The national default rate for student loans has been slowly decreasing after reaching a high of 14.7 percent in 2013. In 2015, the official default rate was 11.8 percent, and so far in 2018 it…
The national default rate for student loans has been slowly decreasing after reaching a high of 14.7 percent in 2013. In 2015, the official default rate was 11.8 percent, and so far in 2018 it has dropped to 10.8 percent, according to Federal Student Aid, an office of the U.S. Department of Education.
Still, with overall student loan debt topping $1.5 trillion in 2018, refinancing one’s student loans may be worth exploring, especially for the significant number of borrowers who are facing default today.
Refinancing could even be the answer for those not facing default but who may be frustrated with the process and are looking for other solutions.
For those considering refinancing, all options should be carefully researched. Refinancing a federal student loan takes the loan out of the hands of the government and puts it in the hands of a private lender. This will effectively remove protections that are available to federal student loan borrowers, like forbearance, forgiveness and income-driven repayment plans, according to the Consumer Financial Protection Bureau.
On the plus side, refinancing could significantly reduce the interest paid over the life of the loan and may also release a co-signer from the loan. Refinancing could also be the answer for borrowers seeking to extend a payment term through lower monthly payments.
For those who are considering the refinancing route, the Student Loan Ranger offers the following tips on how to prepare and qualify.
Explore all private loan options. Determine if the private loan being considered will have a fixed or variable interest rate. A variable rate may be more attractive at the time the loan is taken out, because it is tied to the prime rate, a rate set by banks as a baseline for their most creditworthy borrowers. The prime rate is typically 2-3 percent higher than the federal funds rate. So keep in mind that as the federal funds rate increases, the prime rate will be subject to fluctuation.
Since December 2015, the prime rate has been slowly rising from 3.5 percent to 5.25 percent in September 2018. With a fixed rate loan, the rate will remain the same throughout the life of the loan.
Know where you stand. Just like everything in the lending world, in order to qualify for the very best rates an excellent credit score will probably be required. While most lenders want to see scores in the mid-to-high 600s, aiming for 700 or higher will help with both the approval process and the rate the borrower will qualify for.
This means borrowers will need to know where they stand before starting the process. Consumers can access their credit reports for free every year at annualcreditreport.com. In addition, knowing the credit score, which is not included in the free annual credit report, will be helpful. There are several options for finding out one’s score, many of them free.
Carefully examine your credit report and score. If there are mistakes, borrowers will need to take the time correct them before they start the process of applying for refinancing. If their score is not where it needs to be, borrowers will need to take steps to improve their score before starting on the path to refinancing.
There are five components to credit scoring. Payment history is the most important, counting for 35 percent of a credit score, which is why it is so important to pay all bills on time every month.
Second to payment history is credit utilization, which refers to how much available credit has been accessed by the borrower. This component of amounts owed accounts for 30 percent of a credit score and is the reason consumers are advised not to max out credit cards.
The remaining 35 percent is taken up by credit history at 15 percent, credit mix at 10 percent and new credit at 10 percent. Credit history includes the age of the oldest account and credit mix means the types of credit the borrower has.
A good credit mix will include both installment loans with fixed payments, like student loans, and revolving accounts, like credit cards. Credit history and credit mix may be challenging for young people with student loans, because they may not have had the time to build a long history or acquire a broad mix of accounts.
New credit is the category that student loan refinancing will fall under. Too many new accounts over a short period of time can bring a score down, which is why taking on new credit needs to be done only as needed.
Also when it comes to new credit, it is important to understand credit inquiries and to know the difference between soft and hard inquiries. Hard inquiries count against a score, while soft ones do not. A hard inquiry is when a lender or credit card issuer checks your credit report in order to approve a borrower for credit. When a borrower checks his or her own credit report, it is considered a soft inquiry. Soft inquiries can also be used for preapproval by lenders.
Shop around for the best rates. Some consumers may be concerned about the potential damaging effect of having too many hard inquiries over a short period of time. However, it is important to know that while hard credit inquiries do initially count against a credit score, multiple credit inquiries over a short period for the same purpose will generally only count as one inquiry.
For this reason, borrowers considering refinancing will need to research the lenders and determine which ones they want to apply for and try to get all their applications in within about 30 days or so.
For those student loan borrowers whose scores are not where they need to be to refinance, the steps needed to improve their score will involve decreasing expenses and/or increasing income.
Tracking expenses for a month is a great way to find places to cut back. Taking on a second part-time job will increase income. Neither of these measures has to be forever, but both will help on the path to refinancing student loans at a more affordable rate.