Should you refinance your student loans?

Key points

• You can refinance both federal and private student loans into a private refinance.
• There are no prepayment penalties on federal and private student loans, so nothing stops you from refinancing your student loans.
• Borrowers often seek a refinance to get a lower interest rate or lower monthly student loan payment or to pay off the debt quicker.
• You should beware of refinancing federal student loans into a private refinance, as you’ll lose the superior benefits of federal loans.

There are many pros and cons to refinancing your student loans. You can refinance whether you have federal or private loans. But one thing to note right off the bat is that a refinance is different from a consolidation.

Loan consolidation combines two or more federal student loans into a new federal loan with a new interest rate based on the weighted average of the interest rates on the old loans. It does not change the cost of the loans by much. You cannot include private student loans in a Federal Direct Consolidation Loan.

A private refinance combines private student loans (and, in some cases, federal student loans) into a new private student loan. The interest rate is based on the current credit scores of the borrower and cosigner. It can yield a lower interest rate if the credit scores have improved.

Read a rundown of the reasons why you should and should not refinance your student loans, and how to maximize the benefits of each option.

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Can you refinance your student loans?

There are no prepayment penalties on federal and private student loans, as a matter of law. So, nothing stops you from refinancing federal and private student loans. The new loan pays off the old loans.

Some lenders will allow borrowers to include federal loans along with private student loans in a private refinance.

And lenders will allow borrowers to refinance parent loans into the child’s name, assuming the child has reached the age of majority, satisfied the required credit criteria and is willing to take over responsibility for the loan.

Tip: You can refinance as many times as you want, but it will be financially worthwhile only if you get a better interest rate each time.

Reasons you should refinance your student loans

Below are common reasons for wanting to refinance your student loans:

• Save money by qualifying for a lower interest rate. You may qualify for a lower interest rate if your credit scores have improved or if the loans were borrowed several years ago when interest rates were higher.
• Save money by switching to a shorter repayment term. A shorter repayment term yields a higher monthly payment. Not only does this pay off the debt sooner, but it also reduces the total interest paid over the life of the loan.
• Pay off the debt quicker. A lower interest rate means that more of the monthly loan payment will be applied to the principal balance of the loan. Increasing the monthly loan payment will also cause the student loan debt to be paid off quicker.
• Reduce the monthly loan payment by qualifying for a lower interest rate. Cutting the interest rate in half can cut the monthly loan payment by about 10% to 15%. However, a lower fixed interest rate is often coupled with a shorter repayment term, which can increase the monthly loan payment.
• Reduce the monthly loan payment by switching to a longer repayment term. A longer repayment term yields a lower monthly payment. For example, switching from a 10-year term to a 20-year term can cut the monthly loan payment almost in half. However, this increases the total interest paid over the life of the loan. It also means that you’ll still be repaying your own student loans when your children enroll in college.
• Change servicers. You might decide to refinance your loans to switch from one lender or loan servicer to another. This usually does not yield an improvement in the quality of customer service.
• Streamline repayment. Refinancing your student loans replaces multiple loans with a single loan with a single monthly payment, making it easier to manage your student loans.
• Qualify for a mortgage. Eligibility for a mortgage depends on your debt-to-income ratio. Refinancing your student loans to yield a lower monthly payment may reduce the debt-to-income ratio, helping you qualify for a mortgage.
• Co-signer release. Some private student loans do not offer a co-signer release option. Others have strict eligibility criteria that may make it difficult for you to qualify. If the borrower refinances their private student loans without a co-signer, it effectively releases the co-signer from their obligation to repay the debt.

Interest rates are expected to increase in 2023 due to rate hikes by the Federal Reserve — though keep in mind that if you already have a fixed-rate loan, your rate won’t change. However, if you have a variable-rate loan, it may be a good time to refinance now to lock in a lower interest rate.

You’ve heard about the possibility of broad federal student loan forgiveness? If the Supreme Court rules in favor of the Biden-Harris Administration’s student loan forgiveness plan, federal student loan forgiveness could occur. However, if the legality of this plan hasn’t been decided by June 30, 2023, federal student loan payments will resume 60 days after that. Interest rates won’t increase very quickly in the meantime, so you have time to wait for loan forgiveness, just in case it happens.

On the other hand, there’s no need to wait to refinance private student loans if you can qualify for a lower interest rate.

Reasons you shouldn’t refinance your student loans

There are several reasons not to refinance:

• Refinancing prevents targeting specific loans for quicker repayment. The avalanche method targets the loan with the highest interest rate for quicker repayment, saving you money. The snowball method targets the loan with the lowest loan balance for quicker repayment, causing it to be paid off sooner. Consolidation and refinancing, however, replace multiple loans with a single loan, preventing you from using these debt management techniques.
• Refinancing might not save any money. Compare the weighted average of the interest rates on the old loans with the new interest rate. If the new interest rate is higher, the refinance will increase your costs instead of reducing them.
• A lower fixed interest rate may require a shorter repayment term. In a rising-rate environment, loans with a shorter repayment term will have a lower fixed interest rate than loans with a longer repayment term.
• Refinancing may increase the repayment term, increasing the cost of the loan. A longer repayment term reduces the monthly student loan payment, slowing the repayment trajectory. This increases the total interest paid over the life of the loan, even if you qualify for a lower interest rate.
• If refinancing saves money, it is mostly due to a shorter repayment term, not a lower interest rate. Typically, more than three-quarters of the savings from refinancing comes from a shorter repayment term, not a lower interest rate. Thus, most of the savings could be achieved by making bigger monthly loan payments or extra loan payments without refinancing.
• Refinancing federal student loans will lose the better benefits of federal loans. Federal student loans have longer deferments and forbearances, offer income-driven repayment and other flexible repayment plans, and provide various discharge and forgiveness options. Federal student loans held by the U.S. Department of Education are eligible for the payment pause and interest waiver during the pandemic. Broad student loan forgiveness, if it happens, will likely be limited to federal education loans.
• You can’t change your mind. Refinancing your student loans is irreversible. You can’t undo the refinance.

Tip: When evaluating the impact of a private refinance, compare both the monthly loan payments and the total payments over the life of the loan. A lower monthly loan payment may increase the total cost of the loan by stretching it out over a longer repayment term. A higher monthly loan payment may save more money by reducing the repayment term.

How to refinance your student loans

The first thing to consider when you want to refinance your loan is your credit score: The higher it is, the lower the rate you can get for your refinance.

So check your credit reports at least a month before applying for a private refinance. You can check your credit reports for free at AnnualCreditReport.com. If there are any errors, you can get them corrected by disputing them. The creditor has 30 days to confirm the accuracy of the report or remove the incorrect information. Correcting errors can improve your credit scores, thereby increasing the odds of approval. It may also reduce the loan’s interest rate if you are approved.

You can increase your odds of approval by applying with a creditworthy co-signer. The majority of private student loans are co-signed. Even if you can qualify for a private refinance on your own, applying with a co-signer may qualify you for a lower interest rate. Interest rates are based on the better of the two credit scores.

Tip: Eligibility for a private refinance is generally based on your (and your co-signer’s) credit scores, income, debt-to-income ratio and duration of employment with the current employer.

Shop around for the best loans for you. Apply for a private refinance on the lender’s website to learn the actual interest rate you’ll get. Very few borrowers get the lowest interest rate advertised by lenders. If you apply for several loans within a short period of time, it will not have much of an impact on your credit scores, as the credit bureaus recognize shopping-around behavior.

You can also search for a private refinance on a student loan marketplace. But, beware that most student loan marketplaces do not list all of the private student loans, just those that pay to be listed.