How to refinance your student loans

This is a guest post from Travis Hornsby, founder of Student Loan Planner. I met Travis last year and realized he knows a lot about something that's a blind spot for me. I asked him if he'd be willing to whip up an article for GRS readers about refinancing student loans. Here it is!

How would you like spending $4000 each year and have nothing to show for it? Sounds crazy, right? Yet that's exactly what happens when you find yourself buried in debt — whether it's credit-card debt or student loans.

Let me give you an example.

I had a friend who owed about $200,000 of student debt. He was paying everything back on the standard ten-year plan with the federal government.

He knew there were other lenders out there that would allow him to refinance to a lower interest rate, but he wasn't sure there would be much of a benefit. After I convinced him to explore his options, however, he locked in a rate of 5% instead of 7%. In other words, he cut his annual interest costs by more than $4000.

What could you do with an extra $4000 per year?

Another buddy of mine got a letter in the mail from a major bank that convinced him to refinance his federal loans to a 4.8% variable rate. Not bad. But since he didn't shop around, he didn't realize he could have found a much lower rate! After some research, he went with another lender that gave him a variable rate in the low threes. Because he owed so much, he was able to save about $10,000 per year!

Maybe you have only a modest five figures in student loans. Maybe you've got six figures that you need to pay back. Or perhaps you owe so much you think paying all your student debt off is not on the table. In this article, I want to give you a framework that will allow you can save thousands of dollars by not paying any more interest than necessary.

Are You a Good Candidate For Student Loan Refinancing?

The main reason to refinance student debt is to get a lower interest rate so you can pay it off faster. There are other benefits, though, like reducing the number of loans, getting a better student loan servicer, and committing to a clear plan of becoming debt-free.

You can accomplish all of these secondary objectives while staying under the federal umbrella; the only thing you can't get is the lower interest rate.

The first thing you need to find out is if it's smart to refinance your student loans.

If you owe less than two times your income and work in the private sector, congrats! Refinancing is something worth considering. (If that doesn't describe you, then you might be better off considering student loan forgiveness as an option for paying back student loans.)

Besides having the right amount of debt relative to your income, you also need to be in a solid situation financially to take on a required monthly payment with fewer borrower protections than the federal government provides.

Refinancing a student loan right after graduation isn't a bad idea. You should have at least $5000 cash in the bank and $0 credit card debt. If you aren't there yet, wait on refinancing until you've accomplished this. You'll also want to have a credit score of at least 650.

Where Should You Shop For a Good Deal?

Although it might seem strange, each lender targets a different demographic. Because of this, one lender might look at you favorably while another one might give you a worse offer because you're not their target customer.

Some lenders prefer high-income borrowers so much that they'll intentionally offer a less attractive deal to anyone with lower than a six-figure income.

The only way to know for sure is to shop around and compare at least three options. Some sites (like my own) will give cash-back bonuses from student loan refinancing companies if you apply through their referral links. Since the alternative is getting $0, you might as well pick up a cash back bonus if you're going through the trouble of searching for a rate. (I don't care if you do it through me or somebody else — but you should take advantage of this!)

If you'd rather just get a single option to search based on your circumstances, I also built a student loan refinancing quiz to help narrow things down.

When you apply to any lender, you'll get an answer within a couple minutes if you're pre-qualified.

That said, you still have to submit income documentation, answer questions about your savings and assets, and submit to what's called a hard credit check. This allows the lender to search your credit history for any negative events that could prevent them from extending you an offer.

A hard credit check has a temporary impact on your credit score by knocking that score down a few points. It's similar to opening a credit card. If you shop around at multiple places — as long as it's done within a 30-day window — it'll only count against you once.

The only reason to worry about the hard credit check is if you're about to buy a house within the next month. Other than that, you shouldn't worry.

What Terms Should You Choose?

Choosing a student loan refinancing term is similar to choosing between a 15- or 30-year mortgage. Student loan companies offer more options. The shortest term is 5 years, followed by options for 7-, 10-, 15-, and 20-year terms. (Some companies will even let you choose your monthly payment instead of limiting you to those terms alone!)

The shorter the repayment period, the lower the interest rate.

While I like the five-year term because it ensures you'll get out of debt quickly, you should choose the term that gives you a monthly payment you're comfortable with.

And here's something else important to remember: You can always refinance again if you find a lower rate.

Many borrowers don't realize this, but I have a lot of friends and readers who take the approach of starting off with a 10- or 15-year fixed rate. This gives them a lower monthly payment. Then, once they're in a better financial position, they refinance to a shorter term (with higher payments).

To illustrate, pretend Jimmy has a $50,000 loan at a 6% interest rate with the government. He makes $60,000 a year at a Fortune 500 company, so he owes less than two times his salary. That means he's a good refinancing candidate.

If he chose a five-year term with a 3.5% interest rate, his monthly payment would be $910 a month. But maybe Jimmy isn't ready for that kind of monthly commitment yet. He could refinance instead to a 5% rate for a ten-year term at a monthly payment of $530 a month, which he feels like he is more psychologically comfortable with.

After a couple of years, Jimmy could probably refinance again from a ten-year to a five-year loan. Pretend he made prepayments and now owes about $30,000. His new refinancing would be based on this new principal amount and thus he'd have to pay about $546 a month.

My preference is that you'd get insanely aggressive right away, but I just wanted to mention this since many borrowers leave money on the table by not refinancing more than once. (You can also pick up multiple cash-back bonuses this way similar to credit card reward hacking.)

Final Thoughts

There are a lot of folks out there who could save big bucks if they were to refinance their student loans.

But remember: You only want to refinance if it helps you get a lower interest rate, not just to consolidate loans. A lower rate means more of your payments will go to principal and thus get you out of debt faster.

Be sure to have your financial house in order first before signing up for big monthly payments with a private lender as the government is far more flexible. That said, you shouldn't pay extra money on interest without a good reason.

More about...Debt

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Ross Williams
Ross Williams
2 years ago

Here is a link from consumerfinance.gov: https://www.consumerfinance.gov/ask-cfpb/should-i-refinance-my-federal-student-loan-into-a-private-student-loan-with-a-lower-rate-en-1687/

It emphasizes that people should be careful refinancing from a fixed rate to an adjustable rate loan. If interest rates go up, as they are expected to, your payments will go up with them.

The other thing it points out is that moving from a federal to private you will permanently lose many of the insurance benefits that come with the federal program. Things like death and disability insurance, forbearance if you lose your job and reduced payments if your income changes.

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