In this guide, I want to answer the somewhat complex question asked every day by thousands of Americans: “Should I refinance my student loans?”

If you’re not sure exactly what student loan refinancing is, or if you’ve done some research and want to make sure you’re making the right decision (and need to know where to get started), this guide is for you.

While you can save a lot of money by refinancing, it’s certainly not for everyone and there are many different ways to approach the process. So, make sure to read this article all the way through to learn about the best options for your particular situation.

Why Refinance Your Student Loans?

Refinancing student loans can save you a lot of money ⁠— potentially thousands of dollars. The class of 2017 graduated with an average of $28,650 in student debt, with an average interest rate of 5.8%. That’s not a terrible rate, but let’s look at how much could be saved by lowering it just 1% over the course of a 15-year loan.

  • $28,650 x 5.8% = $238.68 monthly payment with $14.312.44 paid in interest
  • $28,650 x 4.8% = $223.59 monthly payment with $11,595.97 paid in interest

Just with that small reduction in interest, you’ll save a little over $2,700. Not bad. But refinancing student loans doesn’t just mean lowering your interest rate. You can also change the loan terms.

Let’s run the same numbers, but change the term of our loan from 15 years to 10.

  • $28,650 x 4.8% = $301.08 monthly payment $7,480.16 paid in interest

Refinancing to a lower interest rate and a shorter term saved nearly 50% (about $7,000) in interest. 

And these numbers are nothing for those with even larger amounts of student loan debt. If you took out loans for a graduate degree on top of your bachelor’s, chances are you can save $10,000 or more with student loan refinancing.

The good news is that refinancing student loans is a relatively simple and entirely free process. You can get multiple refinancing offers in under five minutes by providing some general information (and without impacting your credit score).

And because refinancing student loans is painless and free, there are no closing costs (as there are when you refinance a mortgage). It’s also a good financial move for millennials to refinance more than once, because as you pay down your student loans your credit score improves, leading to a lower debt-to-income ratio. Those two factors allow you to refinance to an even lower interest rate. And as we saw in the previous example, the lower the interest the bigger the savings.

From a long-term wealth building standpoint, refinancing and subsequently paying off your student loans fast allows you to focus on other financial goals, such as building an emergency fund and investing a larger percentage of your income. Subsequently, you’ll have more years to take advantage of compound growth, which is the surest path towards building wealth.

Should you refinance your student loans - a complete guide

How Does Refinancing Student Loans Work?

Education loan refinancing is simply trading in one loan for a new one, presumably with a lower interest rate. Depending on the offer you choose, you may also get different loan terms (i.e., length of payback).

You were probably relatively young when you initially took out your student loans, and chances are that you didn’t know much about the mechanics of borrowing money (such as interest rates, terms, and fixed rate vs. variable rate).

But you’re more financially savvy now, and you see that those original terms are less than ideal. Fortunately, you’re not stuck with them. Student loan refinancing means you get to choose a new loan with better terms. And the application process is easy:

Most lenders have a calculator on their site.

Input some general financial information and you’ll get preliminary offers. Be sure to check your offers from a few different sites. If you’re car shopping, you don’t buy the first car you see ⁠— you shop around. The same is true when you’re shopping for a loan: you’re looking for the best possible deal.

Choose a handful of the best preliminary quotes.

Then, take the next step and get a more specific offer. Fill out the online loan application (this typically takes 15 to 20 minutes) and provide any requested documentation (which can usually be uploaded, so no printing and mailing of hard copies is required).

Required documents may include a recent pay stub, billing statements for the student loans you want to refinance, ID, proof of address, and proof of graduation. The paperwork is usually the same for all lenders, so once you have it scanned you can apply for a number of quotes within a few minutes.

Neither of these first two steps impacts your credit score; they require only a soft credit check.

Choose the offer with the best rates and terms.

Note that this will trigger a hard pull on your credit report and temporarily lower your score by a few points. The lender may then require additional information. This part of the process can take a few days.

Wait for final approval. 

Once approved for refinancing, your new lender will pay off the loans you’re refinancing in full and issue you a new loan with the final terms you were offered.

Your former loan servicer will notify you that your loan with them has been closed. Do not stop making your monthly payment until you receive this notification, because if there are any hiccups in their reporting or accounting process you risk your credit score being dinged for missed payments.

Once you do receive the “all clear” notice from your old lender, you’ll start making your monthly payment to the new lender.

Choosing the Best Terms

When you’re perusing student loan refinancing offers, you may be tempted to choose the offer with the lowest interest rate. After all, you’re refinancing to save money and a lower rate means more savings. While it probably seems like a no brainer, it isn’t quite that simple.

One important complication is that you’ll see loan offers with both fixed and variable interest rates, and the variable rates will usually be lower than the fixed.

What do those terms mean?

  • A fixed rate loan means the interest rate (and therefore the monthly payment) remains the same for the life of the loan.
  • A variable rate loan means the interest rate (and therefore the monthly payment) can change each month ⁠— usually based on the U.S. federal funds rate.

Interest rates are low right now, but they can (and probably will) rise in the future. If this happens, your payment could increase ⁠— sometimes substantially. So a variable rate loan is a gamble. Is it a gamble you should take? The answer may be “yes” if you can say the following:

  • You currently have a stable, secure income.
  • You plan to pay off the loan quickly by overpaying each month.
  • Your budget can absorb fluctuating monthly payment amounts.

Variable rates are ideal for borrowers who plan to aggressively pay down their student loans. If you have the necessary cash flow to consistently pay more than required each month (in other words, if you have a big gap between your current income and your current expenses, and you’re willing to dedicate it to debt reduction), then it can make sense to opt for the terms that give you the lowest rate in the near term.  

But if your budget only allows you to make the minimum monthly payments, choosing a variable rate loan is a gamble that could cost you big money down the road if (and, most likely, when) interest rates go up.

Choosing the Length of Your Loan

When choosing the length of your loan, shorter terms mean you’ll save in interest but have a higher monthly payment. Most lenders offer repayment terms of five, seven, 10, 15 and 20 years. The money you’ll save in interest is worth the higher monthly payments if you can swing it, so look through your budget and try to find a way to make it work.

Interest is something to avoid (or at least minimize) whenever possible. And of course, the faster you pay off the loans, the earlier you can start building wealth.

There’s also no rule stating that you must refinance all of your student loans. If you have more than one loan, and some of them already have favorable interest rates and terms, you can just refinance the ones with less-than-ideal terms.

Student Loan Refinancing vs. Consolidation

People sometimes confuse refinancing with federal student loan consolidation, but they aren’t the same thing.

When you consolidate federal student loans, you don’t lower your interest rate. Instead, the rate is an average of the interest rates on your current loans, rounded up to the nearest 1/8th percent. What a federal consolidation does is simplify your finances, as all the loans are merged into a single Direct Consolidation Loan.

But frankly, this isn’t much of a benefit. You can just set up all of your loan payments on auto-pay if you want to simplify things.

So if your goal is to save money, skip the consolidation and go for the refinance, which will both lower your interest rate and simplify your finances (because as with consolidation, you’ll have one monthly payment that you make to a single loan servicer).

There is one scenario in which it can be a strategy to consolidate into a Direct Consolidation Loan. Some federal loans are not eligible for IDR (income-driven repayment). To skirt this restriction, you can consolidate into a DCL and then apply for an IDR plan. More on IDR and other student loan repayment options coming up.

Private vs federal student loans

Federal vs. Private Student Loans

Federal student loans are offered by the government. The interest rates for federal student loans are set by the federal government according to the economic conditions at the time of the loan’s origination, and are the same for all borrowers regardless of their financial situation or credit score.

If you took out federal student loans when interest rates were high, you’re stuck with that rate no matter what’s happening in the economy.

That’s the bad news about federal student loans.

The good news is that the terms and conditions of these loans are set by law, and they have some pretty good benefits. For example, whatever the initial interest rate is, it’s almost always lower than those of private student loans offered to students. Additionally, federal loans come with several valuable repayment and forgiveness programs not offered by private lenders. Also, federal loans don’t require borrowers to start paying them back until after graduation, leaving school, or becoming enrolled less than what is considered half-time.

Private student loans are made by entities like banks and credit unions, who set their own terms and conditions. Your credit score is taken into consideration for private loans, and the higher your score is the lower your rate will be. Private loans, even for those with great credit scores, often have higher interest rates than federal loans. And many private loans don’t offer programs for borrowers struggling to make their payments. Some private lenders require repayments while the borrower is still in college, although some do allow deferred payments until graduation.

One Big Caveat:

Refinancing student loans is a great way to save money, but there is one major consideration to take into account before pulling the trigger. As noted previously, federal student loans come with programs that can help borrowers who are struggling to make payments, as well as programs that will forgive remaining loan balances after a certain period of time.

When you refinance federal student loans, they become private student loans ⁠— meaning you’ll lose access to all of those programs. Some private lenders do have loan programs in place that can help struggling borrowers, but they are nowhere near as generous as the federal programs. And there are no forgiveness programs.

Qualifying for Student Loan Refinancing

Not everyone can qualify for student loan refinancing. In order to be approved, you’ll need to meet certain requirements (these are general; all lenders have their own criteria).

  • Good credit score: You’ll typically need a score that’s in at least the high 600s. If your score is too low, you may still be able to qualify by having co-signer (such as a parent).
  • On-time payment history: Lenders want to see a history of on-time payments for your student loans and any other financial obligations that appear on your credit report.
  • Healthy debt-to-income ratio: Lenders are typically looking for a ratio of 50% or lower.
  • Steady employment: Potential borrowers who are unemployed or have been with their current employer for fewer than two years may be rejected.

Alternatives to Refinancing Your Student Loans

If you’re rejected for student loan refinancing, don’t give up hope. There are viable alternatives to refinancing federal student loans.

Student Loan Repayment Programs

Loan repayment programs are usually tied to your income, and are designed to help make sure your student loans don’t break your budget and cause severe financial hardship. While the payments under these plans can still be significant, they’re usually far lower than they would otherwise be. And sometimes, depending on your income, they can be very small or even zero.

One thing to keep in mind with programs that give you lower monthly payments is that you may very well end up paying more money in the long run. These programs typically extend the duration of your loan, which means you’re paying interest for a longer overall period of time. If your monthly payment is very low, chances are you’re only making interest payments and not even chipping away at the principal.

Revised Pay As You Earn (REPAYE)

Caps your monthly payment at 10% of discretionary income.

Pay As You Earn (PAYE)

Caps your monthly payments at 10% of discretionary income. There are some restrictions, however. Your payment under the terms of the plan must be less than it would be under a standard 10-year payment plan; you must have been a new borrower as of October 1, 2007; and you must have taken disbursement of a Direct Loan after October 1, 2011.

Income-Based or Income-Driven Repayment Plan

Payments are based on your income and re-evaluated every year. Should your income decrease, so will your payment. Monthly payments are capped at 10% of discretionary income if the loan was received after July 1, 2014, and 15% if received prior to that date.

Income-Contingent Repayment

Payments are capped at 20% of discretionary income but they may instead be capped by the amount of a fixed payment on your loans over a 12-year term if this amount is less than 20% of discretionary income.

Graduated Repayment Plan

Borrowers make interest-only payments for the first two years.

Student Loan Forgiveness Programs

Unlike repayment programs, student loan forgiveness is exactly what it sounds like: if you meet certain criteria, the federal government will write off the balance of your loan.

That might sound too good to be true, but these programs are real and can save you thousands of dollars if you qualify. However, there are a few important things to be aware of:

It can be hard to get final approval. It’s your responsibility to prove that you qualify for these programs, and some borrowers have had trouble getting their forgiveness requests approved. Make sure you document everything you need as you go ⁠— otherwise, you might find yourself calling your member of Congress 10 years from now, trying to get help dealing with the Education Department. You’re better off just making sure you have your ducks in a row ahead of time.

You’ll be taxed on the forgiven amount. When one part of the government (the Education Department) writes off the balance of your loan, another part of the government (the IRS) deems whatever amount was written off taxable income. So, if you have $50,000 in loans and $25,000 is forgiven, guess what? Your “income” for that year just increased by $25k. Congratulations on the raise!

Even though you have to pay taxes on the forgiven amount, it’s still a great deal. But you need to be aware of this fact so you don’t get an unwelcome surprise when you discover that instead of getting a tax refund, you actually owe the IRS a few thousand dollars.

Some politicians want to eliminate these programs. If you’re counting on student loan forgiveness as part of your long-term financial plan, understand that these programs ⁠— especially the Public Service Loan Forgiveness Program ⁠— are politically contested. There is some uncertainty as to whether these programs will survive as-is, be significantly modified, or be ended altogether. So if you’re planning on taking advantage of this offer, it’s a good idea to pay attention to the news about this issue.

Public Service Loan Forgiveness Program

You must work full-time for a qualified employer, which includes the federal government and eligible non-profit organizations. Borrowers must make payments for 10 years under a qualifying plan, which includes REPAYE, IRB, and standard repayment.

Revised Pay As You Earn Forgiveness

Monthly payments are capped at 10% of discretionary income. Undergraduate loans will be forgiven after 20 years of on-time payments, and graduate loans after 25 years of on-time payments. Not that these payments do not have to be consecutive. If something happens and your on-time streak is broken, you can still be forgiven.

Pay As You Earn Forgiveness

Monthly payments are capped at 10% of discretionary income and forgiven after 20 years of making on-time payments.

Income Based Repayment Forgiveness

Monthly payments are capped at 10% to 15% of discretionary income. Once borrowers make 20 to 25 years of on-time payments (the number of years is determined by the year the loans were disbursed), the remaining balance is forgiven. To qualify, payments must be lower than they are under the standard repayment plan.

Income Contingent Repayment Forgiveness 

Payments are capped at 20% of discretionary income or the amount paid under a fixed 12-year plan, whichever amount is less. After making on-time payments for 25 years, the remaining balance is forgiven.

Federal Perkins Loans Cancellation and Discharge Program

Forgives a percentage of student loan debt for each year of service in an eligible field which includes nursing, military, law enforcement, and public defenders.

The Best Lenders to Refinance Your Student Loans

When it comes time to actually refinance student loans, it’s important to make sure you get quotes from multiple providers. Finding one that saves you even 0.5% over 10 or 15 years can add up to thousands of dollars. So, do your research and read the loan terms carefully before signing a contract.

Here’s a rundown of some of the best options for student loan refinancing at low interest rates.

Student loan refinancing by Earnest

Earnest

Quick summary: Earnest is a great option for those with little credit history because they use other factors for approval, such as income and work history. Earnest also offers flexible repayment terms borrowers can customize before accepting an offer. There are also forbearance options for those who suffer a job loss, and deferment for those serving active duty in the military (or Peace Corps volunteers).

Fees: No origination fee or prepayment penalty.

Minimum loan amount: $5,000.

Compare Refinancing Rates With Earnest

Refinance your student loans with LendKey

LendKey

Quick Summary: LendKey works with community banks and credit unions to find the lowest rates for borrowers. LendKey will show you offers from several lenders at once, which makes shopping for the best rates fast and easy. For those struggling to make payments, LendKey offers forbearance in six-month increments (up to a total of 18 months).

Fees: No origination fee or prepayment penalty.

Minimum loan amount: $5,000.

Compare refinancing rates with LendKey

Student loan refinancing by Credible

Credible

Quick summary: Credible will show you offers from up to eight lenders at once. Credible is so certain that the lenders they work with have the best rates that they’ll give you $200 if you find a better rate elsewhere.

Fees: No origination fee or prepayment penalty.

Minimum loan amount: $5,000.

Compare refinancing rates with Credible

Student Loan Refinancing by SoFi

SoFi

Quick summary: SoFi doesn’t have an income requirement for borrowers and accepts borrowers who have graduated with an associate degree. SoFi offers career coaching, and even job placement programs for borrowers.

Fees: No origination fee or prepayment penalty.

Minimum loan amount: $5,000.

Compare refinancing rates with SoFi

The Pros and Cons of Student Loan Refinancing

As with everything, student loan refinancing has its pros and cons.

PROS:

  • You can save money. With the right loan terms, student loan refinancing can save you thousands of dollars.
  • You choose the terms. Refinancing student loans means choosing new terms that best fit your current circumstances.
  • It simplifies your finances: If you choose to refinance all of your loans, you’ll have just a single monthly payment to keep track of.

CONS:

  • Not everyone is eligible: If your credit score, debt-to-income ratio, or employment history fall short of a lender’s requirements, you won’t be approved.
  • You lose certain protections: Once you refinance your federal student loans, they become private loans and you will no longer have access to repayment or forgiveness programs.

Student Loan Refinancing Summary

If you’ve been out of school for a while and have at least decent credit, there’s a good chance refinancing will result in a lower interest rate and a substantial savings over the life of your loan.

However, when deciding whether or not to refinance your student loans, it’s important to remember that your ultimate goal is to pay off your debt in full as quickly as possible. As such, you should think hard about your financial situation, both today and over a 5-10 year period.

In particular, it’s important to weigh the value of paying off your loan ahead of schedule against the value of upgrading your lifestyle as your income increases. The biggest fixed costs in your budget are your rent and transportation (i.e., your car payment), and people have a tendency to upgrade in each of these categories when they get a better-paying job or a significant promotion.

While quality of life is important for a variety of reasons, paying off your student loan quickly can result in big savings ⁠— sometimes to the tune of thousands or even tens of thousands of dollars. Those savings can be multiplied many times over with smart saving and investment practices.

So, if you just graduated ⁠— or if you have significant debt relative to your current or projected future income ⁠— considering deferring expensive housing and transportation upgrades and diverting a large percentage of your income to debt reduction and investment.