Pros and cons of refinancing student loans

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If you’re one of the 42 million borrowers saddled with federal student loans, you’ve likely come across websites or advertisements urging you to refinance your loans at a much lower interest rate.

Refinancing student loans essentially means that you are trading your current loans to a private lender in exchange for a new loan (hopefully with good financing) that you agree to repay in return.

When you refinance, you can often lower the amount of interest you owe on a monthly basis, which will help you save on monthly payments over time. Refinancing also allows you to choose a more ideal payment plan with the option of repaying the loan over many years or more aggressive repayment over a shorter period of time.

However, there are also disadvantages to consider before deciding to refinance student loans. Below, CNBC Select analyzes the pros and cons of such a step.

Pros of Refinancing Student Loans

The biggest benefit of refinancing student loans comes when you qualify for a lower interest rate, which can help you pay off your principal faster and / or reduce your monthly payment.

Lower monthly payments free up cash that you can use for other expenses or invest in high yield savings account getting above average interest, for example Markus, Goldman Sachs. High return on online savings.

Here are a few more pluses to consider when refinancing student loans:

  • Refinancing allows you to change your payment plan: Once you are eligible for refinancing, you can choose a new loan term, whether it be five, 10 or 20 years. By setting a new maturity, you can decide how quickly you want to pay off your loans. Shorter terms mean more aggressive monthly payments, while longer terms mean lower payments.
  • Your payments are ordered and grouped together: Instead of paying multiple monthly payments to different lenders, refinancing can help you make only one monthly payment to one lender.
  • There is an opportunity to apply with a co-author: Lenders like to see good creditworthiness and low debt-to-income ratio when approving borrowers for refinancing. If you are not eligible, you may have the opportunity to ask a collaborator who meets these criteria to apply with you.
  • Lower monthly payments improve your overall financial picture: When you refinance and get a lower interest rate on your student loans, it’s easier to avoid missing out on a payment. Timely payments are critical to having a healthy credit rating that can help you qualify for the best credit cards and achieve life milestones like your first home mortgage.

Cons of Refinancing Student Loans

The biggest disadvantage of refinancing student loans is the denial of the protections you would otherwise get with federal loans, such as income-driven repayment plans.

Refinancing would also mean the loss of student loan payments and an interest freeze that has been in effect since then. CARES Law passed in March 2020., which the Biden extended at least until September 30, 2021. In addition, you will miss the opportunity federal student loan forgiveness as soon as your loans go from federal to private.

While private student loan lenders do not offer the same protection that you get with federal loans, they do have some alternatives. Some private lenders offer a grace period in the event of unemployment or economic hardship, and the option to pay only interest payments before maturity begins. Be sure to check with a private lender about these safeguards before refinancing.

Here are a few more cons to consider when refinancing student loans:

  • Not every borrower is eligible for refinancing: To get approved, you will probably need good credit and a low debt-to-income ratio (DTI). This shows lenders how much of your monthly income goes towards paying your bills. Usually, a minimum of 650 credit points are required to be eligible for refinancing, but a score of 700 gives you a much better chance of qualifying. Lenders are looking for a DTI below 50%, but the lower the better. To calculate your DTI, divide your total monthly payments by your monthly earnings. Borrowers who do not qualify on their own often need a co-author to do so.
  • Your credit score helps determine the new interest rate: The better your credit rating, the higher your interest rate. However, keep in mind that there is no guarantee that your rate will be lower.
  • Refinancing can extend the maturity of loans: Refinancing student loans when you’ve already paid half of their payments may give you lower monthly payments until the end of the term, but it can increase the amount of time it takes to pay them out in full.
  • You may not get a much lower interest rate: Before choosing refinancing, use student loan refinancing calculators like Sophie to find out how much you will actually save on interest compared to what you are paying now. Many lenders also offer prequalification tools in which borrowers can enter their information to obtain a rate quote without having to submit an actual loan application (resulting in hard loan request). Prequalification allows you to select the best customized rates and conditions so you have a better understanding of what to expect in the event of refinancing without compromising your credit.

Bottom line

Editorial note: The opinions, analyzes, reviews or recommendations expressed in this article are solely owned by the Select editors and have not been reviewed, endorsed or otherwise endorsed by any third party.

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