Student loans can be a heavy and confusing burden to carry after graduation. “Thank god the private refinancing market exists now,” says Joshua Holt, who runs The Big Law Investor blog and refinanced his $190,000 law school debt with Earnest to lighten the load.
Earnest, along with competitors CommonBond, Darien Rowayton Bank (DRB), SoFi, and Citizens Bank, have collectively refinanced more than $5 billion in loans since 2012. Like Holt, many who have been able to tap into the burgeoning private refinancing market view it as one of the best innovations in the personal finance sector, saving tens of thousands of dollars. With competition and the current low interest rate environment, now is an opportune time for millennials to consider refinancing. But it’s not the right choice for everyone.
The decision is complex—it depends on individual circumstances and many unknowns. While it is hard to capture all of the nuances in a succinct guide, one can simplify the decision-making process by focusing on two broad dimensions: (1) Evaluate your potential savings and (2) Contemplate your risk tolerance or the degree of certainty about your current situation.
Will I qualify for refinancing?
All five of the major refinancing companies advertise large potential savings. In reality, however, those savings are not open to just anyone. Companies cherry-pick borrowers “who have excellent income and excellent credit history. It’s doctors and lawyers. Those are the people who are benefiting from the refinancing programs,” Adam Minsky, a Boston lawyer specializing in student loan issues, told the Boston Globe.
Each company determines whether it is willing to refinance your loan and, if so, at what interest rate, using a proprietary method that may include your credit history, your outstanding loan balance, and your current income and occupation. Many require credit scores close to or above 700 as well as a relatively low debt-to-income ratio to qualify; requirements are even more stringent for the lowest-advertised interest rates. But new entrants, competitive pressure, and refined risk algorithms have loosened restrictions and will hopefully make refinancing a more widely-feasible option. As competition intensifies, some companies are differentiating themselves by taking a more holistic look at a candidate’s finances. For example, when Holt refinanced with Earnest, he gave them access to his financial accounts so the company could look at his deposits and conduct a more thorough analysis to determine the real risk. (Holt felt comfortable sharing his information, but changed his passwords after Earnest had completed its review.)
If I qualify, what is the best interest rate I can get?
Aside from maintaining rock-solid credit, the best way to ensure you are getting the lowest interest rate is to shop around. You shouldn’t be afraid of harming your credit score by applying with several lenders at the same time. Typically when you apply for credit (like an auto loan, home mortgage, or private student loan), lenders will pull your credit history, known as a “hard pull” (you don’t want too many hard pulls on your credit as each can lower your credit score). However, the credit bureaus have logic built into their scoring formulas that can discern when consumers are shopping around for a loan and avoid penalizing them. Simply put, they treat multiple inquires resulting from the act of shopping for one loan as a single inquiry. Therefore, if you apply with several lenders, do so in a concentrated time period (within 14 days ideally). Doing so won’t hurt your credit, and it will give you a range of options.
You should also check with your employer and any professional associations you’re a member of, as some have formed partnerships with loan refinancing companies. These partnerships may make it easier to be approved with less-than-pristine credit or even allow you to obtain a better interest rate. For example, last year the American Dental Association (ADA) announced an exclusive partnership with DRB to provide its members “with lower rates that translate into greater peace of mind and substantial savings at a pivotal point in their careers.” By refinancing with DRB through the ADA, members would have their interest rate reduced by an additional 0.25 percent.
Don’t forget to also factor in various incentives that companies may offer. Most will reduce your rate by 0.25 percent if you allow them to automatically deduct the monthly payment from your bank account. Not only will this save you money, but automation will also reduce the likelihood that you will forget to pay your bill and hurt your credit score. Some companies offer other discounts. For example, Citizens Bank offers a loyalty discount of 0.25 percent if you have a qualifying account at the institution.