’re paying hundreds of dollars toward your loans each month, you may not even be making a real dent in the total amount of your debt.
The question of who should consolidate and refinance really depends on what types of student loans you have and what rates are available.
“Be very careful ever mixing federal student loans and private loans when you refinance,” Clark says. “You get so many more protections with the federal loans that you don’t have with the private loans.”
Andrew Pentis, a student loan expert with Student Loan Hero, agrees.
“Refinancing federal student loans into private student loans is not advisable for many borrowers because the protections offered by banks, credit unions and other private lenders still pale in comparison to Uncle Sam’s safety nets,” he told Clark.com. “With federal loans, you can defer payment, receive forbearance, enroll in income-driven repayment and even qualify for loan forgiveness. Most of those options simply aren’t available for private loans.”
If You Have Federal Student Loans
As Clark says, federal student loans come with a lot of built-in protections, including deferment and forbearance options.
Deferment allows you to delay paying your loan for a period of time without accruing additional interest.
Forbearance lets you postpone or temporarily reduce your payments if necessary when times are tough — though interest still continues to accrue while you’re in forbearance.
“It’s a rare situation where it makes sense to refinance because you lose so much, like the forbearance rights if you become unemployed,” Clark says. “With federal student loans, you’ve got to be very thoughtful and careful before agreeing to a refinance. It’s got to be worth it for you to do it.”
Clark’s rule of thumb for when it makes sense to refinance your federal student loans to private loans is that you must be able to save two full percentage points with your new interest rate (for example, going from an 8.25% interest rate to 6.25%).
“I figure the borrower protections on the federal loans are worth about two interest rate points,” Clark says.
If You Have Private Student Loans
Clark has warned people away from private student loans for years.
With private student loans, there are no programs to help with capping your monthly payment based on your income and no wiggle room on scheduled payments with forbearance or deferment. Additionally, private student loans typically cannot even be dismissed in bankruptcy.
“Discharging student loans via bankruptcy is not impossible, but it’s really difficult,” Pentis says. “It’s really only a possibility in rare cases where the borrower can prove their education debt creates an ‘undue burden.’ That’s legalese, but it basically means the borrower has no way of ever repaying the debt — a pretty high bar to clear.”
Clark has long said that if the cost of a degree exceeds what you can borrow under the federal student loan program, you should either pick a cheaper school or work your way through school.
But if you’re already in a private student loan and have the chance to refinance into a lower interest rate, Clark’s advice is clear: “If you can do it, do it!”
You can also take a quiz like this one at Student Loan Hero to find out if refinancing might be right for you.
5 Steps to Refinancing Your Student Loans
So, if you do have federal student loans at a high interest rate or private loans that you can refinance into a better rate, it might make sense for you. But how do you do it? Follow these steps:
1. Know Your Current Loan Balances and Interest Rates
The first thing you need to do if you want to refinance your student loans is to know how much you owe — whether those loans are federal or private, or both — and what interest rates you’re paying on those loans.
You can do this on a piece of paper or in a spreadsheet like Excel or Google Sheets. The important thing is that you have all of the information in one place because you will need it for the following steps.
“You have to be careful if you’re thinking about consolidating different loans into a single loan,” Clark says. “A lot of times what happens is if people have higher interest rate loans and lower interest rate loans that they roll into a single loan, they end up with a higher overall rate. You don’t want to do that.”
So, it’s very important to crunch the numbers to make sure you’re going to end up in a better position if you refinance. Student Loan Hero has a calculator that can help you do that here.
2. Shop Around for a Better Interest Rate
Once you have a handle on your current student loan debt situation, it’s time to start shopping for a better rate. These days, there are several companies that will refinance your student loan debt for you — assuming your credit score, income, and loan situation fits their criteria.
Among the most popular and reputable companies that will do this are:
Additionally, Credible is a website where you can see estimated rates from up to 10 different lenders without even affecting your credit score.
One thing to pay close attention to is whether the loans you’re being offered are fixed rate or variable rate.
“A lot of people are being hoodwinked into going into floating rates when they refi, when they had a fixed rate,” Clark says. “The rate might start out a four-point-something percent, where your fixed rate might be seven. But there’s no cap, usually, on what that rate can go to.”
That means you could end up paying far more on your loan in the long run even if you were able to refinance at a lower initial rate.
3. Select a Lender and Your Loan Terms
Once you’ve compared the loan rates and terms available from different lenders, it’s time to select the loan that works best for you. Remember to keep in mind Clark’s warnings about mixing federal and student loans when consolidating and regarding the danger in variable rate loans.
There’s another thing to keep in mind:
Refinancing to a lower rate will, of course, save you money over time, but choosing a shorter loan term is what can save you even more. The downside is that it may increase your monthly payment. But with a shorter term, you’ll get your loan paid off quicker — and at an even lower cost.
If you can afford to pay a little more each month with a shorter loan term, you’ll save a lot more money over the life of the loan.
4. Apply for the Loan
After you’ve decided which refinancing offer works best for your situation (and hopefully it is the one that will ultimately save you the most money), it’s time to apply for the loan. While the application process may vary slightly from lender to lender, most will require:
- Proof of citizenship (like a Social Security number)
- Some other form of government ID (like a driver’s license)
- Proof of income (like pay stubs)
- Documentation of your outstanding student loans (including origination date, outstanding balance and payment history
Once you have submitted all that to the lender, it’s time to wait for them to make their decision.
5. Make Sure to Continue Paying on Your Current Loan While You Wait for a Decision
Finally, while you wait for the lender’s decision, it’s critical that you keep paying on your existing loans. The approval process can take some time and you may have payments that are due during that period.
If you’re approved, the lender that you’re refinancing with will let you know when everything is in place and it’s okay to stop paying on your other loans. If you miss payments in the meantime, you could be subject to penalties and might do damage to your credit score.
If you graduated from school with a ton of student loan debt, you may feel like there’s no light at the end of the tunnel. It can take decades to pay all of that money back.
However, there are ways to make real progress on paying off student loans — and refinancing is chief among them. If you follow Clark’s advice above and do your research, you could find yourself in a position to have your loans paid off much sooner than you expected.
Have more questions about your student loan debt? Call our Consumer Action Center at 404-892-8227! It’s free and volunteers are standing by to help you Monday-Thursday 10am -7pm ET and Friday 10am-4pm ET.