Should I refinance my student loans? This has been a very popular question In this current environment of near 0% interest rates. It’s a question that I am very happy to hear because that tells me that many people want to take control of their finances and take positive action.Unfortunately, there’s not a one size fits all answer to the question. Whether or not to refinance your student loans is subjective, but I will outline some things to consider that should help anyone wondering to decide.
Student Loan Refinance Rates
First and foremost it is important to keep in mind that the interest rates on federal student loans are 0% until September 30, 2021. So no matter what provider you have, currently the interest is zero, zip, nada! The whole point of refinancing is to secure a lower interest rate.
However, you can’t access an interest rate below zero. If you are thinking proactively I get it. But I suggest shifting your focus to what's most important and that is paying off the loan. However, If you have a loan through a private lender, it is ideal to refinance sooner rather than later being that you are still paying interest on those loans.
According to Federal Reserve data, the average amount of American student loans is nearly $32 thousand.
Before even thinking of refinancing your student loans you first need to take into consideration your credit score. Your credit score is going to determine what rate you will be able to secure, and not just your score but your credit history as well. If you are going to put in the work to refinance you might as well make it worth it by securing the lowest interest rate possible.
And that is done by having good credit, at least a score of 650. Not to mention, if you apply for a new loan and your credit isn’t too hot, you may only get approved for a higher interest rate or you may need a cosigner. So first see where your credit stands, and if needed, take action to fix and/or build your credit.
If you have some work to do on your credit, it’s ok, just start now to work on it. And in the meantime take advantage of the 0% interest if your loan is federal. Knock off as much as you can from the principal amount of your student loan every month so by the time you're ready to refinance, it will be for a much lower amount.
That being said, you probably know where I’m going with this, and that’s to your budget! If you are serious about tackling your student loan debt and taking advantage of 0% rates then give a second look at your budget. What can you trim in order to allocate more to debt repayment?
Student Loan Repayment
I’m not telling you to eat rice and beans for all your meals, but really think about how rare of a time this is to have the opportunity to pay down your federal student loan principal without interest, it’s unprecedented. Whatever sacrifices you make to take advantage of this time, you will thank yourself for in the future.
I really want to touch on why it’s beneficial to pay down the principal. By paying down the principal on your loan you will be ahead of the ball by the time student loan interest comes back. The lower the principal, the less the interest will impact your repayments, which means you will be able to pay off your loans faster and save money simultaneously.s
Here’s an example of how interest rates behave with 2 different principal amounts.
Dona currently has a federal student loan of 30K, she decides to take advantage of the zero percent interest environment and makes a payment of $2,000 per month up until the end of August. Now she is left with 20K on her federal loan and refinances her loan of 20k at an interest rate of 2%. Now with her new loan, she is paying 2% on 20k rather than 2% on 30k.
For her new 20k loan she will pay $33 per month in interest. If she didn’t pay a dime towards her loan during that period then Donna would refinance a 30k loan and her monthly interest would be $50 per month. Looking at it from a monthly perspective it may not seem like a lot, $33 to $50. But if you're just paying the minimums each month the difference adds up and compounds over the life of the loan.
Besides having good credit your potential new lenders will also look at your debt-to-income ratio. Having a debt-to-income ratio below 50% is attractive to lenders. To div out this ratio simply add up all your monthly debt payments and divide them by your gross monthly income.
Lenders also want to see that you have steady employment and that you don’t have any student loans in default. If your credit is at least 650, the debt-to-income ratio is below 50%, and your loan is through a private lender then I say go for the refinance if it makes sense. However, if you’re thinking of refinancing a federal loan I want you to know some things that may be considered a downside.By the way, don't forget to check your student loan balance.