$1.521 trillion. That’s the total amount of student loan debt in 2018. The number is mind boggling. But to put it in perspective, it’s 2.5 times the total of $600 billion from 10 years ago. The average graduate now owes $37,000. Since there’s practically no way to get out of them, the strategy needs to be focused on finding the best way to refinance your student loans.

Let’s go through the process step by step, so you’ll know the best ways to make it happen.

Federal vs. Private Student Loan

Before you even consider refinancing your student loans, you first need to understand the differences between federal and private student loans.

Federal student loans are either provided or guaranteed by the US Department of Education (even if issued by banks or credit unions or colleges themselves). Private student loans are provided by banks and credit unions, but are not guaranteed by the US government in any way.

There are important distinctions between the two types of loans if you are planning to do a refinance.

Bankruptcy. Private student loans can be discharged through bankruptcy, federal loans generally cannot.

Refinancing. Federal loans don’t offer a refinance option. Instead they offer loan consolidations (we’ll discuss the two in the next section). Private student loans do offer refinancing. If you refinance a federal loan into a private loan, you won’t be able to go back to a federal loan later.

Hardship forbearance. A hardship is defined as unemployment, active military duty, economic hardship, disability, or other qualifying event. Forbearance can last up to three years. Federal loans allow you to temporarily make partial payments or halt them if you encounter a hardship. Private lenders may or may not offer hardship forbearance, and where they do, it’s usually under much less generous terms.

Payment relief/loan forgiveness. Federal loans enable you to reduce your monthly payment to 10% of your income through (IBR) plans. Or you can get loan forgiveness through the Public Service Loan Forgiveness (PSLF) plan, after 10 years of employment with a government or charitable organization. Private student loans don’t offer either plan.

Why are these distinctions important? If you refinance federal loans into private loans, you’ll lose important federal loan benefits.

Here’s a table to sum it up.

 Federal Student LoansPrivate Student Loans
Provider and GuarantorBoth by the US Department of EducationProvided by banks and credit unions; not guaranteed by the US government
BankruptcyCannot be dischargedCan be discharged
Hardship forbearanceYesUsually not
Payment relief/loan forgivenessRelief through Income Based Repayment ; forgiveness through Public Service Loan ForgivenessNone

With that in mind, let’s move forward…

Student Loan Consolidation vs. Student Loan Refinancing

These are the two ways you can recast your student loans. Here are the details:

Consolidation. These are available with federal student loans. Numerous federal loans are lumped together in a single loan, with an interest rate that’s the weighted average of all your existing federal loans. It doesn’t lower your interest rate, but It does give you a single monthly payment.

However, you can lower your monthly payment by extending the overall term. For example, if you have one loan with a 10-year term, and two others with 15-year terms, you can consolidate them into a single loan with a 25-year term. That will lower the monthly payment.

Consolidations can be done through the federal Direct Consolidation Loan program. There’s no cost to do a consolidation under this program, nor do you need to qualify based on your income and credit.

Refinance. These are available through private lenders. They’re generally used to get a lower interest rate. You can also consolidate several student loans under the same refinance. The loans can be either federal or private, or a combination of both. Once again, you’ll want to be careful doing a refinance of federal loans, because you’ll lose the benefits that come with them.

Unlike consolidations, you’ll need to qualify for a refinance, based on your income and credit.

Refinances can be done at many banks and credit unions, as well as what I call loan aggregators that scour the internet for the best loan rates on the market and present to you the one that perfectly suits your needs. I’m recommending Credible right now – I think they’re finding the best rates for student refinancing. You can generally refinance up to $250,000 to $500,000 in total student debts.

For the rest of this article, we’re going to focus on refinancing, since consolidation is simple and self-explanatory.

The Benefits of Student Loan Refinancing

We’ve already discussed the potential to lower your interest rate with a refinance. But there are several other benefits:

  1. Consolidating several loans (and payments) into one.
  2. Converting variable rate loans into a fixed rate (or vice-versa).
  3. Changing the term of the loan – shorter for quicker payoff, or longer for a lower payment.
  4. Removing a co-signer.

To decide if a refinance is worth doing, it should result in one or more of these benefits.

Qualifying for Student Loan Refinancing

Unlike federal consolidation loans, you will need to qualify for a private refinance.

Credit. Just as is the case with any other type of loan, your interest rate, as well as whether or not you’ll even get an approval, will be closely tied to your credit score. Credit score requirements vary by lender. Some may set a minimum score of 650, while others may go as low as 600. But the higher your credit score, the lower your interest rate will be. If your credit score is particularly low, the terms you’re offered may not justify the refinance. You may need to raise your credit score, then try again.

Employment. You must have completed your education and be employed to qualify for a refinance. To establish stability, a lender will typically require a minimum of two years of continuous employment. However, you may be approved with less if you work in certain fields, such as health care.

Income. Since there are so many different private lenders, it’s not possible to generalize what the income requirements will be. Many have a minimum income requirement, like $1,000 per month. But most will rely on your debt-to-income (DTI) ratio. That’s your total debts, divided by your gross monthly income. The DTI limit may be set at 40%, or 45%, just as examples.

Cosigners and coborrowers. If either your credit, employment or income are insufficient, you may be able to add a qualified cosigner or coborrower to your refinance. This ability will vary by lender, and there may be secondary income qualifications for you based on your income alone. For example, though a cosigner may get your DTI below 40%, if it’s 70% based on your income alone, the lender still may not approve the loan.

Documentation Needed to Refinance

You’ll need to complete a loan application. You should expect to have the following information and documentation available:

  • A government issued photo ID, such as a driver’s license.
  • Recent pay stubs and W2s confirming your income.
  • Payoff statements for your existing student loan debts.
  • Evidence of your monthly housing expense.
  • College transcripts. Some lenders may use academic performance as a credit criteria, particularly if you’re a recent graduate.

The above is a list of the general documentation requirements, but there may also be lender-specific requirements. You’ll need to check with that lender to be sure your package will be complete.

If you’re including a cosigner, that person will need to be included on the application, and provide similar documentation.

Interest Rates, Fees and Loan Terms

Interest rates. These can be either fixed or variable. Fixed rates are higher than variable rates, but they remain constant throughout the loan term. By contrast, variable rates will change throughout the term of the loan. They’re usually based on a popular index, such as the prime rate or the LIBOR. A margin is added to that rate. For example, if the prime rate is 4.0%, and the margin is 1.0%, the rate will be 5.0%. Your rate will change each time the underlying index changes.

Loan fees. Some lenders may charge application or origination fees. But the majority of banks, credit unions, an online lenders don’t. These are the lenders you should favor.

Loan terms. Private lenders offer a wide variety of loan terms. The general ranges are from five years to as long as 20.

Specific Refinance Provisions to be Aware of

Even if a student loan refinance works for you based on the numbers, there are some provisions to look out for:

Prepayment penalty. Most private lenders don’t charge these fees. But carefully review the loan documents to make sure no such penalty is included. There are enough lenders that don’t have a penalty, and there’s no need to accept a loan that does.

Cosigner release. Most private lenders will allow your cosigner to be released. Common provisions include 24 to 48 consecutive, on-time monthly payments, plus the demonstrated ability to manage the payments on your own. If you’re adding a cosigner to your loan, make sure this provision exists.

Variable rates. These can look very attractive, because the initial rate is much lower than a fixed rate. But interest rates are currently low, and since variable rates provide for increases, it’s entirely possible you’ll be paying a higher rate in the future than you would be on a fixed rate loan. Many variable rate loans have “caps”, which is the maximum a rate can go. But the cap may be set considerably higher than current fixed rates. Go with a variable rate loan only if you’re reasonably certain you can pay it off in just a few years.

Forbearance. Once again, forbearance provisions are much more limited with private loans than federal loans. The terms vary between lenders, and not all lenders offer them. For example, a lender may offer temporary suspension of either interest or principal payments for up to 12 months. Prolonged unemployment may be the cause, and the lender may require you to participate in a program that monitors your progress in finding a new job.

Final Thoughts on the Best Way to Refinance Your Student Loans

As you can see, refinancing your student loans is a complicated process, not the least of which since there are so many potential lenders. Before deciding to do a refinance, make sure it will offer the benefits described above. And even if it does, pay careful attention to the fine print. Like all loan types, there may be a “gotcha provision” you’re not comfortable with.

Check first with your bank or credit union, and then with other financial institutions. But also investigate the possibilities with online loan aggregators, like Credible. Among the many choices, you’re bound to find the loan program that works for you.