What is a Refinance and How Does it work?
Student loan refinancing is the act of replacing an existing loan, with a new loan. The purpose of refinancing is typically to get better terms on the loan either with a reduced interest rate, or a longer/shorter repayment term depending on each individual’s case. Others also find going through a refinance with a private bank often will result in much better customer service than the federal servicers who handle federal student loans.
To start a refinance you need to go through the application process. The application will require some personal information and a credit check. Depending on the evaluation done by the lender, you would get an approval or denial notification. At that point, you would decide to proceed with the refinance or not.
Who Qualifies and When Can You Refinance a Student Loan?
Federal loans can be refinanced either after graduating or after you have stopped attending school for at least 6 months. You do not need a degree to refinance your student loans. Private loans can be refinanced at any time once in repayment, subject to restrictions on your specific loan. Everyone is eligible for a refinance, but the banks often have strict policies on who they will lend to. What is always considered by the bank are the following
Your credit is paramount to a refinance with a private bank. They are under no obligation to provide student loans or refinance student loans and will take work only with borrowers who have a solid credit score and history. Your credit score is based on the following
|Length of Credit History||15%|
|Types of Credit Used||10%|
Debt to Income Ratio
Your debt-to-income ratio is a calculation of all your monthly debt payments divided by your gross monthly income. For example:
Monthly Rent $1,500
Car Payment – $400
Student Loan – $500
Total Monthly Debt – $2,400
Monthly debt of $2,400 divided by your gross monthly income of $6,000 would yield a debt-to-income ratio of 40%. There is a strong correlation between a high debt to income ratio and defaulting on a debt. So you can understand why the debt-to-income ratio is paramount for banks to provide a loan. The lower your debt-to-income ratio the more likely you will be to getting approved. While there is no standard percentage where banks will lend, you typically want to be under 40% to qualify for a loan.
Banks will consider all the debt you have when going through the approval process. They look at things like how much is owed, when is the debt maturity date, what are the monthly payments, and the payment history on the debt.
Another important factor during the approval process is your employment history. Banks want to know that you have reliable work, and the risk of loss of employment is minimized. For that reason, it’s typical that banks want to see at least two years of solid income, and preferably with the same employer showing stability.
What will be a large negative for your application is if you have multiple employers, in different fields, for short periods of time. Of course, every lender has its own criteria, and this is only one factor in the approval process.
Existing Repayment History
This one speaks for itself. If you are applying for a loan where there is no collateral, the only way the bank can benefit from the transaction is by receiving monthly payments on the loan. If you have missed payments on your existing student loan, or other debts, you are unlikely to qualify for a refinance. That being said, again this is only one part of the puzzle. If you currently have a great job with an extremely low debt-to-income ratio but missed one payment in the past, it may not matter at all to the bank.
Is it Worth it to Refinance Student Loans?
There is no one size fits all answer to this question. It largely depends on each borrowers situation, and what they are looking for in a refinance. Typically the main reason for a refinance is either to save money long term, or short term. In the short term refinancing and extending out the term of the loan can drastically reduce your student loan payment. Or, you may want to keep the term the same and get a reduced interest rate which will not only reduce your payment but could save you many thousands of dollars when combining both interest and principal on the loan. The main points to consider for a private student loan refinance are;
- What will my new payment be
- What is the repayment period, or term of the loan
- What is the interest rate compared to my existing rate
- What is my total principal and interest in comparison to my existing loan
In the end, it’s important to do your math, double check your calculations, and decide whether a refinance of your student loans is right for you.
Should I Refinance my Federal Student Loans With a Private Bank?
This question is difficult to answer. Federal loans have many benefits which do not exist with private student loans. These programs are designed to help borrowers, especially during difficult financial times. Private student loans will not offer these protections, so its important to consider these prior to refinancing a federal student loan with a private lender. Some of the best protections offered to federal student loan borrowers are:
- Student Loan Forgiveness Programs
- Income-Driven Repayment Plans
- No payments due until either graduating or leaving school
- Government subsidized loans for underprivileged where the government pays the interest while you are in school on at least half-time basis
These items need to be considered carefully before refinancing a federal student loan with a private lender. You must be sure that you will not benefit from any of the government programs prior to privatizing your loans. If that is the case and there is no benefit to you staying with federal loans, then you can refinance with better terms with a new private lender.
What is the Difference Between a Refinance and Consolidation
A refinance and a consolidation are very similar. A consolidation is when you combine multiple loans into one new loan, and in a refinance you do not necessarily need to have multiple loans. If you are refinancing multiple loans and trying to obtain one new loan, that is a consolidation. Both a refinance and a consolidation are applying for a new loan.
What are the most important things to consider for a student loan refinance?
- Interest Rate – How competitive is the interest rate being provided, and is it a variable interest rate of a fixed rate for the term of the loan?
- Term Length – Do you prefer a long term to spread your payments out and reduce your monthly payment, or a shorter term to fully pay off the loan as quick as possible?
- Customer Service – How is the banks customer service? This one is often overlooked, by the last thing you want is to work with a bank who isn’t friendly.
- Application Process – How difficult is the application process, how long will it take, and how likely do you think it will be that you qualify with a certain lender.
- Co-Signer Release – Does the bank have a co-signer release clause?
- Online Portal – Does the bank have an online portal to track payments and balances?
Does it cost anything to refinance?
No, going through a student loan refinance doesn’t cost a penny.