Higher education is highly expensive. In fact, we’ve written before about how, in 2015, the average college graduate entered the workplace with more than $35K in student loan debt—which will likely take 20+ years to repay—making them the most debt-loaded class to date.
In that same article, we delved into the different types of loans available to college students, as well as methods you can use to minimize the amount of debt you accumulate before finding yourself in over your head.
What happens, though, if you’re already shouldering a hefty college loan balance? In other words, if you’ve missed the opportunity to reduce your debt burden on the front end?
Bankruptcy typically isn’t an option, so an increasing number of consumers look to lower their monthly payments—sometimes drastically—by refinancing through private lenders.
If you’re in a tight spot financially because of your high student loan balance, this might sound like a dream come true. After all, for many of us, student loans are the second largest household debt—trailing only our housing costs.
But before you achieve this, there are many factors to consider and moving parts to be aware of, each of which we’ll outline here.
Let’s start at the ground floor and work our way up. By the time we’re finished, you should have a much better idea about whether or not student loan refinancing is right for you.
What Is Student Loan Refinancing?
When it comes down to it, refinancing student loans is one of the easiest ways to reduce your interest rates, and thereby reduce your monthly payments and the length of your repayment term.
However, according to a recent user survey by StudentLoanHero, more than 1/3 of borrowers don’t know about student loan refinancing.
If you fall in this camp, let’s quickly go over some basics.
Have you ever transferred a balance from one credit card to another that featured a lower interest rate? Refinanced your mortgage or auto loan?
If so, this is also the basic concept behind student loan refinancing: you’re applying for a third-party loan that will be used to pay off one or more of your existing federal and/or private student loans.
As a result, you might be able to save money, while—if you hold multiple loans—consolidating them into one easy monthly payment. But is student loan refinancing the same as consolidation?
In a word, no; formal consolidation is only available for federal loans. This might be confusing since it involves consolidating “several federal student or parent loans into one larger loan, which replaces your original federal student loans.”
However, this just reduces the number of checks you have to write each month, and usually won’t save you any money.
On the other hand, if you’re consolidating existing loans through a private (versus a government) lender, then you’re simply refinancing.
Now you know what it means to refinance student loans, and how it differs from consolidation. But where can you turn to get the ball rolling?
Which Companies Offer Student Loan Refinancing?
In the StudentLoanHero survey above, even among those who were familiar with student loan refinancing, only about 31% had actually refinanced their student loans
This is despite the fact that, according to Congressman John Garamendi, he created the Student Loan Refinancing and Recalculating Act of 2016 because “1 in 7 borrowers default on federal student loans within three years of beginning repayment.”
He also notes, “We know that 30% of Federal Direct student loan dollars are in default, forbearance, or deferment, and at least 40 million Americans are burdened by student loan debt.”
Senator Elizabeth Warren also put forth her Bank on Students Emergency Loan Refinancing Act, which is intended to “allow student loan borrowers to refinance their loans at current rates.” Clearly, this is a problem that needs a solution.
Responses to the ever-increasing mountain of debt faced by college graduates isn’t just coming from the government, though, as dozens of private sector companies have swooped in, promising to help reduce monthly payments and repay loans faster.
We’ve reviewed many of these lenders ourselves, including:
Even traditional lending institutions, like banks and credit unions, have started hopping on the bandwagon, hoping to increase their bottom line while decreasing your monthly expenses.
Which of these is right for you? It’s almost impossible to say from a high-level vantage point, since the best option depends on dozens of different personal factors, such as how much you owe (most lenders have a maximum amount), your current interest rates, private-to-federal loan ratio, other sources of debt, your income, and even your degree program.
Perhaps one of the biggest factors that can impact your options, though, is your credit score. Why? We’ll dive into this important topic in a moment, but let’s first find out how low you can get your monthly payments post-refinance.
How Much Can You Expect to Save by Refinancing Your Student Loans?
Regardless of all the different variables that might impact your monthly payment, many private lenders claim to help you save huge chunks of change.
For example, SoFi promises to help members save an average of $18,936, while Earnest claims to deliver $17,936 average savings. For CommonBond, it’s $14,000.
In most cases, though, these advertisements are based on very specific criteria. So, if your credit score, loan terms, income, or any of the other variables we talked about above are different, what you’ll pay (and ultimately save) can change.
Let’s look at a couple basic examples and see how different APRs can affect your expenses.
The interest rates on older federal student loans can reach as high as 9%. On the other hand, most of the companies mentioned in the previous section have rates averaging between about 2% and 12%.
Pro tip: All of the numbers here were generated using StudentLoanHero’s loan refinancing calculator. I found it super simple to use and would recommend using your own numbers for more precise results.
Example 1: You have a balance of $35,000, with a 7.5% average APR across all your private and federal loans. You’re 2 years into your 20-year repayment schedule, with a $280 monthly payment. After refinancing, though, you drop your APR to 5%. If you maintain your 20-year repayment timeline, your monthly payment would only decrease by about $40. However, you’d be able to save more than $14,500 in interest!
Example 2: What if you wanted to pay off your loan faster? Amazingly, if we keep all of the variables from our previous example the same, but increase your monthly payment to your current amount, you’d be able to save nearly $19K in interest—and pay off your loan 4 years earlier!
Example 3: What if your APR hit rock bottom at something super low, like 3.199%? You’d save a whopping $21,500 in interest over the course of your loan! And again, if you decided to maintain your current monthly payment, with this interest rate, you’d be able to reduce your repayment schedule by another 2 years.
As you can see, even shaving just a couple percentage points off your current APR can have a massive impact on your monthly payments and/or how long it takes to pay off your loan.
But how realistic is it that you’ll be able to save any money by refinancing your student loans—or that you’ll even qualify in the first place? We’ll address this ultra-important question next.
The Pros and Cons of Refinancing Your Student Loans
We’ve mentioned it on more than one occasion, but shopping for anything—whether it’s a shirt or a refinanced student loan—is almost always an exercise in compromise.
So, regardless of which lender you choose, there’s rarely a “perfect” solution for everyone. Personal preference also plays a big role, which means that what you might consider a benefit, someone else might consider a deal-breaker.
Given this, let’s take a high-level perspective at some of the pros and cons associated with refinancing student loans.
Clearly, the biggest potential benefit when refinancing student loans is saving money and/or paying off your debt faster by decreasing your interest rate (or locking in a fixed rate) and consolidating different loans.
Some lenders even allow you to choose the terms of your loan (after being approved, of course), based on your unique situation.
You’ll probably need a decent credit score:
Speaking of approval, difficulty obtaining refinance loans is perhaps the biggest downfall, often making them unreachable for those who need them most. Why?
Just like any other loan, your credit score will likely be the number one factor that determines your eligibility for a student loan refinance.
Sure, some lenders claim to also implement alternative underwriting guidelines, such as looking at the school you attended, degree program, GPA, standardized test scores, and more, but rest assured that your FICO score will still remain front and center.
Now, as you might imagine, if someone needs to decrease their monthly payment, it’s fairly likely that they’re under at least some level of financial distress.
And what happens when someone is unable to pay their bills? One of the first things to sink is their credit score, thereby placing them squarely in a catch-22: They need to refinance in order to pay on time and increase their credit score, but they won’t qualify for a loan until their score improves.
To emphasize this point, in her 2014 article for The Washington Post, Danielle Paquette writes that the “grim reality of refinancing, however, is that most borrowers … aren’t eligible for the deal,” since lenders generally require “steady income and a high credit score.”
For example, “Citizens Bank takes on the federal and private student loans of borrowers with a minimum FICO score of 660,” while “SoFi’s average client makes $150,000, chief executive Mike Cagney said, and has an average FICO score of 770.”
Even the Bank on Students Emergency Loan Refinancing Act we discussed earlier wouldn’t apply to “the most distressed borrowers, those in default whose loans have exploded with penalties and fees.” Which—again—is squarely who needs it most.
You could lose some important benefits:
Federal loans come with some great benefits, such as income-based repayment, loan forgiveness in some instances, grace periods, and more.
Once these loans are paid off by a private lender, though, many of these benefits go by the wayside.
Pro tip: Returning again to the StudentLoanHero survey, nearly one quarter (24.72%) of respondents said they were “willing to give up access to federal student loan repayment options such as income-driven repayment and forgiveness in exchange for a lower interest rate.” Ultimately, it depends on your specific situation.
Important Factors Things to Consider When Refinancing Your Student Loans
To provide you with actionable information, we spoke with Mark Kantrowitz, publisher of Cappex.com, a free web site that connects students with colleges and financial aid, as well as Pamela Toney, Global Campus VP of Student Operations for Colorado State University.
Both professionals have been working within the student loan refinancing field for years, and they provided us with some insightful advice you can immediately put to use:
1. When Should You Apply?
Mark says that if you’re thinking about refinancing your student loans, it’s best if you wait until a few years after graduation. Why? While you’re in school you generally have greater credit utilization, which will automatically drop your score.
However, once you’ve graduated and have a few years of responsibly managing your credit under your belt, your score should improve enough so that you could qualify for a lower interest rate.
What if this isn’t an option? You’ll almost certainly need a cosigner, who will also assume responsibility for your debt should you default.
In this same vein, Pamela notes that if you refinance too early after graduation, you could lose your grace period and be required to begin repaying your loans earlier.
2. Should You Apply in the First Place?
Pamela and Mark also emphasized that you might want to be wary of consolidating your federal loans into private ones, since you’ll potentially lose a lot of benefits, such as death and disability discharges, income-driven repayment, three years of deferments and forbearances (private student loans are limited to 1 year of forbearances), and public service loan forgiveness.
Want to maintain these benefits, but gain the advantage of a single payment? Pamela states:
“Federal Student Loan services can give you the same types of payment arrangements on your loans in this manner without requiring you to consolidate your loans.
“They can even consolidate your multiple loans that they hold for you (you get a new loan each year you are repackaged at your school) and they can give you a consolidated payment for all of your loans that will allow you to make one payment but maintain the interest and benefits on your loans.”
Not only this, but Mark told us that “the interest rates on Federal Stafford and Perkins loans are usually much cheaper” than what a private lender can provide.
This might be even more of a reason to keep your federal and private student loans separate.
To help, before applying, Pamela recommends understanding “who your current lenders are and whether the loans are federal or private. You can find your Federal Loan lenders at www.nslds.ed.gov.”
3. Mind the Numbers
After checking your federal and private loans, Pamela recommends understanding which of your loans carry fixed APRs, and which carry variable rates.
Mark adds to this by noting, “Consolidation does not always save money. If one of the student's loans has a high interest rate and the others have low interest rates, the student may be better off targeting the highest-rate loan for quicker repayment.”
To this last point, remember that if your number one goal is to reduce your monthly payment amount, make sure the lender isn’t increasing your interest rate but spreading it out over a longer period of time (e.g. going from a 10-year loan to a 15-year)—or changing your APR from a fixed rate to a variable rate.
This could end up costing you a whole lot more in the long run.
Pamela adds a final word of warning: “ Ensure that you consolidate ALL of your federal loans. We have seen students who consolidate all but one loan and don’t realize that they missed one, causing that loan to go unpaid and fall into default.”
For Further Reading on Student Loan Debt:
- Student Loan History Timeline
- 5 Simple Tips for Repaying Student Loans Faster and Getting Out of Debt
- Top Student Loan Scams
Mark Kantrowitz is a nationally recognized expert on student financial aid, scholarships, and student loans. His mission is to deliver practical information, advice, and tools to students and their families so they can make informed decisions about planning and paying for college. He is the author of four bestselling books about scholarships and financial aid.
As Vice President of Student Operations for Colorado State University’s Global Campus, Pamela Toney specializes in working with adult learners who have challenges with previous student debt, as well as future tuition bills, for bachelor’s and master’s degree completion.