With interest rates rising, should you refinance student loans?

What is happening

The Federal Reserve has raised rates four times this year in response to record inflation. Student loan costs can become higher for borrowers with variable rate private loans.

why is it important

Refinancing student loans can help you get a lower or fixed interest rate. With rates expected to continue to rise, refinancing earlier may be wise.

The The Federal Reserve has raised interest rates 2.25% in 2022 via four rate hikes, and the agency is likely not done yet. New minutes from the Fed’s last meeting indicate another 50-point hike is on the way when the board meets again in September.

When the Fed raises the federal funds rate, interest rates for many borrowers also rise, including for credit cards, mortgages, personal loans, or variable-rate private student loans. If you hold student loans with a high annual percentage rate (APR), you may want to consider refinancing your student loans before interest rates rise further.

Student loan refinancing means 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 what you are currently paying or a good fixed rate that you can lock in for the life of the loan. You can also choose a longer loan term to lower your monthly payment, although you’ll end up paying more overall.

Here’s everything you need to know to get started with student loan refinancing. To learn more about student loans, get the latest news at student loan cancellation and whether or not the pause on federal student loan payments will be extended after August 31.

Refinancing Private vs. Federal Loans

If you have student loan debt, you have either a private loan or a 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. An estimated 90% of student loan debt held is in federal loans. It makes more 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 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 that if you have a private loan, it’s a good idea to refinance a fixed rate loan before interest rates are rising.

If you have a federal loan, your repayments are currently on hold and you may be considering refinancing if you’re worried about paying the monthly payment when the freeze lifts. In this case, there are other options you should explore first, such as an income-contingent repayment (IDR) plan, which can help make monthly payments more affordable. You should also consider pandemic relief benefits and, most importantly, loan forgiveness programs like Cancellation of civil service loans and the Teacher Loan Forgiveness Program.

While refinancing your federal student loans is often discouraged due to the many benefits that come with government loans, if you still think it’s the right choice for you, Kantrowitz advises waiting until the midterm elections in November. . “If student loan forgiveness is accepted, it will be before the midterms. So, refinancing now will void your eligibility for forgiveness.”

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 will 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 may also qualify you for even lower rates.

Your current loan repayment history will also impact your credit score: if you’re struggling to pay your current student loans and have missed payments, lenders may be hesitant to sign you up for a new one.

If your credit is “bad” — a FICO score below 580 — talk to your lender about adjusting your payment plan so you can get back on track. Work on improving your credit by paying off your debt and making your payments on time.

Before refinancing, Kantrowitz advises checking your credit reports (which is completely free in 2022) and troubleshooting. If you find items that do not apply to you or if you have incorrect information, you can challenge them — Your creditor will have 30 days to confirm the accuracy of your report or remove errors, so it’s best to check your credit report at least 30 days before refinancing.

2. Assess your debt-to-income ratio (DTI)

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

Your income level shows lenders that you are making enough money to repay your loans and meet your payments. Kantrowitz suggests looking at refinancing minimum income thresholds, which typically 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 have a lot of debt, could be a red flag for lenders. For example, if you have a monthly debt of $1,000 and earn $4,000 per month, your DTI would be 25% ($1,000 divided by $4,000). However, if you have monthly debt of $2,500 and earn $4,000 per month, your DTI will be much higher – 62.5% – which could affect your ability to get a new loan.

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

3. Compare student lenders

It’s important to shop around with different lenders to make sure you get the best rates and terms. The interest of refinancing is to pay less, either in lower interest from a reduced rate, or in more affordable monthly payments over a longer term.

Kantrowitz points out that borrowers need to 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 be sure to choose a plan that offers the highest monthly payment you can afford.”

4. Check if you are prequalified for a new loan

When researching lenders, many may offer the option to prequalify, allowing you to see what your potential interest rates and monthly payments would look like. Depending on the change from the terms of your current loan, you can decide if refinancing is right for you. Prequalification requires a soft credit draw, so it won’t affect your credit score. Keep in mind that prequalification does not guarantee loan approval or specific rates.

5. Consider a co-signer for your student loan

Student loan refinance lenders often allow you to add a cosigner to your loan — or release one. If you don’t have a long-standing credit history, you may need someone with good or excellent credit to co-sign your loan. When you add a co-signer, they take responsibility for the loan with you. This means your co-signer will have 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. To do this, make sure you meet the criteria for credit and consecutive on-time payments.

Next steps to refinance

Once you’ve committed to refinance your student loans, there are steps you can take to get the interest rate and payment plan you want.

First, start 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 suits your budget. Once you have chosen a lender, you submit a formal application and wait for their approval, which usually takes two to three weeks. Once your new lender approves your application, they will repay your old loan directly and you will begin making regular payments to your new lender.

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