With the low-interest rates that have come with the coronavirus pandemic, this is an ideal time for some people to refinance their student loans, depending on the type of loan they have.
Student loans are one of the biggest financial undertakings people face, and legislators aimed to limit their burden when they suspended federal student loan payments and the accrual of interest until September 30. Since payments have been paused, borrowers with federal loans will likely want to wait to make a decision on refinancing, but for those with private loans, it's a no-brainer, experts told Newsweek.
"There is no reason why borrowers should not refinance private student loans, if they can qualify for a lower interest rate," Mark Kantrowitz, publisher and vice president of research for Savingforcollege.com, told Newsweek.
Interest rates for undergraduate student loans are at historic or near historic lows, Kantrowitz said, but eligibility depends on a borrower's credit score, debt-to-income ratio and duration of employment. Although some lenders are accommodating borrowers whose employment was disrupted because of the pandemic, those with steady employment and high credit scores are more likely to qualify for refinancing and be offered a lower interest rate.
When it comes to refinancing, the higher the credit score the better. Anna Helhoski, a student loans expert at NerdWallet, said borrowers will need a minimum score in the high 600s. For those who can qualify, she said, refinancing private student loans is the "smartest option" they have.
Even decreasing the interest rate on a loan by a few percentage points could save people "hundreds if not thousands of dollars," over the course of the loan, said Tara Falcone, a CFA, CPA and founder of ReisUp. It's important to read the fine print, though, and experts say pay attention to the length of the loan, as well as the type of interest rate.
Some deals will have a lower interest rate, giving the impression that a borrower will save money. But if the deal extends the term of the loan, it ends up costing more in the long run, Falcone said.
Fixed versus variable interest rates can also heavily affect the amount a borrower pays over the loan's lifetime, Kantrowitz explained. Although variable rates may be lower initially, they can only go up, so a fixed rate is "probably the smartest option" since they're still "extraordinarily low."
"The only circumstance in which a variable rate is preferred should be when the borrower will pay off the loan in full before interest rates rise too much," Kantrowitz said.
Since credit scores are a major factor in determining a borrower's eligibility for refinancing, Katherine Creed, an investment adviser representative at Cetera Investors, recommends that people know that number before making any moves. When lenders pull a person's credit score, it's considered a "hard inquiry" and can have a negative impact on their overall score.
So instead of going to the lender with knowing your credit score is, Creed recommends using a credit bureau, such as Experian, Equifax or TransUnion, which can provide a credit report and a credit score. This way, a borrower knows if refinancing is an option before a hard inquiry is done.
Aside from the hard inquiry, which will have only a minimal impact, there's little downside to refinancing for private loan borrowers, but that's not the case for those with federal student loans.
There are certain benefits for people with federal loans, such as longer deferments and forbearances, death and disability discharges, income-driven repayment and loan forgiveness options. When a person with a federal loan refinances, it becomes a private loan, so Kantrowitz said people need to consider the "the trade-off between the loss of these benefits and the possibility of lower interest rates."
Another benefit federal loan borrowers will give up by refinancing is the payment pause afforded under the federal CARES Act. Democrats are looking to extend that suspension until September 30, 2021, but with a congressional deal on the next economic relief package in flux, Helhoski said right now is not the time to refinance a federal loan.
"If that forbearance isn't extended, federal loan borrowers should still think twice about refinancing, because they'll lose options to lower payments through income-driven repayment and potentially miss out on any additional protections in the future," Helhoski said.
Even though payments are paused, Creed said, this is a "great time" to attack the principal on a person's loan. So if a person is financially able to make payments, he or she "absolutely" should. As a financial adviser, she cautions people against using enhanced unemployment benefits to pay down their loans before speaking to an expert, as this could leave them without an emergency fund.
Borrowers need to approach a strategy for their loans by analyzing their own individual situation and shouldn't try to follow a one-size-fits-all plan. But the one thing Falcone said no one should do is default on payments.
"No matter what is going on in your financial life, there are ways to defer or go through forbearance that simply not making the payment will not afford you," Falcone said. "If you decide to just not make a payment, it can ruin your credit for years to come, and it'll end up costing you so much more on anything in the future."
