Understanding Student Loan Refinancing: How It Works and Its Benefit

Student loan refinancing is a lending strategy that can help you make payments more manageable, lower your interest rate, and reduce the amount of interest you'll pay over the life of the loan. With approximately 43 million Americans currently managing student debt, refinancing has become a popular strategy for borrowers looking to ease their financial burden.

Not sure if refinancing is right for you? Here's what you need to know.

What is student loan refinancing?

When you refinance a student loan, you take out a new private loan to pay off one or more existing student loans. There are many reasons to consider refinancing, including lowering your monthly payment, shortening your repayment period, or locking in a better interest rate.

You can refinance both federal and private student loans. However, if you refinance federal student loans, you'll lose any federally granted protections or repayment benefits, such as income-driven repayment (IDR), payment relief options, and access to loan forgiveness.

You can refinance your student loans as many times as you'd like, so it's a good idea to shop around every so often. David Green, CEO of the student lending platform Earnest, a Credible partner, suggests shopping around every six months, if possible. But, he notes, “If we're in an environment where rates are declining very steeply, as we've seen in the past, it can be worth it to do it more often.”

Current student loan refinance rates

How does student loan refinancing work?

When you refinance a student loan, you replace one or multiple loans with a single loan. For example, let's say you have two private student loans: One for $15,000 and another for $35,000. Each month, you make two payments.

When you refinance those loans, you take out a single loan for $50,000. The two original loans are paid off, and you're left with a single $50,000 loan on which you make regular payments.

You can also refinance a single loan to change the interest or repayment terms. Let's say you have a student loan with a $35,000 balance and a 6% interest rate. You recently found out that you're eligible for a 4.5% interest rate through another lender.

If you refinance the loan, the new lender will pay off your original $35,000 loan and issue you a new loan for that amount. Once the refinance is completed, you will have a new loan with a lower interest rate and new repayment terms.

Interest rates and loan terms

When you refinance your loan, even with the same lender, your original repayment terms and interest rate are no longer valid. During the application and approval process, the lender will determine your eligibility as well as your new interest rate, repayment period, and monthly payment.

Interest rates and loan terms are based on several factors, including:

• Your credit score
• Your cosigner's credit score, if applicable
• Your financial health, including income and other debts
• The total amount you're refinancing

If your application is approved, you can typically choose a repayment period, often between five and 20 years. Shorter repayment periods usually lead to higher monthly payments but lower interest rates. You'll pay less for your loan over time. Longer repayment terms often have lower monthly payments but higher rates, so you'll likely pay more for the loan in the long run.

Most lenders offer both fixed and variable interest rates. Fixed rates are predictable and remain the same throughout the loan agreements. Variable rates can fluctuate over the life of the loan and may lead to higher or lower loan payments.

Who qualifies for student loan refinancing?

Every lender sets student loan refinancing eligibility requirements, so minimum qualifications vary. However, lenders typically use the following criteria to determine eligibility:

Credit score

Generally, lenders are more likely to approve borrowers who have good credit. A good FICO score ranges from 670 to 739. The higher your score, the better your approval chances and the lower your interest rate.

Credit score requirements vary by lender. For instance, Elfi requires borrowers to have a credit score of 680 or higher. Earnest, on the other hand, has a minimum credit score requirement of 650.

Income requirements

Lenders want to know you have the financial means to repay your debt. As such, they often set minimum income requirements and ask you to provide proof of employment during the application process.

Some lenders specify a minimum income level, such as $35,000 or $60,000 a year, while others seek a “sufficient” amount to comfortably meet your repayment obligations. Generally, the higher your income, the better.

Debt-to-income ratio

Your debt-to-income (DTI) ratio is the relationship between your income and debts expressed as a percentage. It indicates how much of your income goes towards debt obligations, such as mortgage payments, personal loans, credit card balances, and student loans.

Like other eligibility factors, DTI ratio requirements vary by lender. Generally speaking, lenders favor a DTI of 36% or less. The lower your DTI, the better positioned you'll be for loan approval and lower interest rates.

Loan amount

Most lenders set a minimum loan amount, such as $5,000 or $10,000, and won't issue a loan for less than that. Information about the minimum loan amount is generally listed on the lender's site as part of their eligibility disclosure or in the loan amount field in the preliminary application or student loan quote form. If it's unclear, you can contact the lender directly to find out.

Adding a cosigner

If you don't meet the lender's eligibility requirements, you may still be able to refinance by adding a cosigner to your loan application. A cosigner takes on the legal responsibility of repaying the loan if the primary borrower can't meet repayment obligations.

A cosigner may not always lead to loan approval, but having one can increase your approval odds. This is especially true if you're trying to refinance student loans with bad credit, have a DTI that's too high, or don't meet the income requirements.

Benefits of refinancing student loans

If you're on the fence about student loan refinancing, here are some benefits to consider:

Lower interest rates

Refinancing your loans when rates are more favorable or after you improve your credit score can make a big difference in the long run.

“Like many borrowers, after graduating from law school, I refinanced my student loans to secure a more favorable interest rate,” says Erika Kullberg, attorney, financial influencer, and founder of Erika.com, a site that specializes in personal finance and financial well-being.

Kullberg, who says she leveraged refinancing to pay off her $200,000 student loans in just two years, notes, “The less you spend on interest, the more of your hard-earned money goes to paying off the principal balance.”

See Also: 6 Ways to Lower Your Student Loan Interest Rate Now

Lower monthly payments

Refinancing your student loans may also help you secure a lower monthly payment. This can happen if you qualify for a lower interest rate or choose to extend your repayment term, reducing the amount due each month.

However, be cautious when choosing a longer repayment term. While your monthly payment may be lower, you'll pay more in interest over the loan term.

Simplified loan management

If you have more than one student loan, refinancing them into a single loan can make it easier to manage payment and other loan activities. Instead of juggling multiple payment due dates and amounts, you'll just have one loan to keep track of.

Customized repayment terms

Maybe you want to pay off your student debt faster. Or, perhaps your current situation makes it hard to meet existing loan obligations. When you refinance your student loans, you'll be able to choose from multiple repayment options.

Shorter repayment terms can help you repay your loan faster, while longer terms can make monthly payments more manageable. Since you can refinance your student loans as frequently as you'd like, you can reevaluate your needs and refinance again when your financial circumstances change.

Potential drawbacks of refinancing

Refinancing isn't always the right choice, especially if you can't qualify for a lower interest rate on your own or with a cosigner. Beyond that, the biggest drawbacks arise when refinancing federal student loans.

“One of the main downsides you need to be aware of when refinancing applies to borrowers with federal student loans. When you refinance your federal student loans into a private loan, you lose valuable federal protections like access to federal forbearance, deferment, and forgiveness programs,” says Kullberg.

Green echoes her sentiments, “The biggest reason not to refinance is that you would lose federal protections.”

“If you think you're someone who would need an income-driven repayment program, you should consider that.” Adding, “If that's not you, and you want to refinance, it can save you thousands of dollars, especially with rates being lower than they've been the past couple of years.”

Steps to refinance student loans

The process of refinancing your loans is straightforward. Completing the application with your chosen lender can take as little as 15 minutes or less. If you're ready to refinance, follow these steps:

1. Evaluate your existing loans

Green suggests that borrowers take inventory of and understand their current loan details before beginning the student loan refinance process.

“How many loans do they have? Are they federal loans taken from the government or private loans taken from a different lender? What are the interest rates on those loans?” The answers to these questions, he says, empower borrowers to make informed decisions.

You can answer many of these questions by logging into your lender's account portal, contacting them by phone, or reviewing relevant documents, like statements and your loan agreement.

2. Gather essential documents and information

When you apply for a student loan refinance, you'll generally need the following information:

• Personal information, such as your social security number and birth date.
• Information about your existing loan(s), including the loan balance and lender.
• Employment details, such as your income and the name of your employer.
• Educational information, including the name of the school you attended and the degree you earned or were working towards.

3. Compare lenders to find the best rates

Once armed with the information you need, you can begin researching and comparing lenders. Kullberg notes it's “a good idea to read online reviews of each lender you're considering and to review all rates and terms carefully before choosing a lender.”

However, don't limit your comparison to rates and repayment terms. Take into account other loan features and benefits, including:

• Discounts: Many lenders offer a rate discount of 0.25 percentage points when you sign up for auto-pay.
• Payment flexibility and safeguards: Some lenders may offer temporary relief in the form of loan forbearance or deferment. These options allow you to pause payments in times of financial hardship.
• Fees or penalties: Some lenders may charge prepayment penalties, late fees, or origination fees.

Most lenders run a soft credit inquiry during the prequalification stage. Soft inquiries won't harm your credit score. However, always check with the lender to avoid unnecessary hard inquiries, which will temporarily lower your credit score.

Learn More: How to Get Rates Without Affecting Your Credit Score

Green recommends that borrowers call a prospective lender in addition to standard comparison metrics, such as loan terms, features, and potential fees.

“See if somebody picks up the phone; see if it's a real person or an AI bot.” He adds that borrowers should go to the lender with any questions to get a feel for how they answer questions and the level of detail they provide. This can be a good indicator of how the lender will handle future questions or concerns.

Tips for maximizing approval chances

While you may not be able to control eligibility requirements, there are some things you can do to improve your chances of approval and lock in lower rates.

• Improve your credit score by paying bills on time, paying down debts, and limiting credit applications.
• Decrease your debt and/or increase your income to reach a favorable DTI ratio.
• Research lenders to determine which one best suits your financial circumstances, credit score, desired refinance amount, and degree or industry.
• Consider applying with a cosigner who has better credit and a stable income.

See Also: 8 Best Loans for Refinancing Without a Cosigner