When Graduates Should (And Not) Refinance Student Loans
Editor’s note: This article is part of a series of graduate investment advises that draw on the expertise of finance professionals, university faculties, and of course InvestorPlaces’s own analysts and writers. Read more about Moving Money for Current Graduates here and check out the Top Stocks 2021 to find out which stocks are best for new graduates.
Student debt is a tremendous burden, American adults said in 2011 Pew Research Survey. 10 years later this burden is almost unbearable. The latest statistics show that the national student loan debt was $ 1.70 trillion in 2020, compared to $ 0.96 trillion in 2011.
As the national student loan balance increases, more and more college graduates are struggling to repay the debt. According to data from Educationdata.orgApproximately 37% of graduates ages 60 and older have student loans outstanding.
College students unable to pay for their education out of their own pocket often rely on loans to get through school. Most students take out loans with the expectation that they will be able to repay them after graduation.
But a combination of factors makes this easier said than done. Many young people take out loans without realizing that the financial burden they can pay back over the years can lead to it. Stagnant wages and poorly paid entry-level jobs, as well as compound interest, often mean difficulties in repaying loans quickly.
That is why so many students are amazed how to pay off student debt in a quick, effective way that won’t break you at the end of each month. One such option is student loan refinancing.
What is Student Loan Refinance?
Refinancing of loans refers to securing new debt to repay outstanding loans. Often times, the new loans are associated with lower interest rates and installments. Also, the refinance pushes the repayment deadline further into the future and gives you the much-needed deadline.
One disadvantage of refinancing student loans can be an increased total loan amount – lower monthly payments can mean longer payment terms and generate more interest. But when there is less monthly debt, those drowning in debt often have some room to breathe and get back on track.
With Fixed-rate loans that hit record lows week after weekNew graduates should seriously consider refinancing their student loans.
Refinancing student loans
If you think loan refinancing is the best option for you, here is a step-by-step guide.
Step 1: pre-qualify for refinancing
In the real sense, student loan refinancing means that a company will buy your current loan commitment and give you a new loan with different terms. That won’t happen if the company has doubts about your credibility.
So the first step is to find out if the refinance lender can help you with this Refinance Student Loans. Different companies have different admission criteria. For example, your credit score usually has to be pretty good. And your debt-to-income ratio (DTI) usually needs to be less than 20%, preferably lower.
Step 2: Select suitable refinancers for your needs
Now that you have a rough idea of your refinancing ability, it is time to find the right lender. It is important to note that your situation determines the lender. For example, some lenders only accept customers with a college degree.
Step 3: Compare Interest Rates and Repayment Terms Between Lenders
Ideally, you should be given a list of lenders who will accept customers in your situation. It helps to realize that every company charges different rates. Most lenders provide estimates based on the information you provide. Keep shopping until you find the lender with the lowest interest rates.
Step 4: choose the best option for you
Lenders adjust the refinancing of loans to either floating or fixed interest rates. Each structure affects the total amount refundable differently. For example, the floating interest rates are often lower at the beginning of the repayment but increase in later stages. The problem here is that the structure allows for a longer repayment period, which increases the total loan amount.
It depends on how much you can afford per installment. All the better if your income can support a fixed interest structure. This structure shortens the repayment period and reduces the amount of interest you pay on top of your loan principle.
Step 5: apply for refinancing
A typical refinancing loan application requires detailed personal financial information. The lender wants to know if you are funding another loan, a breakdown of your current income, and so on. It is important to note that any information you provide must be verifiable.
Qualification for student loan refinancing
As with any other loan, the refinance loan borrowers must meet some requirements. While refinancing lenders may use unique eligibility criteria, any lender will likely look at the following points to determine your eligibility.
Your credit score
A credit score is a number that estimates your creditworthiness – basically, it measures your ability to repay debt. In the US, you are creditworthy if your credit score is between 300 and 850. Most refinance lenders prefer a credit score of 650 and above.
Your credit history
Lenders record all of your credit-related transactions for future reference. And lenders share these files with each other. Lenders consider borrowers with poor credit history to be risky and may reject their applications.
No lender will accept your refinancing loan application without proof of employment and income statement. Lenders need to know that you will have the money to meet your obligations when they occur.
Proof of university degree or degree
Some lenders accept clients without a degree, but most will not consider your application without a college degree. This assumes that university-educated borrowers have better chances of finding meaningful employment and then paying off their debts. A college degree is also solid proof that the loan you are trying to refinance was actually used to pay for your education costs.
As mentioned earlier, a credit score is a metric that estimates your creditworthiness. A low credit score will turn lenders away because you are one of the risky customers.
Since lenders are in a highly competitive business environment, some of them are willing to take a higher risk. This means that acceptable credit scores vary among lenders.
Fair Isaac Corporation (FICO) is a leading provider of credit score information to lenders in the United States. The company’s FICO scores are a general reference point for the accepted range of credit scores required to secure a loan.
FICO below 580 is bad and above 800 is exceptional. You must be in the “fair” range – between 580 and 669 – to qualify for a loan from some lenders, although most lenders prefer FICO scores above 669 which are “good” or better.
When do you need to refinance your student loan?
There are times when refinancing your student loan is a more profitable or useful option than others.
Look for low interest rates
The economic climate often goes through recessions and upswings. As with all central banks around the world, the Federal Reserve reacts to business cycles by lowering or raising the key interest rate. The interest rate environment is inhospitable at a time of economic boom, as when the Fed raises interest rates, private lenders follow suit to hedge their profits.
Therefore, in a recession, the interest rate environment is best when interest rates are low, provided that private lenders follow the Fed. Refinancing student loans during this period can save you significant savings as the new terms may have lower interest rates than the previous loan.
Your finances are solid (ish)
A higher salary lowers your debt-to-income ratio. Lenders prefer borrowers with a low DTI as they will likely pay off the debt as agreed. You are likely to get better terms if lenders perceive you as a reliable customer.
You have private student loans
Federal student loans enjoy specific benefits that are not offered by private lenders. For example, federal student loans are eligible for forgiveness or forbearance. The bad news is that you risk losing benefits if you choose to refinance federal student loans with private lenders. Hence, it only makes sense to refinance private student loans.
Does the refinancing really help?
Most of the time, people refinance student loans primarily to reduce the total amount payable. Let’s say the interest rate environment is looking better, so it’s the right time to refinance. However, your creditworthiness could be worse than before, which means you are likely to face tougher terms. In the long term, hard terms increase the total loan amount, which primarily nullifies the reason for the refinancing. Weigh all of the factors when considering refinancing your student loan.
Refinancing vs. Consolidation
As mentioned earlier, student loan refinancing involves taking out a new loan to pay off the outstanding loan. The new loan has completely different terms and rates.
Conversely, student loan consolidation does not replace outstanding loans with new ones, but involves consolidating existing loans into a single one. The consolidated loan has a single fixed exchange rate that is a weighted average of the interest rates on the previous loan.
The main difference between student loan refinancing and consolidation is that refinancing can result in new terms while remaining constant after consolidation. Consolidation only provides convenience in paying student loans and retains eligibility for federal loan programs.