If you graduated from college sometime in the last decade, chances are that you’re seriously burdened by student loan debt. More than 44 million Americans have student loan debt. In 2017, 53% of adults between the ages of 18-29 with bachelor’s degrees or higher had outstanding student debt. As a result, the national student loan debt surpassed $1.5 trillion in 2018 and continues to rise.
For many graduates, paying off this debt can be a long and difficult endeavor. In recent years, pay increases have failed to keep up with inflation for most workers. This problem is compounded for those who have student loans with high interest rates. And the interest rates for student loans are generally much higher than those for other common forms of secured credit.
Enter Student Loan Refinancing
An option for people looking to ease the burden of student loans is to refinance their debt. Refinancing works like this:
- The borrower researches and applies to refinance through a lender like a bank, credit union, or online lender.
- The lender establishes a new loan, including new terms and rates, with the borrower.
- The lender pays off the borrower’s original student loan provider. The borrower then begins student loan payments to the new lender.
Refinancing basically allows student loan borrowers to pay off debt at a potentially lower interest rate, over a time frame better suited to the borrower. This can save them money over the course of their loan repayment. At first glance, the process may seem self-explanatory, but there are many subtleties to student loan refinancing. Some borrowers who are unaware of these factors may turn away from refinancing and lose out on several benefits. Therefore, it’s good to develop an understanding of things like interest rates.
It Comes Down to Interest Rates
Interest rates are at the core of most decisions that student loan borrowers make. A high interest rate means you will pay more in the long run, while a lower interest rate can provide great savings. The key motivation behind refinancing is to secure the lowest possible interest rate, and thus the best deal. But how can this be done?
Many factors go into determining the interest rates for student loans. For federal loans, your interest rate depends entirely on the type of loan and the time you got it. The government sets new interest rates every year, depending on the economic climate of the time. You can see in this chart that interest rates were generally quite high from 2006 to 2010, and then decreased. For the 2017-18 school year, they have risen again.
If you took out a private loan to pay for college, your specific lender will have determined your interest rate. This likely was done through a sophisticated process that considers your individual financial situation and economic conditions of the time. The same will be true when you refinance.
Here are some tips to help you secure the best interest rate:
- A Good Credit Score. When it comes to any sort of loan, having good credit will make the lender feel more confident about you. Lenders want to work with borrowers who are likely to pay their loans back on a timely basis and are more likely to offer enticements such as low interest rates to borrowers with great credit histories.
- A Reliable Co-Signer. Similar to above, lenders also like it when your co-signer has good credit. A co-signer who always pays their debt in a timely fashion will make lenders more confident about working with you. This is especially helpful if you don’t have an excellent credit history of your own just yet.
- Sign Up For AutoPay. AutoPay is a system that automatically takes your monthly loan payments out of your bank account. This can be very useful if you sometimes forget to pay bills, and it can also lower your interest rates. Lenders want to receive payments on time, so many lenders will reduce your interest rate for signing up for AutoPay.
- Refinance at the Right Time. As with federal student loans, the interest rates for private loans are tied to the state of the economy. During times of economic recession, interest rates will often decrease in an effort to promote spending. This can be especially important if you’re thinking about a variable rate loan, which we’ll talk about next.
Variable vs Fixed Rate Refinancing
One of the most important dilemmas that you will face in refinancing is whether to apply for a variable or a fixed rate loan. If you have taken out a federal student loan, then you’re already familiar with fixed-rate loans. With a fixed-rate loan, your interest rate is locked in at a particular percentage when you borrow the money. It remains the same over time unless you refinance for a lower rate.
By contrast, the interest rate in a variable rate loan can change over the term of your repayment period. This usually tracks economic conditions over time. Variable rate loans often start at lower rates than their fixed-rate counterparts, but those rates can increase later on. This can work well if you plan on paying off your debt very quickly (before interest rates can increase).
A student loan refinancing calculator can help you decide exactly which kind of loan is best for your situation.
Student loans can be a serious burden. However, if you refinance your student loans at a favorable interest rate, you can save money in the long term and make repaying your debt much easier.