It's a cruel fact of life that paying off your loans doesn't just mean repaying the amount you borrowed. Each of your loans also has an interest rate, a fee your lender charges you for borrowing money. But you don't have to feel stuck with those rates forever. If you've built a strong credit history and make a solid income, refinancing your student loans could lower your overall interest rate.
Student loan refinancing works like this: When you refinance, you replace your existing loans with a new private loan at a new interest rate, based on the credit and employment history you've built up. Refinancing might also extend your repayment term or lower your monthly payments. But not everyone qualifies. And if you refinance federal loans into a private loan, you risk losing important protections, such as flexible repayment options and the ability to postpone payments when you're unemployed.
"There are some private loans that are including some consumer protections in their loans these days," says Heather Jarvis, an attorney specializing in student loan training and education based in Wilmington, North Carolina. "But people should begin from a position of caution when considering refinancing their federal student loans."
Ask yourself the following 10 questions during your refinancing research to make the best decision for you.
When you're first exploring refinancing
1. How much do you owe?
Private lenders might require refinancers to have a minimum outstanding student loan balance -- often $7,500 to $10,000 or more. Check your potential new lender's requirements on this point first.
If your loan balance is too low to qualify for refinance, consider adjusting your budget to pay off your loans faster. Pay a little more than the minimum due each month, and ask your servicer to put the extra toward the principal so it lowers your balance. Getting rid of your highest-interest loans first will save you the most money.
2. What loan types do you have and what are their interest rates?
Before you refinance, understand your loan types and their interest rates. You can look up your federal loans on the National Student Loan Data System. Private lenders will have your loan information on file. To refinance, your loans need to be in good standing, meaning you're current on your payments and haven't gone into default.
Congress sets federal loan interest rates, and they can change year to year, though once you have a rate, it's fixed. Since 2006, interest rates on Direct Loans for undergrads have ranged from 3.4% to 6.8%. Private loan interest rates have variable rates -- which means that they go up and down over time, based on the market -- that depend on the credit score of the borrower or cosigner. Private student loan borrowers paid between 3.4% and 13.99% in interest in December 2011, according to the Consumer Finance Protection Bureau (CFPB).
It's key to know how much you're paying in interest. The higher the rate on your current loans, the more you could save from refinancing.
When you're learning if you're eligible
3. Do you have a steady income?
Refinancing companies will give you a better rate if you have a steady income from full-time employment, which signals that you're more likely to make on-time payments. Some lenders may even require their refinancers to have graduated from specific schools or graduate programs.
4. What's your credit score?
Your credit score is an important element of your eligibility for refinancing. It takes into account your payment history on your monthly bills, the types of loans and credit cards you have and how much you owe on them, among other factors. If you have a score in the high 600s or above, it's more likely you'll qualify for a refinance.
If your score is lower, you might not qualify -- or your refinance options might not be an improvement. "You can look around to refinance, but you should not be surprised if the offers you receive aren't any better than what you've already got," Jarvis says.
A co-signer might help you qualify or receive a better rate, if he or she is willing to take on the responsibility the loan if you can't repay it.
5. Are you planning to shop around with different lenders?
When a lender checks your credit, that inquiry might show up on your credit report, temporarily lowering your credit score. Only "hard pulls," which lenders perform to give you your final interest rate, have this effect. Lenders also perform "a soft pull" to give you an idea of your new interest rate during the research stage, but these don't lower your score.
Jarvis recommends shopping around within a short window of time, say one month, so the credit bureaus recognize that you (and your co-signer, if you have one) are comparing offers and not attempting to take out multiple new lines of credit.
When you're deciding which loans to refinance
6. Do you plan to take advantage of Public Service Loan Forgiveness?
When you're ready to refinance, give careful thought to whether to include federal loans. By making your federal loans private, you could lose options like extended or income-based repayment, Public Service Loan Forgiveness, and the ability to temporarily defer your loans interest-free.
If you're sure you won't need these protections, and you're confident that your income and credit score will stay strong throughout your repayment term, it might be worthwhile to refinance your federal loans. Otherwise, refinance only your private loans and continue making separate payments on your federal loans.
7. What protections does the lender offer if you lose your job or can't otherwise afford your student loan payments?
Some private lenders will let you postpone your payments for a short time if you're unemployed, but these programs might have more restrictions than the federal options. If you can postpone payments, ask your lender whether interest will accrue during that time and what happens if you default.
When you've decided to refinance
8. How are variable interest rates calculated?
You can generally choose between a variable interest rate and a fixed rate for your refinanced loan. Fixed rates are less risky because they stay the same over time. Variable rates often start out lower than fixed rates, but they could go up based on the index they're tied to -- the London Interbank Offered Rate or the prime rate, for instance. A change in your interest rate will affect the amount you pay per month.
"It's important to know how often the variable rate is adjusted as well as if there's any limit on how high the interest rate can go," Jarvis says.
That's especially important because the Federal Reserve has said it might raise interest rates in the coming months.
9. When do you need to start making payments?
Make sure you have all the information you need from your lender before your first payment is due. Find out:
- What day you're first expected to make a payment
- How much you'll owe each month
- What your new interest rate will be
- How long your repayment term will be
- How to pay more than the minimum each month, if you choose
10. Are there discounts available on your payments?
Many lenders offer an interest rate reduction if you opt for automatic debit, which will also help you make payments on time. Fill out any applications required for this or other discounts, and find out if there are any circumstances under which you could lose them. If you temporarily postpone payments, for instance, ask your lender if you'll still be eligible for an interest rate reduction when you resume.
If you're eligible for refinancing, you could save a lot of money in interest over the life of your student loans. That's especially true if you're paying a high interest rate on a private loan and your credit score qualifies you for a lower rate today. But there's a lot to consider before you refinance, especially if you have federal loans. So don't be shy: Ask as many questions as it takes to know exactly what you're signing up for.