Borrowers may not want to refinance federal student loans until the payment pause expires on December 31, 2022. After all, refinancing federal loans with private lenders means resuming repayments immediately.
But with interest rates rapidly rising and student loan forgiveness suspended, those considering refinancing must prepare their finances soon. If you start now, you can work to pay off high-interest debt, improve your credit score, and find the best refinance deals.
How to Prepare Your Finances for Student Loan Refinancing
When you refinance your student loans, you are replacing your student loans with a private student loan. Unlike federal student loans, refinance lenders base eligibility and interest rates on creditworthiness and overall financial health. While some lenders offer refinance loans for those with less than stellar credit or low income, it doesn’t make sense to refinance without a better interest rate or better terms.
There is no one-size-fits-all approach to refinancing. However, following these steps can increase your chances of getting better rates and being approved.
1. Pay off high-interest debt
If possible, pay off high-interest debt before applying for refinancing. Lenders base eligibility on a number of financial health factors. One of the main ones is your debt-to-income ratio, which is the amount of your monthly debt payments divided by your gross annual income.
For the lender, your DTI indicates your ability to handle another monthly payment. The higher your DTI, the harder it will be to get approved. With a lower ratio, you are more likely to be approved and receive the lowest interest rates. Generally, lenders favor co-signers and primary borrowers with a DTI below 50%.
Before refinancing, check the DTI requirements on the lender’s website. Typically, this information is listed under “eligibility requirements” or in the terms and agreements document.
Next, calculate your ratio using a calculator or a simple equation. Add up all of your monthly debts, including mortgages, credit cards, and other loans, then add up all of your monthly gross income. Divide the monthly debt by your income to arrive at your DTI percentage.
2. Improve your credit score
Improving your credit score is a great way to prepare for refinancing your student loans. Lenders want creditworthy borrowers, and your credit score is a primary indicator of your financial habits.
With the FICO scoring system – which most lenders use – a very good to excellent score is above 740. The average score in America is between 670 and 739 and most lenders accept borrowers with these scores. But it’s likely that if your score is at or below average, you won’t be offered the most competitive rates.
Generally, those with a credit score in the mid-700s and above have the best chance of getting the lowest interest rates.
How to improve your credit score
Factors such as paying your bills on time, how many lines of credit you have, how long specific accounts have been open, and how much debt you owe determine your score.
Your score improves over time, but some habits can cause a small jump quickly. For example, your credit utilization rate — the amount of available credit you’re using against your overall limit — accounts for about 30% of your score. Reducing your usage rate on all your cards and making your monthly payments on time are the fastest ways to increase your score.
Time is also an important factor in growing your credit. If you have a poor credit history, you’ll likely need a creditworthy co-signer to increase your chances of approval.
How to check your credit score
If you have a credit card, you can probably check your score for free through your account portal on the repairer’s website. You can also view your credit report free of charge from one of three credit bureaus: Experian, Equifax or Transunion.
Due to the ongoing pandemic, you can get a free credit report every week. Normally, free reports are limited to once per year per office.
Your credit report records your credit score in depth, listing every hard check, missed payment, and account history. It’s essential to check your report at least once a year to get a complete picture of your financial health.
If you notice a discrepancy or error in your report, dispute it with the reporting agency. Clearing mistakes can help improve your score.
When refinancing your loans, one of the most important things you can do is shop around. Each lender offers different requirements, repayment terms and interest rates. When you prequalify with multiple lenders, you can compare lenders and find the one that best suits your needs.
Most refinance companies offer prequalification, allowing you to see your eligibility and expected interest rate without applying. Prequalification does not impact your credit score like the application does and minimizes the risk of getting multiple rigorous checks on your credit report.
If the lender offers minimal information about eligibility requirements and no prequalification tools, it may be better to choose a more transparent lender. Your goal of refinancing is to save money, and if you can’t guarantee that, applying is probably not worth it.
See if the lender offers fixed or variable interest rates. Due to inflation, the Federal Reserve has raised rates at record speed. Private lenders raised their rates in response. If the lender you choose only offers variable rates — interest rates that are subject to change based on market conditions — your rates will likely continue to rise as the Fed attempts to rein in rising inflation.
Finally, consider hardship options, potential discounts, and any other unique features offered by the lender.
Should I refinance my student loans now?
If you only have high-interest private student loans, consider refinancing as soon as possible. Interest rates should continue to rise. If you lock in the lowest possible fixed rate now, you can always refinance again once rates deflate.
If you have a combination of federal and private student loans and are considering refinancing, start preparing your finances now. It may be best to wait until the federal payment break expires on December 31 so you don’t have to resume payments sooner. But if you’re currently making payments and have prequalified for a lower rate with a refinance loan, consider applying as soon as possible to lock it in.
Remember that you lose access to rebate programs and repayment benefits after refinancing federal loans. Research your federal benefits and private lender relief programs to determine if the time is right to refinance your federal debt.