To refinance or not to refinance is a question student loan borrowers grapple with on a daily basis. On one hand, refinancing could mean a lower monthly payment. However, refinancing also means giving up some of the benefits of federal loans.
But with the average amount of student loan debt standing at $29,000 and the default rate for student loan debt hoovering around 14%, refinancing may be a good way to get out from under a large burden.
“Now is the right time to refinance because you can cut your interest rate in half,” says Todd Klapprodt, director of product and analytics at LendingTree, a Charlotte-based online lending exchange. “But the criteria is going to be a little more stringent for borrowers.”
Student loan refinancing is starting to increase in popularity, although it still represents a small portion of the student loan market. According to MeasureOne, a San Francisco company that tracks the student loan industry, refinances accounted for about 4.4% of private student loans during the first three quarters of the 2014-2015 school year. That’s up slightly from 4.1% in the same period during the 2013-2014 school year.
Stringent standards when it comes to refinancing
Borrowers looking to refinance student loans are going to face tougher underwriting standards than for credit cards and car loans. With the default rate high among student borrowers, financial institutions are hesitant to refinance just anyone’s student loan debt. As a result, experts say, a good candidate for refinancing has typically already graduated from school and is already gainfully employed. What’s more, in order to get the best interest rate on your student loan refinance, you need a FICO score that is close to 750 (although you could be eligible to refinance with a credit score as low as 700, according to Klapprodt). He says lenders are looking for an income of at least $75,000 on average.
“A refinance isn’t for someone who feels economic uncertainty or doesn’t feel confident in their job,” says Jenny Chou, Chief Strategy Officer at DRB Student Loan, a Dairen, Connecticut-based student loan lender. “Federal loans in particular come with certain benefits that, when you refinance, you won’t receive anymore.”
The perks of federal loans
Borrowers who stay with a federal student loan may pay more in interest rates, but there are benefits to federal loans if you’re struggling to make payments. The government has a number of programs designed to assist borrowers, including income-based repayment. If your outstanding federal student loan debt is higher than your income each year, or if your student loan debt accounts for a significant portion of your annual income, you may be eligible for a lower payment. A deferment or forbearance is another option for federal student loans, which means you’ll be able to temporarily postpone making your student loan payments or temporarily reduce the amount you pay. Programs like that are unique to federal student loans, and won’t be available if your refinance into a private loan.
Refinancing is a no-brainer – if you fit the bill
For people who fit the bill, refinancing can be a great option. After all, there aren’t any origination fees, application fees or prepayment penalties. You can also pick the terms of the loan. According to Chou, the standard loan terms are 5, 10, 15 and 20 years, although some lenders are flexible, allowing you to choose a loan term that fits your situation. Not to mention, you can lower your interest rate by as much as 2% or more on average, says Klapprodt. That could mean thousands of dollars in savings, particularly if the interest rate on your loan is around 6% or more. For people who took out loans from 2006 through 2012, the interest rate on unsubsidized Stafford loans is 6.8%. The interest rate on the Federal Plus loan for the same period is between 7.9% and 8.5%.
While refinancing your student loans can save you a lot of money, borrowers have to be careful. After all, if they refinance into a variable loan where rates can change, they could end up paying a higher rate if interest rates rise enough. Experts say in that case, it’s a good idea to go with a lender that puts a cap on interest rates. What’s more, they need to shop around, since every lender is going to offer different rates and terms. “You have to make sure you are fully informed about what the federal program offers, as well as the private refinance options,” says Klapprodt. “There’s no one-size-fits-all.”