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No Student Loan Forgiveness? Take a Look at Loan Refinancing Before Rates Rise

graduation cap with 100 dollar bill
Catherine Lane/Getty Images

What's happening

President Biden recently announced $10,000 to $20,000 in federal loan forgiveness. If you have private student debt, you're not eligible for this forgiveness, but refinancing may help you save money.

Why it matters

Refinancing student loans can help you lock in a lower or fixed interest rate. With rates expected to continue rising, refinancing sooner may make sense.

While borrowers holding federal student loans got big news last week — $10,000 to $20,000 in forgiveness for eligible recipients and an extended pause on payments and interest until 2023 — those who owe money on private student loans are still faced with their same burdens of debt and payments. Private loans account for a little more than 7%, or $148 billion, of existing student loan debt.

Not only are private student loan holders ineligible for loan cancellation, those with loans at variable interest rates are facing the possibility of increased payments. The Federal Reserve has raised interest rates to 2.25% in 2022 via four rate hikes, and the agency likely isn't done yet. New minutes from the Fed's last meeting indicate that another 0.5% increase is coming when the board meets in September.

If you're holding student loans with a high annual percentage rate, you might want to consider refinancing your student loans before interest rates rise any further. Here's everything you need to know to get started with student loan refinancing. For more on student loans, learn how the Public Service Loan Forgiveness program can cancel all federal student loans and how some employers are helping workers with student loan debt.

Refinancing private vs. federal loans

Refinancing student loans means that you take out a new loan that pays off your existing debts. Refinancing only makes sense if you can find a lower interest rate than you are currently paying or a good fixed rate that you can lock in for the loan's duration. You might also choose a longer loan term to reduce your monthly payment, though you'll end up paying more overall.

If you have student loan debt, you either have a private or federal loan — private loans are made by a lender such as a bank, state agency or school, while federal loans are funded by the federal government. It's estimated that 90% of the student loan debt held is in federal loans. It makes most sense to refinance private loans, which tend to have higher interest rates, rather than federal loans, which tend to have lower interest rates and more regulation.

When you refinance a private loan, you'll do so with another private lender. You cannot refinance a private loan with a federal loan. Student loan expert Mark Kantrowitz, author of How to Appeal for More College Financial Aid, says if you have a private loan, it's advisable to refinance to a fixed-rate loan before interest rates rise

Though payments remain paused through the end of 2022, if you hold federal student loans, you may be considering refinancing if you're worried about affording the monthly payment when the freeze is lifted. In this case, there are other options you should explore first, such as an income-driven repayment plan, which can help make monthly payments more affordable. You should also check your eligibility for additional loan forgiveness programs like Public Service Loan Forgiveness and the Teacher Loan Forgiveness Program.

If you have a federal loan, the only way to refinance is through a private lender — unless you're refinancing federal loans through the PSLF program — which will eliminate some of the benefits that come along with government loans. Because of this, refinancing your federal student loans is often discouraged, but if you still think it's the right choice, wait until you receive any eligible loan forgiveness before refinancing, so you don't miss out on this benefit.

What to consider before refinancing

1. Check your credit score and improve it if necessary

In order to qualify for a lower interest rate than your current loan, you'll need a good credit score. A FICO score of at least 670 is considered "good" and can help you qualify for student loan refinancing — a higher credit score can also qualify you for even lower rates. 

Your current loan payment history will also impact your credit score: If you're having trouble affording your current student loans and have missed payments, lenders may hesitate to sign you a new one. 

If your credit is "poor" — a FICO score under 580 — talk to your lender about adjusting your payment plan so you can get back on track. Work on improving your credit by paying down your debt and making your payments on time. 

Before refinancing, Kantrowitz advises checking your credit reports (which is completely free in 2022) and looking for errors. If you find items that don't apply to you or have wrong information, you can dispute them — your creditor will have 30 days to confirm the accuracy of your report or remove the errors, so it is best to check your credit report at least 30 days before refinancing. 

2. Evaluate your debt-to-income ratio

Lenders will likely look at your income, the income of your co-signer (if you have one) and your debt-to-income ratio, which is your total monthly debt payments divided by your total gross monthly income. 

Your income level demonstrates to lenders that you earn enough money to repay your loans and keep up with your payments. Kantrowitz suggests taking a look at refinancing minimum income thresholds, which usually hover around $30,000. 

Your DTI ratio represents the debt you hold compared to the amount of money you earn. A high DTI, which shows you carry a large amount of debt, could be a red flag for lenders. For example, if you carry $1,000 in debt monthly and make $4,000 a month, your DTI would be 25% ($1,000 divided by $4,000). However, if you carry $2,500 in debt monthly and make $4,000 a month, your DTI will be much higher — 62.5% — which could impact your ability to secure a new loan. 

To refinance your student loans you generally want to have a DTI of 50% or less. 

3. Compare student loan lenders

It's important to shop different lenders to make sure you're getting the best rates and terms. The whole point of refinancing is to pay less, either in lower interest from a reduced rate or more affordable monthly payments from a longer term.

Kantrowitz stresses that borrowers should consider monthly loan payments, total repayment terms and interest rates. "Remember that longer repayment terms mean lower monthly payments, but more interest over the life of a loan. Try to avoid repayment terms longer than 10 years, and make sure to choose a plan that offers the highest monthly payment you can afford."

4. Check to see if you prequalify for a new loan

As you shop around for lenders, many may offer the option to prequalify, allowing you to see what your potential interest rates and monthly payments would look like. Based on the change from your current loan terms, you can decide if refinancing makes sense for you. Prequalification requires a soft credit pull, so it won't impact your credit score. Keep in mind, prequalification does not guarantee loan approval or specific rates.

5. Consider a co-signer for your student loan

Student loan refinancing lenders often allow you to add a co-signer to your loan — or to release one. If you don't have a longstanding credit history, you may need someone with a good or excellent credit score to co-sign your loan. When you add a co-signer, they are taking on the loan responsibility with you. This means your co-signer will be required to make payments if you can't, and your repayment history will impact their credit score as well as yours.

Conversely, if you want to release a current co-signer, you can refinance a private student loan in your name alone. In order to do so, make sure you meet the credit and consecutive on-time payments criteria. 

Next steps to refinance

Once you've committed to refinancing your student loans, there are steps you can take to secure the interest rate and payment plan you want.

First, begin shopping around with other student lenders. Compare rates and terms and get prequalified to browse your options and decide which loan term and lender best fits your budget. Once you decide on a lender, you'll submit a formal application and wait for approval, which usually takes two to three weeks. After your new lender approves your application, they'll pay off your old loan directly and you'll start making regular payments to your new lender. 

For more student loan news, read more about President Biden's widespread student loan forgiveness plan, find out if forgiven student loans will increase your tax bill and understand how loan forgiveness may impact your credit score.