The Federal Reserve has raised rates four times this year in response to record high inflation. Student loan costs may get more expensive for borrowers with private loans at variable rates.
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.
The2.25% 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 50-point increase is coming when the board meets again in September.
When the Fed raises the federal funds rate, the interest rates for many borrowers increase as well, including for credit cards, mortgages, personal loans or private student loans with variable rates. If you’re holding student loans with high annual percentage rate (APR), you might want to consider refinancing your student loans before interest rates rise any further.
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.
Here’s everything you need to know to get started with student loan refinancing. For more on student loans, get the latest onand whether or not the will be extended past Aug. 31.
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 makes most 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 advisable to refinance to a fixed-rate loan before.
If you have a federal loan, your repayments are currently paused, and 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 (IDR) plan, which can help make monthly payments more affordable. You should also consider pandemic relief benefits and, most significantly, loan forgiveness programs likeand the Teacher Loan Forgiveness Program.
Though refinancing your federal student loans is often discouraged because of 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 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 it if necessary
In order to qualify for a lower interest rate than your current loan, you’ll need a. A of at least 670 is considered “good” and can help you qualify for student loan refinancing — a 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) and looking for errors. If you find items that don’t apply to you or have wrong information, you can — 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 (DTI) ratio
Lenders will likely look at your income, the income of your co-signer (if you have one) and your debt-to-income (DTI) 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, 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.
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