For some borrowers, student loan refinancing is absolutely worth it. Refinancing can save hundreds or even thousands of dollars per year.
However, student loan refinancing isn’t always the right move. In fact, student loan refinancing is an awful decision for many borrowers. Refinancing the wrong loans could cost thousands of dollars and destroy your credit.
The purpose of this guide is to help borrowers quickly determine whether or not student loan refinancing is the right solution for their personal debt situation.
When is it a Good Idea to Refinance Student Loans?
Deciding when the time is right to refinance will depend on many circumstances. Additionally, whether or not refinancing is a good idea will depend upon the student loans that you have.
Private Student Loans – The decision to refinance is fairly simple. If you can get a better deal — meaning lower monthly payments and/or a better interest rate — refinancing is a good idea.
Federal Student Loans – Federal student loans are more complicated. When a borrower refinances their federal loans, they are converting federal debt into private debt. Borrowers that want to keep the federal perks and protections should probably avoid a refinance.
Important Reminder:Keep in mind that refinancing is not an all-or-nothing process. Borrowers can pick and choose the loans to include in the refinance. Some should choose only to refinance their private loans, while others may choose only to refinance one or two high-interest loans.
When Shouldn’t You Refinance Student Loans?
If you are trying to decide whether or not refinancing is worth it or a mistake, it helps to keep in mind how refinancing works.
The refinance lender pays off your existing loans with funds from a brand new student loan. If the old loan is better than a proposed new loan, you shouldn’t refinance.
Interest rates and monthly payments are the obvious concerns, but there are other factors. Generally speaking, a fixed-rate loan is preferable to a variable-rate loan. Additionally, avoiding a cosigner is preferred. Some borrowers even refinance to remove their cosigners from their student loans.
What is the Downside to Refinancing Student Loans?
The biggest danger of student loan refinancing comes with refinancing federal student loans.
Refinance lenders may be able to offer lower interest rates, but they cannot compete with the federal government’s income-driven repayment plans or student loan forgiveness options.
Further complicating things is the fact that once a student loan has been refinanced, there is no way to “undo” the process. If borrowers suspect that they may need federal protections in the future, it would be a mistake to refinance the federal loans.
Along those same lines, borrowers optimistic about the chances of federal student loan cancellation should not refinance. I don’t think cancellation is a high probability, but avoid refinancing if you want to plan for it.
There are also a few minor downsides that borrowers might wish to avoid:
- Dealing with a new lender – In a refinance, your old loans are paid in full and a new student loan is created. This means working with a new company and its rules.
- Time spent refinancing – Checking rates with just one lender normally takes about 10 minutes. However, borrowers are advised to shop around for the lowest possible rate, so expect to invest at least about an hour to find the best option.
- Higher monthly payments – Some borrowers choose to refinance at the lowest possible interest rate. These rates are only available on 5-year loans. This shorter repayment length often means higher monthly payments. Borrowers concerned about monthly payment amounts should focus on 20-year loans.
Will Refinancing Hurt My Credit Score?
For the vast majority of borrowers, the credit score impact on student loan refinancing is minimal. Some see a slight increase, some see a slight decrease, but the movement is usually small.
Some factors might help your credit score:
- Fewer open lines of credit
- An improved debt-to-income ratio
Other factors may lower credit scores:
- Oldest lines of credit removed from credit report
- The inquiry from the hard-pull to get the loan
Finally, the refinancing process may cause a couple of oddities in your credit report for the first month or two after the process is completed. For this reason, borrowers should avoid refinancing if they are about to apply for a mortgage or other major loan.
What is a Good Interest Rate?
Whether or not student loan refinancing is worth it will depend heavily on the interest rates offered.
Because market conditions change, it is hard to say with certainty what makes a good rate or a bad rate. That being said, any interest rate improvement is usually a good rate. Borrowers always have the option of refinancing a second or third time if even better rates become available.
At present, the best student loan interest rates are available from the following lenders:
|Rank||Lender||Lowest Rate||Sherpa Review|
|T-1||1.88%||Splash Financial Review|
|2||1.89%||Laurel Road Review|
Borrowers looking for longer than five years to repay their loans may prefer to focus on the lenders with the best 20-year loan interest rates:
|Rank||Lender||Lowest Rate||Sherpa Review|
|3||3.53%||Splash Financial Review|
Does the Pandemic Change whether or not Student Loan Refinancing is Worth It?
The government has gotten pretty aggressive about helping student loan borrowers get through the pandemic. Most notably, payments have been suspended and interest rates on federally held student loans have been lowered to 0%.
For federal student loan borrowers, this means the right move is to wait to refinance. No lender can compete with a 0% interest rate. Additionally, we are in a time of economic uncertainty. Many Americans have lost their jobs. If you have concerns about employment stability, giving up the federal protections is also probably a mistake.
Private loan borrowers don’t have the same concerns. Private lenders have continued to charge interest throughout the pandemic. If you have the opportunity to get better loan terms, it is still worth doing.
Quick Recap: The Pros and Cons of Refinancing Student Loans
Setting aside the minor headaches and smaller perks, there are two major pros and cons to refinancing student loans.
Pro: Lower interest rates – Eliminating high-interest debt and replacing it with low-interest debt is a huge win for borrowers.
Con: Losing out on Federal Protections – Not all borrowers need the federal perks, but no private lender can compete with the federal protections offered.
Pro: Lower monthly payments – The value of a lower monthly bill comes from the opportunities that it creates. Borrowers can build up an emergency fund, save for retirement, and qualify for a larger mortgage.
Con: Passing a credit check – The borrowers who most need the services of student loan refinancing are the ones who will have the hardest time getting approved.
The borrowers that can qualify for lower monthly payments or a better interest rate without missing federal protections are the ones who will most benefit from student loan refinancing.