Loans

With Interest Rate Hikes on the Way, Should You Refinance Your Student Loans?

Refinancing your private loan could save money as inflation skyrockets.

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It's a common student loan conundrum: Your student loan monthly payments are too high, and you can access lower rates and a better repayment plan through other lenders. What's the best way for you to save money and access a repayment plan that works for you?

Student loan refinancing can be the answer to high interest rates. When you refinance, you take out a new loan that pays off the balance of your existing student loans. This new loan could either have a lower interest rate, helping you save money in interest over time, or a new repayment timeline, which can make your monthly payments more manageable.

With interest rates likely to rise soon -- and the possibility of several rate hikes in 2022 alone -- now might be a prime time to refinance your student loans. Here's everything you need to know to get started.

Refinancing private vs. federal loans

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 for federal loans. In most cases, it will make sense to refinance private loans, which tend to have higher interest rates and not 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 into 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 currently advisable to refinance to a fixed-rate loan before interest rates rise

If you have a federal loan, your repayments might currently be on pause, and you may be debating 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 income-driven repayment (IDR), which can help make monthly payments more affordable, pandemic relief benefits and, most significantly, loan forgiveness programs, such as Public Service Loan Forgiveness

Though refinancing your federal student loans is often discouraged, if you think it's the right choice for you, Kantrowitz advises waiting until the midterm elections in November to refinance: "If student loan forgiveness passes, it will be prior to the midterms. So, refinancing now will negate your forgiveness eligibility."

What to consider before refinancing

1. Check your credit score and improve 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... though a higher credit score can also qualify you for lower rates. Your current loan payment history will also contribute to your credit score: If you're having trouble affording your current student loans and have missed a few payments, lenders may hesitate to sign you a new one. 

If your credit is poor, talk to your lender about adjusting your payment plan so you can get back on track. In the meantime work on improving your credit, because the key is to pay down your debt and make your payments on time. 

Before refinancing, Kantrowitz advises checking your credit reports (for free) and looking for errors. If you find errors, you can remove them by disputing them; your creditor will have 30 days to confirm the accuracy of your report or remove the errors, so it is best to access your credit report 30 days or more before refinancing. 

2. Evaluate your income, and your debt-to-income ratio, or DTI 

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

Your income level shows lenders 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 have compared to the amount of money you earn. A high DTI, which shows you carry a larger amount of debt, may be a red flag to 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. 

In general, to refinance your student loans you want a DTI of 50% or less. 

3. Compare lenders

It's important to shop different lenders to make sure you're getting the optimal rates and terms. Kantrowitz emphasizes considering monthly loan payments, total repayment terms and interest rates. He says, "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 ten years, and make sure to choose a plan that offers the highest monthly payment you can afford."

4. Find out if you prequalify

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

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, too. This means your co-signer will be required to make payments if you're unable to, and your repayment history will impact their credit score. 

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.