What is student loan refinancing and how does it work?

Student loan refinancing is when you apply for a new loan to pay off your current student loans. Refinancing student loans can be daunting, but it can also offer significant benefits for borrowers. With the potential to lower interest rates and save money in the long run, refinancing can be an attractive option.

However, it’s important to understand the process and potential risks before making a decision. From federal student loan refinancing risks to how to find the best refinance loans, here’s what you need to know.

How does student loan refinancing work?

Understanding how refinancing student loans works is important before you decide to make such a significant financial decision. If you decide to refinance your student loans, you’ll need to choose which loans you want to refinance.

Refinancing is available only through private lenders, which is an important consideration as you decide which loans to refinance. You’ll lose protections like specialized repayment plans and potential loan forgiveness when refinancing federal student loans.

1. Research lenders

You’ll want to find lenders offering the lowest interest rate and most favorable loan terms for your needs.

Consider each lender’s available payment plans, too. Some offer a single option, while others let you customize your repayment timeline to suit your budget. Keep hardship options in mind should you encounter financial hardship in the future.

Finally, research each lenders’ reputation on sites such as TrustPilot.

2. Get prequalified

Many lenders offer prequalification — where you enter basic information about yourself and your existing loans in exchange for a rate quote. Unlike a formal application, prequalification does not hurt your credit score. It’s the best way to compare the rates available to you among lenders. That said, you’ll need to formally apply after selecting a lender, which does require a hard credit pull.

If you have poor credit or a low income, you may not be approved to refinance your student loans. It’s possible you could qualify with a co-signer who has a better credit history.

3. Begin repaying the new loan

Once approved for a loan, the loan funds will be used to pay off your existing student loans. From there, you’ll begin making payments on your new refinanced loan. With a lower interest rate or shorter repayment term, you’ll pay less over time on your refinanced loan than you would have with your previous loans.

Who is eligible for student loan refinancing?

With the question of ‘What is student loan refinancing?’ addressed, another important factor to consider is eligibility requirements. There’s no minimum standard for refinancing; each institution determines what constitutes an eligible borrower for itself.

Factors that affect eligibility

As you search for a student loan refinance loan, consider how you stand in each of these qualifying categories:

• Your credit score: Your credit is the biggest factor in getting approved for student loan refinancing. The higher your credit score, the more likely you are to get approved and secure the lowest interest rate offered. Most lenders like to see a credit score of at least 650 and a credit history free of late payments.
• Your debt-to-income ratio: The more debt you have, the riskier you look to lenders. It shows them you’re less likely to make payments in case an emergency arises. Before applying for refinancing, try to get your debt-to-income ratio below 50 percent.
• Your job: You’ll need to prove that you have a steady income and can financially afford the payments. Many lenders set a minimum annual income, though the amount varies and may not be publicly shared.
• Your loans: Lenders establish a minimum amount you can refinance. If you have less than $5,000 left on your loans, you may have difficulty finding a lender willing to refinance.
• Your graduation status: Some lenders will let you refinance if you don’t graduate, but most lenders require you to complete a program before you can refinance.

When is student loan refinancing a good idea?

Borrowers with high interest rates on private loans are the best refinance candidates because they have the potential to save the most money. But even without a better rate, refinancing to a shorter term can also help you save. However, you’ll have a higher monthly payment.

For example, let’s say you owe $50,000 with a 12 percent interest rate and a 10-year term. The table shows how your savings would break down if you refinanced to a 6 percent rate or kept the same rate but refinanced to a shorter term.

Based on these figures, either option would save you about $20,000 in interest.

You can use a student loan calculator to estimate how much you could save.

Other people who may want to consider refinancing their student loans include:

• Borrowers who want to consolidate multiple loans into one.
• Borrowers with large monthly payments who qualify for a longer repayment period.
• Borrowers who want to release their co-signer from an existing loan.
• Borrowers who have a higher income or better credit score than when they took out their original loan.

When is student loan refinancing a bad idea?

Refinancing is not the best option for everyone. Borrowers with federal student loans, in particular, should think carefully about the drawbacks.

Refinancing federal student loans takes away many of their benefits. For instance, you will no longer have the option to pursue loan forgiveness through programs like income-driven repayment plans or Public Service Loan Forgiveness.

You should also think twice about refinancing if:

• You’re offered a higher interest rate than what you’re currently paying.
• You’re offered a longer repayment term than your current loan term.
• You’re near the end of your loan term.

How student loan refinancing can help your credit score

Refinancing student loans can impact your credit score for the worse or for the better, depending on your financial situation.

How student loan refinancing can help your credit score

If you manage your money right, refinancing could improve your credit. This is particularly true if refinancing helps you make your monthly payments. These factors have a positive impact on your credit score:

• Consistent payment history: Paying your loans by the due date proves that you are a responsible borrower, and those timely payments will translate to a higher credit score.
• More affordable payments: If you were struggling to make payments before, refinancing could be a good way to lower your monthly bill, making the expense more manageable. A more affordable bill, in turn, can make it easier to stay on top of your monthly payments moving forward, allowing you to establish a solid track record of consistent, on-time repayment.

How student loan refinancing can hurt your credit score

There are a few circumstances where refinancing could be detrimental to your credit score. In most cases, however, the impact is temporary and relatively small. Here’s what may cause a dip in your credit score:

• A hard credit inquiry: Refinance of any loan will require a hard credit check. Lenders want to see whether you have a history of responsibly using credit and repaying debt. Hard credit checks can knock a few points off your credit score.
• Multiple loan applications: If you apply with several lenders to secure the best loan terms and rates possible, you could also end up with multiple inquiries impacting your score. To avoid this type of ramification, completing all applications within a few weeks or a month is often best. Credit scoring models typically consider all loan inquiries within about 45 days as one inquiry, which reduces the impact on your score.
• Replacing an old account with a new one: The age or length of your accounts is one of the factors credit bureaus use to calculate your overall credit score. Credit history accounts for 15 percent of your FICO score. When you refinance, you replace an old credit account with a new one. This reduces the average age of your accounts, which can have a small negative effect.
• Missed payments: The biggest impact on your credit score is your payment history. If you’re overambitious with your monthly payment when you refinance and miss a payment, your credit score could drop significantly. Your payment history makes up 35 percent of your FICO score.

The bottom line

Now that you know what refinancing student loans means, it’s important to remember when it can be a beneficial move. Student loan refinancing can help some borrowers save money by allowing them to swap out their existing loans with a new private loan with a lower rate.

That said, it’s not the right choice for everyone. If you have federal student loans, consider that refinancing means giving up access to benefits like federal forbearance and student loan forgiveness programs.

If you believe refinancing is right for you, compare rates, terms and fees from as many lenders as possible.

Frequently asked questions

• Can you refinance federal student loans?

  Yes, you can refinance federal student loans. Doing so requires you to take out a private student loan to pay off your existing federal student loans.

  But before you refinance your federal student loans, understand that you’ll lose access to federal benefits, such as income-driven repayment (IDR) plans and student loan forgiveness programs.

• How often can you refinance student loans?

  Provided you qualify, you can refinance as often as you want.
  There’s no set limit. However, keep in mind that if you refinance too often, it can hurt your credit score.

  When you apply for a private student loan, a lender usually performs a hard credit check to assess your credit health, which results in a temporary ding to your credit score.

• When is the best time to refinance student loans?

  The best time to refinance depends on several factors, such as your credit score and income.

  Refinancing could be a good idea if you have a steady income and your credit has improved since taking out your original loan.