There’s no denying that college is expensive. A recent report shows that the average 2018 college graduate has nearly $40,000 in student loans. Depending on the salary of their first “real” job, a graduate might be struggling to make the monthly payments once their student loans enter repayment status. This is where refinancing comes into the picture!
What Is Student Loan Refinancing?
Each college student has the option of applying for federal and private student loans to pay for their education. Both types of student loans can be refinanced (federal loans call the process consolidation instead of refinancing). This article will focus on private student loan refinancing.
Refinancing of any loan is renegotiating your outstanding loan balance and accrued interest for a new interest rate and repayment terms. As a college graduate might have private loans from two or three different lenders, the refinancing process will merge all those loans into one account with a single interest rate and one monthly payment. That means instead of paying $257 the 15th of each month to “Bank A” for a loan with a 6.0% interest rate and $200 to “Bank B” on the 27th for a loan with 6.3% interest, only one payment of $425 needs to be paid on the 1st of each month and the new interest rate is 5.5%.
Advantages of Student Loan Refinancing
Possibly the best benefit of student loan refinancing is the potential to secure a lower interest rate than what is charged on your current student loans. As you have a steady income and a potentially higher credit score than when the loans were originated during college, you might qualify for lower interest rates. As a cautionary note, these lower interest rates might have a longer repayment period than your original loans. This means you are charged less interest each month but will pay more if you use the full loan repayment period (10 years, 15 years, 20 years, etc.) to pay off the principal.
Sometimes it takes a year or two to earn a salary high enough that allows a graduate to pay their bills without struggling to make ends meet. Because a lower interest rate is charged, you should have a lower monthly payment and a longer repayment period.
If you struggle to make the minimum payment on your original loans, think about refinancing. The difference could potentially make all the difference in your monthly budget by refinancing. Of course, if you can pay more than the minimum payment, you will pay off the loan sooner and pay less interest.
Another benefit of refinancing is a single due date. Depending on when the due dates are for your current student loans and when you receive your paycheck, your wallet might feel very thin. Plus, having multiple bills due on multiple days during the month increases the likelihood of forgetting to make a payment.
With one due date for all your student loans, it is easier to keep track of when you need to make the payment. You should be able to schedule the due date for after you receive your paycheck, ensuring you have plenty of money in the bank.
Disadvantages of Student Loan Refinancing
If you have a mixture of federal and private student loans, you might have to refinance each type of loan separately. Due to several nuances between federal and private loans, many lenders will not refinance federal and private student loans in the same package.
While refinancing can be a lifesaver for some, refinancing can cost more money in the long-run if you only make the minimum monthly payment each month. Besides the potential application and origination fees a refinancing lender may charge an applicant, they do not offer lower interest rates. Some graduates need the lower payments just to make ends meet in the short-term, but will still have to pay back the entire loan amount plus interest even if it takes the entire 15 or 25-year life of the loan to do it.
This is the same thing when comparing a 15-year mortgage to a 30-year mortgage or a 3-year auto loan to a 5-year auto loan. Shorter loans require a higher monthly payment to meet the deadline. As long as the loan doesn’t have an early payoff or prepay penalty, you can pay back your student loan sooner without having to pay an additional fee. Even if you do, it might be cheaper to pay the penalty than pay interest for the life of the loan.
Fixed or Variable Interest Rate
Depending on how much of a monthly payment you can afford and how fast you intend to pay off your loans, you will need to decide between a fixed interest rate or variable interest rate.
Fixed Interest Rates
Fixed interest rates are best for those that will require at least 5 years to repay their loans because the rate will remain constant for the life of the loan. Nobody can predict the future, but, interest rates for most loans are near record lows at the present moment and they are more likely to increase instead of decrease in the future.
Current fixed rates for student loan refinancing range from 6% to 12%. If you secure a rate today at 6% and rates increase to 10% in 15 years when you pay off the loan, think of all the extra money you saved by going with a fixed interest rate instead of a variable interest rate.
Variable Interest Rates
On the other hand, variable interest rates are best if you plan to pay off your loans in less than five years or sooner. Variable interest rates currently range from 2% to 8% depending on your creditworthiness and repayment terms. If rates do rise, they most likely will not exceed the current fixed rates by the time you pay off your loan.
Keep in mind that lower interest rates usually come with a shorter repayment period. If you do not feel comfortable that you can make the required monthly payments to meet the deadline, you should opt for a longer repayment period, even it charges a higher interest rate. By choosing a variable rate you will probably still have a lower rate than a similar fixed rate loan.
If both types of loans are charging near-similar interest rates, it might be better to go with a fixed rate plan. The interest rate might be a little higher than a variable, but you have an extra safety net for a longer repayment period in case you cannot meet the monthly payments required by a variable loan. Also, a fixed rate also hedges against any variable rate increases. If you can still prepay your loan, you will still be saving money overall.
When To Apply For Refinancing
The ideal candidate for refinancing is somebody struggling to make their current monthly payments. Refinancing might provide them the ability to pay their student loans, rent, electric bill, and build up an emergency fund. You might also benefit from refinancing if you can qualify for a lower interest rate than what your student loan provider currently charges. The potential savings increase with a larger balance (you might need a $10,000 minimum balance just to qualify for any student loan refinancing) as the principal will accrue less interest every month.
Refinancing might even be beneficial if you plan to pay off your loan early. As one of the perks of refinancing is the potential to save money, try to apply for a program that will not charge an application or origination fee. If your credit score is lower or you have a lower income this might be a little difficult, but, fee-free programs do exist.
When Not To Apply For Refinancing
Sometimes refinancing is more trouble than it is worth. This might be your case if you can already pay off your student loans within the next 4 to 5 years. Most programs also require a minimum loan balance (i.e. $10,000) to apply for refinancing. If you are right at this level and have a similar interest rate, it might not be worth the hassle.
Another reason to not pursue refinancing is if you have no trouble making the minimum payments and the interest rate isn’t significantly different. It might be tempting to refinance to get the lower monthly rate. But, if you are not disciplined to pay more than the minimum, it might be better to keep your original loans. The shorter repayment period might mean you will pay less interest, even if the overall interest rate is higher.
Should I Refinance My Private Student Loans Summary
Paying for student loans isn’t the most exciting facet of life. Refinancing can serve two different purposes. It allows low-earning graduates the ability to pay the student loan obligations by extending the repayment period or it helps others pay less interest even if they prepay. Many graduates can benefit from refinancing if done properly, and every college graduate should at least consider it if they qualify.