Refinancing student loans is similar to refinancing other types of debt — you apply for a loan and use the money to pay off your existing loans. With student loans, the refinancing lender will generally send the money directly to your current loan servicers, and you’ll then start making monthly payments to your new lender.
You may be able to simplify your monthly payments by combining multiple student loans into one new loan. Refinancing could also save you money if you get approved for a lower interest rate than you’re currently paying, and you may be able to decrease your monthly payments depending on your loan’s rate and term.
10 questions to ask when deciding if you should refinance your student loans
There are many pros and cons to refinancing student loans, but everyone’s circumstances are different and there isn’t a universal answer to whether refinancing your student loans is a good idea.
What is certain is that once you refinance your loans you can’t undo the process — your old loan has been paid off, and you’re working with a new loan now. You may be able to refinance again, but you’ll never be able to switch back to your original terms.
To help you decide the best course of action for your situation, ask yourself the following questions. The answers can help you determine if you should refinance your student loans.
1. Do you have federal or private student loans?
A variety of institutions originate student loans, including the U.S. Department of Education and private banks. As a result, you may have federal student loans, private student loans or a mix of the two.
You may be able to refinance federal or private student loans, and you may be able to combine both your federal and private loans into one new private student loan. (Only private lenders offer refinancing.)
If you have federal student loans, one of the largest potential downsides to refinancing is that your new private loan won’t be eligible for federal student loan programs, including income-driven repayment programs, forgiveness, cancellation, forbearance, deferment and discharge options. Private lenders may offer some similar programs that allow you to delay making payments if you’re experiencing a hardship, but they don’t offer loan forgiveness programs.
If you have private student loans, replacing your current loan with a new private student loan may not be as difficult of a decision. However, you’ll still want to compare each lenders’ programs and benefits rather than solely comparing the interest rates and loan terms.
2. Do you plan on using a federal repayment plan?
Federal student loans may be eligible for up to five income-driven repayment (IDR) plans. In some cases, your monthly payment amount could drop to $0, and you can switch between plans for free at any time.
The IDR plans can be especially helpful for those who are having trouble finding work or are pursuing a career in a low-paying industry. In addition to making your monthly payments more affordable, with four of the IDR plans, the remainder of your loan balance could be forgiven after you make payments for 20 to 25 years.
If you’re on an IDR plan, or think being able to switch to an IDR plan could be helpful in the future, you may not want to refinance your federal student loans. After refinancing, your new private loan won’t be eligible for federal IDR plans.
3. Do you want to use a federal loan forgiveness or cancellation program?
Your federal student loans may be eligible for a forgiveness program, such as the Public Service Loan Forgiveness (PSLF) program or the Perkins loan cancellation program. Private student loans aren’t eligible for these programs.
If you’re considering one of the programs, you may want to research all the eligibility requirements, including which loans qualify for the program and the requirements for receiving forgiveness or cancellation.
Those who qualify, or who have already been making eligible payments towards one of the programs, may not want to refinance the loans that will be forgiven or canceled.
However, private student loans don’t qualify for the programs and there are different types of federal student loans, some of which may not be eligible for the program you’re pursuing. You may want to consider refinancing those loans.
4. Can you save money by lowering your interest rate?
Congress sets the interest rate on federal student loans, and if you previously took out a private student loan your interest rate could depend on the lender, your creditworthiness and your cosigner if you had one.
When you refinance your student loans, the interest rate of the new loan can also vary depending on your current creditworthiness, the lender and a cosigner.
Lowering your interest rate can save you money in interest payments over the lifetime of your loan and may lead to lower monthly payments depending on your new loan’s term (the amount of time you have to repay the loan).
If you’re only able to get approved for refinancing with a higher interest rate than you currently have, then generally it won’t make sense to go through with the refinancing.
5. What is your credit score?
Your eligibility for refinancing student loans, and the rate and terms you’ll receive, may depend in part on your credit score. Having a high credit score can help you get better rates and terms, and the best offers may go to those with a score in the good to excellent range (e.g., a FICO score above 670). Some refinancing lenders also have a minimum credit score requirement that you must exceed to be eligible for a loan.
If your credit score has increased since you first took out a private student loan, that may be an indication that you could qualify for a lower interest rate now. On the other hand, if it’s dropped, you may not qualify for a lower rate and might want to focus on building your credit and increasing your score before refinancing.
6. What is your income, and what other financial obligations do you have?
Along with a credit score, lenders may look at your income relative to your overall required monthly payments — your debt-to-income ratio. DTI can be an important factor in determining your eligibility for refinancing and your interest rate offer. If your rent or mortgage, loan payments, credit card bills and other monthly obligations make up a large portion of your monthly income, it could be more difficult to qualify for a good rate.
Applicants who have a high credit score and want to refinance their student loans but don’t qualify for a low rate may want to focus on paying down debts, decreasing other financial obligations and increasing their income before reapplying.
7. What could happen if you can’t afford your loan payments?
Federal student loans offer prescribed options for borrowers who have trouble making payments. You may be eligible for an income-driven plan, which can lower your payment amount. Or, you might be able to temporarily stop making payments by putting your loans into deferment or forbearance if you return to school, join the Peace Corps, lose your job, have a medical emergency or meet other criteria.
Although private student loan companies may offer borrowers some hardship options, they vary by lender, and some lenders determine eligibility on a case-by-case basis. If you think you may have trouble making payments later, and particularly if you don’t have an emergency fund to fall back on, you may want to hold off on refinancing your federal student loans.
If you do decide to refinance, carefully review different companies’ hardship policies. You may want to choose the lender with the most favorable or lenient policies, even if it isn’t the one that offers you the lowest rate.
To lower the risk of refinancing, you could choose to refinance at a longer loan term. Although a longer term could result in a slightly higher interest rate, it could also lower your monthly payments. You can always pay more than the required amount to pay off your loan early, but the lower required payment gives you more flexibility if you run into financial trouble.
8. Will you need a cosigner to qualify?
Applicants who have trouble qualifying for refinancing on their own may be able to add a creditworthy cosigner to their application. Even if you qualify on your own, having a creditworthy cosigner could help you get a lower rate.
You can ask any creditworthy person to cosign as long as they meet the lender’s eligibility requirements, although you may feel most comfortable asking a family member. That person takes on a risk by cosigning your loan, because they will be legally liable for the student loan if you don’t pay.
The liability could make it more difficult for the cosigner to qualify for financing elsewhere, and missed payments could hurt the cosigner’s credit. If you stop making payments altogether, both your and your cosigner’s credit could take major hits, and you both might start getting collection calls.
If you do need a cosigner to qualify, you could look for a student loan refinancing lender that offers a cosigner release. Here’s how it works: After making a series of full and on-time payments, you can apply to take over the loan. You’ll need to pass a credit check and qualify for the loan on your own, and if you do, the cosigner will be taken off the loan and you can continue with the same rate and terms.
9. What will the lender do if something happens to you or your cosigner?
With federal student loans, any remaining debt can be discharged if the borrower, or the student for whom a parent PLUS loan was taken out, dies or becomes permanently and totally disabled.
Some private lenders offer a similar arrangement to borrowers, but others may handle these situations on a case-by-case basis and don’t guarantee a discharge. If the debt isn’t discharged, you could be leaving your cosigner with a large bill to pay, or it could be taken from your estate.
Also, review the contract to see what happens if a cosigner dies or declares bankruptcy. In the past, it was a common practice for lenders to place a student loan in default when this happened, meaning you’ll owe the entire balance right away even if you had been making your monthly payments on time. Automatic defaults aren’t as common anymore, but it’s still something you should double check.
10. Which student loans should you refinance?
Based on your circumstances and answers to the questions above, you may find that you want to refinance some of your student loans and leave the others as is.
You may also be able to accomplish some of your goals, such as simplifying your monthly payments, by consolidating federal student loans. Consolidation allows you to combine multiple federal student loans into one loan, and you can choose which servicer you’d like to work with for your new loan.
However, consolidation is only available on federal student loans, and it won’t necessarily save you money, because your new loan will have the weighted average interest rate of the loans you’re consolidating. So if the largest loan you’re consolidating has a lower interest rate than the rates on your loans with smaller balances, the weighted average may produce a lower overall interest rate on your consolidation loan. On the flip side, if your loans with the largest balances also have the highest interest rates, you could actually end up with a higher interest rate on your consolidation loan.
If you decide to refinance additional loans later, or want to refinance all your loans together at some point, you may be able to do that as well. Even if you refinance all your loans now, you may want to refinance again if interest rates drop or your creditworthiness improves.