Student loan debt is a common component of earning a college degree. In fact, a recent report found that undergraduate students borrow an average of $37,337 to earn a degree. But even if you owe less, student loan debt can still be a financial burden that lasts for decades.
One way to shorten the payoff timeline, and potentially save money, is by refinancing. Not everyone is eligible to refinance their student loan(s), and for some people it’s not a great choice. If you’re considering options for your student loan debt, the information below can help you decide if refinancing is right for you.
Pros and cons of student loan refinancing
Refinancing your loans can be a huge help, but it’s not always the best way to manage student loan debt. Here are some potential outcomes to consider:
Reduce your interest charges
If you qualify for refinancing, you may be able to secure a loan with a lower interest rate than you’re paying now. Refinancing can also move you from a loan with a variable interest rate (one that changes periodically) to a fixed rate. Both of these changes can drastically reduce the total cost of borrowing.
Change your payments
Refinancing student loan debt provides a strategy to restructure your repayment. In other words, you may be able to get a better payment arrangement with the new lender.
For example, refinancing can result in an extended repayment timeline, which will likely increase your overall interest charges but reduce your monthly payments. Alternatively, a shorter repayment period reduces your interest charges and saves you money overall.
If you pay off multiple loans with your refinance loan, you can also get some relief by reducing the number of monthly payments you have to make and the loan accounts you have to manage.
You might not qualify
Student loan refinancing is not as simple as filling out an application and receiving the funds. Lenders look at several factors, including credit history and scores, income, and in some cases, career trajectory of the borrower.
The combination of these factors can make it incredibly difficult to qualify for a refinanced student loan, especially right after graduation. If your credit scores are around 650 or lower, for example, you may need some time to improve them before applying.
You could lose payment flexibility
If you have federal student loans, refinancing is usually not a good option. The Department of Education (ED) does not offer student loan refinancing, so you’ll have to go through a private lender.
While that might sound harmless enough, moving your debt to a private lender means giving up all of the flexibility the ED offers, including income-driven repayment plans, interest-free deferred payments and loan forgiveness plans. If you do have federal loans, you’re better off looking into one of the ED’s plans or applying for their Direct Consolidation Loan.
What to Consider Before Applying for Student Loan Refinancing
Before applying for a student loan refinance, consider what private lenders look for from an applicant. Each lender is a little different, but understanding the common requirements makes your application stronger from the start.
Good credit
First and foremost, private lenders want to ensure that you’re not a risky borrower. To evaluate the risk of an applicant, lenders take a close look at your credit history.
Specifically, they look for any missteps with debt in the past, like late payments on credit cards and loans, collection accounts or bankruptcies. Student loan borrowers who have these issues on their credit reports are not as likely to get approved for a new refinance loan. And while borrowers with only fair credit scores can be approved, you’ll need scores in the mid-to-high 700s to qualify for the lowest interest rates available.
If you’re hoping to improve your scores and qualify for a refinance loan, one or more of the following actions can help:
- Review your credit reports: Pull all three of your free credit reports from AnnualCreditReport.com. Search them for errors relating to your credit history and signs of fraud. If you find either, follow the instructions on the report to file a dispute.
- Become an authorized user: Ask a loved one with good credit to add you to their credit card as an authorized user. Doing so allows their account history to appear on your credit reports and can improve your scores.
- Open a secured credit card: If your credit scores are too low to qualify for a regular credit card, build your scores from scratch by applying for a secured credit card at your local credit union. You’ll have to make a cash deposit to open the account, but doing so allows you to build credit by adding on-time monthly payments to your credit reports.
Income and debt
In addition to a strong credit profile, private lenders also want to know you can repay the new loan. For this requirement, lenders look to your income history and future earning potential, as well as the amount of debt you carry.
Without steady income or employment history, you may not have a great chance of getting approved for a refinance loan. If your debt payments eat up more than 35% of your gross monthly income (that’s income before taxes and withholdings), the lender may also view you as a high risk for missing future payments.
In other words, some people may need more time on the job before they can qualify for a refinance loan, and/or they may need to increase their income and pay off debt before applying.
Is student loan refinancing right for you?
Refinancing your student loans with a private lender is not a simple feat, but following the steps above will improve your chances of finding a good loan and being approved.
For some graduates, however, it is best to hold off until your circumstances change. That could mean looking for a higher-paying job or a promotion, or taking several months to pay down credit card debt and improve your credit scores.
Need help figuring out how to manage your student loan debt or improve your credit in the meantime? Schedule an appointment with a Certified Credit Counselor to get one-on-one advice on how to reach your financial goals, whether they’re related to student loan debt or not.