If you took out a student loan while you were in college and are finding the monthly payments too high, there is a solution for you. Chances are, the lender from whom you borrowed the loan a few years ago gave it to you at a high interest rate. When you were in college, your credit score would have been lower and you probably did not have a full-time high paying job back then. You were a higher credit risk for the lender and hence, you were charged a higher interest rate.
But if you have graduated from college or are about to, you could opt to refinance your student loan. Your credit profile will have changed quite a bit from those early college days. You may now have a stable job, and your credit score may have improved as well. By refinancing, it is possible for you to get the same loan which you currently have at a much lower interest rate. You could be saving a significant amount every month by refinancing your student loan.
Refinancing and consolidation are two terms mentioned quite frequently when student loans are discussed. They are not the same thing, and there are some key differences that you must understand if you hold a student loan.
Direct consolidation loan is a government program which allows a borrower to combine all their federal education loans into a single loan. The interest rate on this new combined loan will be the weighted average of the individual loan interest rates which have been combined to form the new consolidated loan. Consolidation is combining several smaller loans into one single loan.
Refinancing, on the other hand, is very different from consolidation. When you refinance a loan, you essentially get a new loan with a new term and lower interest rate. You replace your old loan with this new loan. On average, it is observed that refinancing a student loan can save up to $20,000 over the life of the loan.
So is it better to refinance a student loan or consolidate the loans?
Re-financing and consolidation are similar. It ultimately boils down to the terms that you are getting for each option. You will want to compare the weighted average or your existing loans against the new interest rate that a refinanced option is giving you. Ultimately, your cash flow needs will influence which option is best for your particular situation.
If you have private student loans, or if you do not plan to use any federal forgiveness program benefits or income-dependent repayment plan, then refinancing could be a good option. If you feel like your cash flows are strained, or you need some extra cash to pay-off another loan or make an investment, then refinancing could worth a look-in. Refinancing works best when you have a stable job and a few months/years of work history. You can get better loan terms with a rising income. So, if you feel that you are on the cusp of getting a promotion and a raise, then refinancing will work well just after you get your raise.
The interest rate is the key to refinancing. So ideally, you would want to go with the lender with the lowest interest rate. You may also want to look at other factors like availability of deferment or forbearance and flexibility in the repayment plan if your financial situation gets disrupted by an unexpected event. Overall, you must feel comfortable working with the lender. The comfort level and attractive interest rates are things that play a major role in choosing a particular lender to work with.
Also, make sure you look at the APR and loan term very closely. It is entirely possible that your monthly payment will be lower, but you may be paying a higher interest rate which is spread out over a longer term. Simply having a lower monthly payment but paying longer and higher in the long term makes the loan more expensive than what you already have. The whole idea when trying to save money is to try and find a shorter term loan or a loan with the same duration but a lower interest rate. The ideal scenario would be to get a shorter term loan and a lower interest rate.
Generally speaking, refinancing should not cost you. Lenders who are reputed and have a long-standing presence in the industry tend to not charge any loan origination fees or any pre-payment penalties. It is quite possible that some debt re-structuring firms may have certain charges and fees related to refinancing. But, that is on a case-by-case basis. Make sure you read all the fine print before you apply for a refinancing online. If the fine print is not clear, then call or email to clarify how the entire refinancing process works with a particular lender.
Yes, you will lose some benefits like income-linked payment, forbearance, deferment. You may also lose the right to claim student loan tax deduction which you may have been doing previously. Consult a tax expert on this one if you are unsure how refinancing affects your tax returns.
If you have answered the above questions and have decided to go for a student loan refinancing, then the next question which arises is how do I make sure that my refinancing application is successful?
Student loan lenders and refinancers have very clear and in many cases, strict rules related to underwriting such loans. Since private money is at risk when it is lent out, the student loan lenders will want to safeguard themselves. They will try to make sure that they lend to students who have a fairly high probability of repaying these loans. So, the application process and the documentation is very important. You will want to come across as someone who is reliable and who can be trusted upon. Following are some key pointers that you must keep in mind before making a refinancing application:
Anything over 700 is considered excellent, while it is important to at least be in the 600’s in order to not have any trouble with the refinancing application. A credit score also affects the interest rate which you will receive on your loan. A lower credit score means higher risk, hence a higher interest rate. A higher credit score means lower risk, and hence a lower interest rate.
If you have any other expenses or any other debt, then the lender will want to see an income which is capable of covering the interest on that additional debt along with your regular expenses and interest on the new loan. Gather all your pay stubs, your income tax returns, and any other expense and debt details. Make an organized file with all this financial information. If you submit all your documents and records in a systematic manner, your application will move forward quicker. If for some reason, your income is not high enough to meet all the expenses and interest payments, it may be possible for you to get a co-signer with you. This co-signer should have a stronger financial profile than you and by teaming up with a stronger financial profile, you may increase your chances of successfully refinancing your loan.
Try to repay existing debt: If you have any car loans, credit card debt, or any other outstanding debt, then try to pay it off before you apply for the refinancing. The interest from all that outstanding debt will eat into your income and leave a lower amount for servicing the refinanced loan. This, in turn, will reduce the amount that you can borrow. So, if you repay your existing debt, then it does not influence the underwriting process and it also reflects well on your credit score. You will come across as someone who can meet financial obligations.
Following the above guidelines should get you well-prepared for submitting a refinancing application. If however for some reason, you are not successful in your refinancing application, then you may want to consider the following:
Another benefit of applying to multiple lenders is the ability to negotiate and compare interest rates. Different lenders will offer you different interest rates and other conditions. By having multiple offers on hand, you can pick and choose the best option, or negotiate the inclusion of certain options such as deferment or forbearance. Applying to many lenders will not take up significantly more time from your schedule because the information that you need to gather will be more or less the same. The same application file, bar a few changes, will most probably work with most lenders.
All the above steps should make you well-informed about the entire student loan refinancing process. You will have a good understanding of when to go for refinancing and what kind of person is the right fit for refinancing of student loans. You can start preparing right away using the guidelines above. However, it will be even better if you have someone to guide you along the way.