America has a real debt problem. With the national student loan debt now sitting somewhere around $1.6 trillion, it’s very clear that you need to seize any opportunity you can to diminish your contribution to the statistic.
Low-interest rates make the present an incredible time for you to refinance your student loans. Indeed, it is only through refinancing that you will be able to take advantage of these low rates anyway. In this article, we explain how interest rates and refinancing work to help you better understand the unique position borrowers are currently in.
How are student loan interest rates determined?
Federal student loan rates are set annually. The determination happens in May and is a response to the 10-year treasury. This means that the low rates we are seeing right now will have no bearing on what you pay for your own loans—with one exception.
Borrowers that refinance into the private loan sector will be able to immediately take advantage of the new rates. Loans in this sector tend to be more flexible and can be either fixed or variable. Terms may also be more tailored to your situation.
For instance, private loans may be informed by variables such as your credit score, your terms of employment, your income, and possibly even your education. Private loans often move in fluctuation with the 1-month LIBOR (London Interbank Offered Rate).
In response to Covid-19 and its impact on the market, the Fed has cut rates substantially—an opportunity that puts borrowers in a unique position. However, going in with a strategy is key to ensuring that you experience all possible benefits.
Student Loan Refinancing Strategies
You can’t go into refinancing blind and expect to see good results. The situation is no different than any other financial determination: without a strategy, it’s probably not going to go very well.
Don’t assume that all lenders are the same. For one thing, rates may vary from place to place. Terms can also vary from place to place. For example, some lenders may tailor their policies to specifically suit a certain type of person. Said customers then receive favorable terms.
Consequently, you will find it to your advantage to seek programs that are the most specific to your situation. It is in doing so that you will get the best possible rates.
Consolidate or Refinance?
There is more than one option as you reconsider your borrowing situation. When you refinance, your loan is taken to a new entity. This lending company pays off your previous loan and then sets the entirety of your debt into a new loan, complete with a different interest rate, and possibly, unique terms.
Consolidating is a little bit different. When you consolidate your loans, all student debt is lumped together in a single entity and fixed into a new rate that accounts for the average of your loans.
Consolidation does not see all of the potential benefits that can be derived from refinancing but does win out in a single key category—simplicity. You lose out on flexibility but benefit from the straightforwardness of the maneuver.
Timing is Everything
You can address your loan situation in a piecemeal sort of way if that is most suitable to your situation. For example, if money is a little bit tight, you may find it most sensible to go after loans with higher interest rates first, and then work from there.
Bear in mind that lifestyle factors may also determine whether or not now is the time to refinance. Refinancing can have a temporary impact on your credit score, and may also tighten your cash to debt ratio in the short term.
Consequently, it may not be optimal to refinance if you are in the middle of a major purchase (a house, a business, etc.). You can, however, still benefit from tackling loans with the highest interest rates.
You Should Try to Do Everything at Once (But You Don’t Have to)
That said, the faster you refinance for better rates, the sooner you enjoy long term savings. If your finances permit it, locking into the most advantageous rates possible will make the most sense for your financial health.
However, monthly expenditure does typically go up when you go from a federal loan to a private one. The reason for this is simple: shorter loan periods. For example, if you go from a 30-year federal loan to a 15-year private loan, your monthly payments may go up significantly.
You save in the long run, but you also put yourself in a potentially precarious situation. If something in your finances changes, or if you encounter a sudden emergency, your new loan situation could quickly become burdensome.
Account for these variables as you consider your situation. If you can tackle all of your loans at once, great. However, you should still note that you can reap benefits just by targeting one or two high-interest loans.
The Best Rate That Works for Your Finances
It all comes down to finding the best rate for your finances. This could even mean prepaying loans, and/or combining a repaying approach with a refinancing option.
When you prepay loans, you aren’t changing your rates, but you are saving money on interest in the long run. This is particularly advantageous if you want to keep your monthly finances a little bit more flexible.
What You Need to Know Before Refinancing Your Student Loans
Understand that by refinancing, you may lose out on special opportunities (deferments, etc.) that are only available on the federal level. Once you refinance privately, you will remain in that situation for the life of your loan.
Refinancing may not be right for people who aren’t prepared to repay their loans relatively quickly. Consider your personal finances as they relate to your loans before making any decisions.
The majority of you should refinance.