No student loan forgiveness? Take a look at the loan refinance before the rate hike

What is happening

President Biden recently announced a $10,000 to $20,000 rebate on federal loans. If you have private student debt, you are not eligible for this discount, but refinancing can help you save money.

why is it important

Refinancing student loans can help you get a lower or fixed interest rate. With rates expected to continue to rise, refinancing earlier may be wise.

As federal student loan borrowers received big news last week – Discount of $10,000 to $20,000 for eligible beneficiaries and a extended pause on payments and interest until 2023 – those who owe money on private student loans still face the same burden of debt and payments. Private loans represent just over 7%or $148 billion, of existing student loan debt.

Not only are private student loan holders ineligible to have their loan forgiven, but those with variable interest rate loans face the possibility of increased payments. The The Federal Reserve has raised interest rates to 2.25% in 2022 via four rate hikes, and the agency is likely not done yet. New minutes from the last Fed meeting say another 0.5% increase is coming when the board meets in September.

If you hold student loans with a high annual rate, you may want to consider refinancing your student loans before interest rates rise further. Here’s everything you need to know to get started with student loan refinancing. To learn more about student loans, find out how the Civil Service Loan Cancellation Program can cancel all federal student loans and how some employers help workers with student loan debt.

Refinancing Private vs. Federal Loans

Student loan refinancing means you take out a new loan that pays off your existing debts. Refinancing only makes sense if you can find a lower interest rate than what you are currently paying or a good fixed rate that you can lock in for the life of the loan. You can also choose a longer loan term to lower your monthly payment, although you’ll end up paying more overall.

If you have student loan debt, you have either a private loan or a federal loan – private loans are made by a lender such as a bank, state agency, or school, while federal loans are funded by the federal government. We think that 90% of student loan debt held is federal loans. It makes more sense to refinance private loans, which tend to have higher interest rates, rather than federal loans, which tend to have lower interest rates and more regulation.

When you refinance a private loan, you do so with another private lender. You cannot refinance a private loan with a federal loan. Student loan expert Mark Kantrowitz, author of How to Apply for More College Financial Aidsays if you have a private loan, it is advisable to refinance a fixed rate loan before interest rates are rising.

Although payments remain suspended until the end of 2022, if you have federal student loans, you may consider refinancing if you are concerned about paying the monthly payment when the freeze is lifted. In this case, there are other options you should explore first, such as a income-based repayment plan, which can help make monthly payments more affordable. You should also check your eligibility for additional loan forgiveness programs like Cancellation of civil service loans and the Teacher Loan Forgiveness Program.

If you have a federal loan, the only way to refinance is through a private lender — unless you’re refinancing federal loans through the PSLF program — which will eliminate some of the benefits that come with government loans. For this reason, refinancing your federal student loans is often discouraged, but if you still think it’s the right choice, wait until you receive qualifying loan forgiveness before refinancing, so you don’t miss out on this benefit.

What to consider before refinancing

1. Check your credit score and improve it if necessary

In order to qualify for a lower interest rate than your current loan, you will need a good credit score. A FICO score of at least 670 is considered “good” and can help you qualify for student loan refinancing – a higher credit score may also qualify you for even lower rates.

Your current loan repayment history will also impact your credit score: if you’re struggling to pay your current student loans and have missed payments, lenders may be hesitant to sign you up for a new one.

If your credit is “bad” — a FICO score below 580 — talk to your lender about adjusting your payment plan so you can get back on track. Work on improving your credit by paying off your debt and making your payments on time.

Before refinancing, Kantrowitz advises checking your credit reports (which is completely free in 2022) and troubleshooting. If you find items that do not apply to you or if you have incorrect information, you can challenge them — your creditor will have 30 days to confirm the accuracy of your report or remove errors, so it’s best to check your credit report at least 30 days before refinancing.

2. Assess your debt to income ratio

Lenders will likely look at your income, your co-signer’s income (if you have one), and your debt-to-equity ratio, which is your total monthly debt payments divided by your total gross monthly income.

Your income level shows lenders that you are making enough money to repay your loans and meet your payments. Kantrowitz suggests looking at refinancing minimum income thresholds, which typically hover around $30,000.

Your DTI ratio represents the debt you hold compared to the amount of money you earn. A high DTI, which shows you have a lot of debt, could be a red flag for lenders. For example, if you have a monthly debt of $1,000 and earn $4,000 per month, your DTI would be 25% ($1,000 divided by $4,000). However, if you have monthly debt of $2,500 and earn $4,000 per month, your DTI will be much higher – 62.5% – which could affect your ability to get a new loan.

To refinance your student loans, you generally want to have a DTI of 50% or less.

3. Compare student lenders

It’s important to shop around with different lenders to make sure you get the best rates and terms. The interest of refinancing is to pay less, either in lower interest from a reduced rate, or in more affordable monthly payments over a longer term.

Kantrowitz points out that borrowers need to consider monthly loan payments, total repayment terms and interest rates. “Remember that longer repayment terms mean lower monthly payments, but more interest over the life of a loan. Try to avoid repayment terms longer than 10 years and be sure to choose a plan that offers the highest monthly payment you can afford.”

4. Check if you are prequalified for a new loan

When researching lenders, many may offer the option to prequalify, allowing you to see what your potential interest rates and monthly payments would look like. Depending on the change from the terms of your current loan, you can decide if refinancing is right for you. Prequalification requires a soft credit draw, so it won’t affect your credit score. Keep in mind that prequalification does not guarantee loan approval or specific rates.

5. Consider a co-signer for your student loan

Student loan refinance lenders often allow you to add a cosigner to your loan — or release one. If you don’t have a long-standing credit history, you may need someone with good or excellent credit to co-sign your loan. When you add a co-signer, they take responsibility for the loan with you. This means your co-signer will have to make payments if you can’t, and your repayment history will impact their credit score as well as yours.

Conversely, if you want to release a current co-signer, you can refinance a private student loan in your name alone. To do this, make sure you meet the criteria for credit and consecutive on-time payments.

Next steps to refinance

Once you’ve committed to refinance your student loans, there are steps you can take to get the interest rate and payment plan you want.

First, start shopping around with other student lenders. Compare rates and terms and get prequalified to browse your options and decide which loan term and lender best suits your budget. Once you have chosen a lender, you submit a formal application and wait for their approval, which usually takes two to three weeks. Once your new lender approves your application, they will repay your old loan directly and you will begin making regular payments to your new lender.

For more information on student loans, learn more about President Biden general student loan cancellation planfind out if canceled student loans increase your tax bill and understand how loan forgiveness can impact your credit score.

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