Male student sitting in a classroom considering student loans and learning how to refinance student loans.
17 September 2021

For students and their families, college life is an exciting time. But with that excitement comes the reality of how to pay for it all. In addition to the grants, scholarships, and savings put aside, borrowing money through private or federal student loans is a good option to cover remaining costs. When a student leaves college or graduates, the repayment of their student loans will start, so it’s important to be knowledgeable and as prepared as possible.

One of the best ways to financially manage the repayment of student loans over time is through student loan refinancing. Some student loan borrowers have an opportunity to lower the interest rate on their loans, extend or reduce the repayment term, or a combination of these benefits. While the motivating factor behind refinancing student loans differs from one borrower to the next, it’s necessary to understand what refinancing is, how it works, and if it makes sense for you from a financial perspective. 


What Is Student Loan Refinancing?

Refinancing student loans involves the process of taking out a new loan. The new loan is used to pay off the remaining balance of a previous loan or loans, and then repayment begins on the new, refinanced loan. Online lenders and financial institutions offer student loan refinancing to well-qualified borrowers, up to certain limits and with varied loan terms. 

The purpose of getting a new loan through a refinance is to change the terms inherent to the original loan or loans. For instance, borrowers may have the opportunity to lower the interest rate by refinancing, which could help reduce the total amount paid over the life of the loan. In other cases, the length of time repayment takes place, known as the repayment term, may be extended or reduced with a refinanced student loan. 

Extending the repayment term may help lower the monthly payment required. However, a longer payment term with a lower monthly payment could mean a higher total cost of borrowing. On the other hand, reducing the repayment term may increase the monthly payment. While the monthly payment obligation may be higher, the borrower could enjoy paying off a student loan balance quicker.


What Is the Difference Between Refinancing and Consolidating?

Refinancing is often used interchangeably with the term “consolidating” in the student loan world. However, consolidating a student loan is different from refinancing. Consolidating is the process by which federal student loans are transitioned into a single loan or fewer loans, but with a weighted average interest rate based on the original loan interest rates. Refinancing doesn’t take into account the interest rate on current loans to determine the new rate. Rather, this is done by evaluating a borrower’s creditworthiness. Additionally, refinancing is offered through private lenders and isn’t restricted to only federal student loans.


How Loans Borrowers Can Refinance

Borrowers with either federal or private student loans have the opportunity to refinance to a new student loan if the benefits outweigh the costs of doing so. Refinancing federal student loans requires getting a new, private loan to pay off the balance of the original federal loan or loans. Similarly, refinancing private student loans means obtaining a new loan to pay off the original loan or loans, often from a different private lender. Whether refinancing federal or private student loans, borrowers who refinance end up with a new private student loan with different terms than the original loans they had. 

Refinancing doesn’t have to be an all-or-nothing strategy, however. Borrowers can refinance a portion of their private or federal loans, or all of them, depending on what they’re trying to achieve with the refinance. For instance, if a federal student loan has a lower interest rate than what is offered for a refinanced private loan, it may make the most financial sense to keep that specific federal student loan out of the refinance mix. 

Also, borrowers can combine federal and private loans into a single refinanced loan, so long as the new lender approves the new loan amount. Lenders may also have requirements surrounding which loans can be refinanced, based on the college or university the student attended and used the original funds. In many cases, lenders have an approved list of institutions that meet their requirements, and borrowers can check with the lender they select for a refinance to ensure their original loans qualify.


How Student Loan Refinancing Works

The process of refinancing student loans is a bit more nuanced than obtaining a federal student loan. Whether refinancing federal or private loans, borrowers must first consider which lender they want to use for the refinance. The first step is to evaluate a few different lenders based on the interest rates they offer, the repayment terms available, and other perks that may come with the refinanced loan. Utilizing a student loan refinance marketplace, such as our partner Splash Financial, can be beneficial in this process. Splash Financial compiles student loan refinancing offers from online lenders, banks, and credit unions in a single platform, helping streamline the process of selecting a refinance lender. 

Although many lenders initially offer quotes for refinancing online or over the phone, the new loan terms are only fully known once a complete application is submitted. An application for student loan refinancing is similar to other loan applications; borrowers must provide personal identifying information, including name, home address, and date of birth, as well as income information. In addition, lenders require a credit check for all borrowers listed on an application. 

Because private student loans do not require collateral—an asset or account used to back the loan in case of a default—the borrower’s credit history and score are used to determine if they’re an acceptable risk. As a result, a borrower with little to no credit history or a low credit score due to financial mistakes in the past may not be easily approved for a student loan refinance. Additionally, borrowers with a low or unsteady income aren’t likely to qualify on their own. 

Suppose these financial issues present challenges in the refinance application process. In that case, a co-signer may be used to improve the chances of getting approved. A co-signer is another person listed on the loan who, in theory, has stronger credit, more reliable income, or both. It’s essential to understand that co-signers are as responsible as the borrower when it comes to repaying the refinanced loan.

Once a student loan refinance application is accepted, the lender will provide you with the loan details, which include the repayment term, often ranging from five to 20 years, the interest rate, either variable or fixed, and the required monthly payment based on the selected loan terms. As the borrower, you can then determine if the student loan refinance meets your needs. If so, the loan is processed, and funds are sent to the original loan(s) to pay off the remaining balance. You will then begin payment on the new refinanced loan.


Benefits and Downsides of Refinancing

Student loan refinancing exists as a way to help borrowers better manage their loan obligations over time. One of the most noted benefits of refinancing is the ability to lower the total cost of borrowing by reducing the interest charged on the loan. A reduction in the interest rate can drastically reduce how much a borrower pays over the life of a loan. Many private lenders offer lower interest rates than federal student loan rates. In addition to a potentially lower interest rate, refinancing may also pave the way for more manageable monthly payments. Refinancing could extend the repayment term, making monthly payments lower. Alternatively, borrowers wanting to speed up the repayment process can shorten the repayment term. While the latter increases the monthly payment, the total repayment timeline can be significantly reduced. 

Although these advantages to student loan refinancing are promising for some borrowers, downsides exist. First, refinancing federal student loans to private loans takes away the inherent benefits of federal loans. For example, borrowers no longer have access to income-based repayment plans or potential loan forgiveness through federal forgiveness programs. Also, forbearance and deferment of payments due to financial hardship may not be available through private refinanced student loans. 

It’s also important to note that while interest rates on refinanced student loans can be lower than other private or federal loans, borrowers need to pay close attention. Many student loan refinance lenders offer variable interest rates. While interest rates are low, a variable rate can look far more attractive than fixed interest rates. However, as interest rates rise, variable rates on refinanced loans follow suit. This means that a borrower’s monthly payment, and ultimately their total cost of borrowing, can increase substantially. It’s important for borrowers to be aware of this when considering a variable interest rate loan. 


Should You Refinance Your Student Loans?

Answering the question, “Is a student loan refinance right for me?” comes down to a comparison of the advantages and drawbacks of the process. Student loan borrowers who have high interest rate loans, whether federal or private, may consider refinancing for a lower interest rate to save money throughout the repayment term. However, it’s crucial to evaluate the new terms of the loan, including the repayment timeline, whether the rate is variable or fixed, and other benefits that may be lost with the refinance. 

For borrowers considering refinancing to shorten a repayment period, paying extra toward loans as they currently stand may be a more straightforward process. Extending the repayment period or lowering a monthly payment may be done through consolidating federal student loans and transitioning to an income-based repayment plan instead of refinancing. It’s essential that borrowers consider these options in addition to the potential of refinancing if the purpose is to alter the repayment term. 

Finally, borrowers must consider their ability to refinance their student loans. Individuals who have lackluster credit or low income may not be eligible to refinance without a cosigner. If a co-signer is not available, borrowers may have to look for alternatives to refinancing until their credit is stronger or their income is higher. Consolidation of federal student loans or working directly with the lender for private student loans may be a more viable solution than refinancing. Overall, well-qualified borrowers who understand the benefits and downsides are in the best position to refinance their student loans.