Borrowers have a tremendous amount of student loans. It’s estimated that the total federal student loan debt is at $1.6 trillion, and private student loan debt exceeds $123 billion.
With so much debt, many borrowers are turning to student loan refinancing to lower their interest rates and repay their loans. But how does student loan refinancing work, and how are student loan refinance rates determined? Here’s what you need to know before refinancing your loans.
How does student loan refinancing work?
Student loan refinancing is a process where you work with a private lender to take out a loan for the amount of your current education debt. You can refinance federal or private student loans and qualify for a lower interest rate, different repayment term, and even a lower monthly payment. Refinancing your loans can help you save money over time or pay off your loans faster.
How are student loan refinance rates determined?
When thinking about refinancing, it’s important to know that rates can vary a great deal from lender to lender. And, not all borrowers will qualify for the lowest advertised rates. Lenders determine your individual interest rates based on the following five factors:
1. Interest rate type
What are student loan refinance rates, and how do they work? When you refinance your student loans, you have the option of choosing variable or fixed interest rates.
Variable interest rates tend to start lower than fixed rates. However, they can fluctuate over the life of your loan, impacting your monthly payments and how much interest accrues on your loan.
Fixed interest rates are usually higher than variable rates, but they’ll never change, and your payments will never increase.
Variable rates are best for borrowers who want to pay off their loans as quickly as possible. They can take advantage of the lower initial rate to accelerate their debt repayment and pay off the loan before the rate increases too much.
For borrowers who don’t want to worry about market changes, fixed interest rates make more sense since you’ll have a set monthly payment.
When establishing variable interest rates, student loan refinancing lenders look to the London Interbank Rate (LIBOR). The LIBOR interest rate is the rate at which banks are willing to lend to one another.
The LIBOR isn’t the rate you’ll pay when you refinance your loans. Instead, refinancing lenders use it as an index that guides their rates. Lenders will typically charge you the LIBOR rate plus a percentage for their margin.
For example, the three-month LIBOR rate is 0.206% as of November 23, 2020. If a lender’s rates are the LIBOR plus a 2% margin, your interest rate would be 2.206%.
The LIBOR rate is constantly changing, so your rate can increase or decrease based on the LIBOR’s performance.
3. Credit score
Your credit score has a significant impact on what interest rates you’ll qualify for when you refinance your student loans. Lenders tend to reserve the best student loan refinance rates for borrowers who have an excellent credit score, meaning a score between 800 and 850.
|Credit Score Range||Rating||Percentage of Population|
|300 – 578||Very Poor||16%|
|580 – 668||Fair||17%|
|670 – 739||Good||21%|
|740 – 799||Very Good||25%|
|800 – 850||Excellent||21%|
If you have a lower score, you might still qualify for a loan, but you will likely have to pay a higher interest rate. To improve your loan application, focus on boosting your credit score. Make all of your monthly payments on time, pay down existing debt, and limit new credit applications.
If you have less-than-perfect credit or insufficient income, it can be difficult to qualify for a loan with a competitive interest rate on your own. However, some lenders allow you to add a cosigner to your application. A cosigner — someone with good to excellent credit and a steady source of income — applies for the loan with you, sharing responsibility for its repayment.
By adding a cosigner to your application, you become a more attractive candidate for a loan. Lenders are more likely to approve you and give you a lower rate than if you applied by yourself.
5. Loan term
The lowest interest rates are typically associated with shorter loan terms. If you want the best possible rate, opt for a loan term of five to eight years; you’ll get a lower rate than if you applied for a loan with a term of 10 to 20 years. Plus, you’ll pay off your loans earlier, eliminating that burden from your life.
When to apply for student loan refinancing
If you’re trying to decide when the best time to refinance your loans is, you should know that current refinance rates are at historic lows.
Rates can vary from lender to lender, so it’s a good idea to comparison shop before submitting an application. Purefy’s Compare Rates tool makes the process quick and easy; just fill out one simple form, and you’ll get quotes from top refinancing lenders without impacting your credit score.
Keep in mind that there’s no limit on how many times you can refinance your loans. If you refinance now and your credit improves or interest rates drop later on, you can refinance your loans again to take advantage of the lower rates.