Does My Rate Always Drop If I Refinance Student Loans?
Refinancing your student loans is always encouraged by financial "professionals." However, three circumstances have to happen for you to have the ability to refinance.
- Your financial situation has to improve. In finance, we say that "you are now more credit worthy." When you initially received your student loan, the finance company took a risk. They do not know your income, if you are going to graduate, etc... Once you graduate and have a job, many of those risks are no longer applicable. The amount you are charged is directly correlated to the perceived risk. The higher the risk, the greater the amount charged (the interest rate). The lower the risk, the lower the amount charged. If you are perceived as "lower risk," you will be able to refinance into a lower rate, all else equal.
- Market interest rates have to decline or stay the same. Interest rates today will not be the same as interest rates two years from now. If market interest rates stay the same or decrease and your perceived risk (as detailed above) decreases, then your rate will decrease, all else equal. If market interest rates increase, then refinancing may not make sense because your rate may be better than current market rates.
- You may notice that I underlined all else equal in the two items above. When you refinance, other factors are considered, such as current income, overall debt, payment history, etc... These other factors may make you ineligible to refinance. For example, if you have $150,000 in student loans and make $50,000 a year, finance companies may consider you a greater risk than before. Therefore, if they did refinance your student loans, the interest rate would probably be higher than what you currently have. In that case, it makes no since to refinance. You will notice that the factors mentioned above mostly have to do with your financial picture. Obviously, if you recently graduated (i.e., less than five years), you haven't had the time to build your financial profile.
I must point out that while refinancing your student loans may sound great, it is not for everyone. If you work in the public sector or can take advantage of federal debt relief programs, you may not want to refinance. These programs do not transfer to private refinance loans.
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