So far in our financial goals blog series, we’ve talked about why it’s important to have a budget. We also talked about strategies for creating a budget. Later in January, we tackled yet another topic: learning about money and getting familiar with money topics and trends. (It’s only February, and look at what you’ve already accomplished!)
Let’s turn our focus to erasing debt.
Top 2 financial goals
If you ask someone, “What’s your top financial goal this year?” you might hear one of these two answers (or both):
Pay off debt
Save more money
We’ll consider both these goals but, first, how to pay off debt: student loan debt.
Student loan debt
In February 2017, Forbes reported that student loan debt followed mortgage debt as the second highest debt group for consumers.
For that reason alone, it warrants discussion, specifically ways to reduce or eliminate it, starting with refinancing your student loan at a lower rate.
Not just for mortgages: Student loan borrowers refinancing at lower rates
The interest charges that pile up on student loans each month can make it seem like you’re hardly making any progress in paying down your debt.
A good chunk of your monthly payment can go to covering the interest you owe. Only then is the rest of your payment applied to your loan principal.
With many federal student loans carrying interest rates of 6%, 7%, or 8%, and some borrowers stretching out their payment over as long as 20 or 25 years, borrowers often end up paying more in interest than the amount they originally borrowed for school.
But if the rates on your student loans are high, that doesn’t mean you’re stuck with them.
Just as homeowners can take advantage of changes in interest rates to refinance their mortgage at lower rates, a growing number of private lenders are willing to refinance student loan debt.
Student loan refinancing explained
To refinance your student loans, you take out a loan from a private lender, and use the proceeds to pay off high-interest student loans.
Unlike the “one-size-fits-all” interest rates on government student loans, rates offered by private lenders depend on the borrower’s credit worthiness and the interest rate environment.
So if you’ve established a credit and earnings history since leaving school, you could be eligible to lower the rates on your student loans—federal or private.
Lenders all have their own rules for qualifying borrowers and setting interest rates and terms, so it’s a good idea to check rates you can qualify for with multiple lenders.
The Credible.com marketplace makes it easy to do that. Thanks to the Credible marketplace’s integrations with credit bureaus, borrowers can see the actual rates they prequalify for with a range of vetted lenders in about two minutes. Because the process uses a “soft” credit inquiry, your credit score is protected, and you don’t share any personal information with lenders unless you see an option you want to proceed with.
Savings from refinancing
When refinancing student loans, choosing a loan with a shorter repayment term can produce the biggest interest rate reduction and greatest overall savings. Borrowers who want to reduce their monthly payment often choose a loan with a longer repayment term.
Borrowers who have refinanced their student loans through the Credible.com marketplace into a loan with a shorter repayment term reduced their interest rate by 1.71 percentage points, and can expect to save an average of $18,668 over the life of their new loan.
Those refinancing into loans with a longer repayment term lowered their interest rate by 1.36 percentage points and cut their student loan payments by $218 a month.
Three situations where refinancing can pay off
Refinancing often makes the most sense for borrowers who have completed their degree and embarked on a career. An established earnings and credit history will help borrowers qualify for the best rates.
Here are three situations where refinancing may be a good option:
The monthly payments on your existing federal or private student loans aren’t a stretch, and you can qualify for better rates from a private lender.
Your existing student loans carry variable rates, and you would like to switch to a fixed-rate loan.
You are interested in lowering the monthly payments on your private student loans by refinancing into a loan with a longer repayment term and lower interest rate.
A high debt-to-income ratio is the most common reason borrowers are turned down for refinancing. Other issues that can stand in the way of refinancing with some lenders include the lack of a degree, the school attended, and the size of the loan to be refinanced.
Every lender has its own set of borrower requirements, and borrowers who are eligible to refinance are frequently accepted by some lenders and rejected by others. In other words, don’t assume that because you’ve been turned down by one lender that refinancing is not an option.
Borrowers who are turned down for refinancing, or aren’t offered rates that would make it worthwhile, can also try applying with a cosigner.
A cosigner agrees to take on the full responsibility for a loan if the primary borrower fails to repay it. The cosigner’s good credit can help borrowers get approved for refinancing, or get approved at a lower rate. While cosigners are typically parents, spouses, or other relatives, a friend or employer can also act as a cosigner. In fact, anyone who is at least 18 years old and a U.S. citizen or permanent resident can be a cosigner.
Do your research
Refinancing federal student loans with a private lender means giving up borrower benefits like access to income-driven repayment plans, and potential loan forgiveness after 10, 20 or 25 years of payments.
If you think you may qualify for Public Service Loan Forgiveness, or are uncertain about your job security, refinancing federal student loans might not make sense.
Private lenders will often provide loan forbearance or deferment to borrowers facing temporary economic hardships, and some may offer borrower protections that are similar to those provided with federal loans. Make sure to review each lender’s terms and conditions.
Often, borrowers decide the savings they can achieve through refinancing are worth more to them than the federal borrower benefits they’re giving up. If you stretch your payments out over a longer period of time in a federal repayment plan, you won’t get a lower interest rate. That means you may pay considerably more interest in the long run, particularly if you don’t qualify for loan forgiveness.
Refinancing is not the same as rolling up multiple government student loans into a federal Direct Consolidation Loan. Although a federal Direct Consolidation Loan can provide borrowers with a single monthly payment, and in some cases help them qualify for income-driven repayment, it does not reduce their effective interest rate. The interest rate on a federal Direct Consolidation Loan is the weighted average of the rates on the loans being consolidated, rounded up to the nearest one-eighth of one percent.