If you refinance your student loans, you could lower your interest rate or monthly payment. But you've got to pick the right time to take the leap.
Refinancing student loans can simplify your life. You consolidate multiple loans into one loan with one payment and (ideally) a lower interest rate. But when should you refinance?
If you refinance right out of school (or before you graduate), you may not have the financial stability needed for the lowest rates. If you wait until your loans are nearly paid off, the refinancing might not save you any money.
To get the most out of refinancing, go through the checklist below. The more criteria you meet, the more likely you've picked the right time to refinance.
You have a high (and improved) credit score
Higher credit scores mean better interest rates, since you're less of a risk to the new lender. You're in a particularly good spot to refinance if your credit has improved since graduation.
Many banks require a minimum credit score to refinance. Citizen Bank, one of the largest refinancing companies, requires a FICO score of 660 or above. Borrowers who use SoFi, another popular refinancing company, have an average credit score as high as 770. Ideally you should be in the 690-850 FICO credit score range to get the best refinancing rates.
You have a stable income
Job-hunting? Working part-time? Considering a career switch? Don't refinance just yet. The timing will be better down the road.
Right after graduation, it may be tempting to refinance -- especially if you have a job already. But if you wait a year or two, make payments on time and improve your credit score, you're more likely to get the best refinancing rate possible.
You should also have solid income relative to your debt (all debt, not just student loan debt) to get the best rates. If you can afford to put 10 percent of your discretionary income each month towards student loans -- the federal guideline for affordable monthly payments -- you're in good shape of refinance. Discretionary income is the amount left over after necessary expenses such as rent, food, and car payments.
You have over $10,000 in loans
Smaller loans, or nearly-paid-off loans, often aren't worth refinancing.
Most lenders offer payment plans over five to 20 years for refinanced loans. If you have less than $10,000 in loans and plan to pay them off in less than five years, refinancing may extend your payment term. Your best bet is to stick with your original loans. If you pay over a longer period of time, you'll pay more interest overall.
The interest rate on your current loans is 6.5 percent or higher
The most beneficial part of refinancing is the lower interest rate on the new loan. You can pay much less over the life of the loan through a refinance -- but only if your rates are high to begin with.
Refinancing combines loans, which means a low-interest-rate loan can be combined with a high-interest-rate loan. The higher your interest rates, the more likely refinancing is to help lower your rate.
Avoid refinancing if you already have low interest rates on your loans (below 5 percent) and you expect your rates to stay low. The best fixed refinancing rates (the same over the life of the loan) are around 3.5 percent, so if your interest rate is already that low, refinancing won't change much.
If you have subsidized federal loans where the government pays the interest, you might not want to refinance these loans either. The new loan will have stricter terms and you could end up paying more interest.
You can manage steady payments
The drawback of the lower interest rate you'll get from refinancing is a higher monthly payment over the loan's life. Federal loan holders should be able to make payments under the Standard Repayment Plan (one of several repayment options available) to get the most from refinancing. Borrowers on the Standard Repayment Plan pay a fixed amount of at least $50 each month. Again, a good guideline to follow for affordable payments is 10 percent of your discretionary income.
When you refinance, you switch from a federal to a private lender. A major benefit of federal loans is repayment flexibility -- if your financial situation changes, you can switch to an extended or income-based repayment plan. Private lenders usually won't offer the same options. Before you refinance, make sure you're comfortable making payments at the same monthly rate for the foreseeable future.
A refinanced loan will likely have a higher monthly payment than your previous loan. This higher payment saves you money in the long run, but you should be able to handle it in the short term as well.
You don't qualify for forgiveness programs or borrower benefits
Public service workers, such as government workers or teachers in public schools, qualify for federal loan forgiveness programs after ten years of service. If you're on track for Public Service Loan Forgiveness, this program's a better bet for you than refinancing. A new loan may also eliminate any borrower benefits associated with your original loans, like a principal reduction or a cash rewards program.
You've been able to start saving
To really get the best benefit from your refinanced loan, wait until you have some financial security. You should have a cushion for emergencies, so you're still able to make the same monthly payment if unexpected expenses arise.
Remember
When you refinance, you sacrifice future payment flexibility for a chance to save on overall cost. Refinancing can lower your overall payments substantially -- if you get the timing right.
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