How Does Student Loan Refinancing Work?

Renee Layberry
May 4, 2021

Your college degree is expensive, of course, with the top expenses being tuition, room and board, and books. Many students rely on student loans to cover these costs and then face the reality of paying these loans after they graduate.    Deciding when (or if) you should refinance your student loans is important. That decision can help you pay off your debt either more quickly or with less interest or both. Learn more about student loan refinancing and how to determine whether refinancing is a good fit for your financial situation.  

Student loan refinancing: the basics

Student loan refinancing involves consolidating your existing student loans into one loan that comes with a lower interest rate. Once you’ve researched refinancing and determined that it’s right for you, you can enjoy a lower monthly payment and even pay off your loans faster.   Refinancing requires plenty of research to determine whether you’re a good fit. Your personal financial profile and type of student loans play a role in deciding whether you should pursue refinancing.   Let’s dive in and take a look at how student loan refinancing works.  

Refinancing federal loans

Several types of federal student loans are available, including direct subsidized loans based on financial need and direct unsubsidized loans that do not have any income eligibility.    Federal student loans deliver several advantages, which is why many students pursue them. They come with fixed interest rates that are usually lower than private loans. College students without much credit or income history can acquire them without a cosigner.    Perhaps best of all, these loans have flexible repayment plans, including the option to delay payments if you can’t afford them straight out of college.   Photo by Jasmine Coro
  Refinancing federal loans requires careful consideration. That’s because federal student loans offer borrowers some benefits that you could lose if you refinance. These benefits include:
  • Income-based repayment. This benefit adjusts the amount of money you pay every month based on your income level and family size. So, if you happen to be unemployed or in a challenging financial situation, you can enjoy a reduced federal student loan payment that better fits your budget.
  • Loan forgiveness. Depending on your field, you might even be eligible for loan forgiveness if you stick with your federal loans. For example, some teachers can request loan forgiveness, which delivers substantial long-term savings.
  • Suspended payments. During times of economic unrest, you might be able to suspend your federal student loan payments. For example, during the COVID-19 pandemic, the U.S. government suspended payments on federal student loans to offer some financial relief.

The all-important interest rate

If you do choose to finance your federal student loan with a private lender, you’ll be walking away from these benefits. The driving reason behind refinancing your federal loan with a private lender will likely be the interest rate. Federal interest rates don’t typically fall when the market’s interest rates do. So, if you’re looking into refinancing during a time of historically low-interest rates, you might be able to do better when you go private.   When you opt for refinancing, make sure you secure a fixed interest rate. Variable interest rates shift with the market, which means you might be paying a historically low rate now, but you might not be in a few years. You want to know precisely the payment schedule you’re committing to when you refinance, so seek out low fixed interest rates if you’re refinancing a federal loan.   woman typing on laptop looking at her monthly expenses Photo by @evfoto via Twenty20

Refinancing private loans

Some college students secure private loans instead of or in addition to federal student loans. These private loans usually carry a higher interest rate than federal loans, especially when you’re a young adult who doesn’t have much credit or employment history. A high variable interest rate can mean you’re paying a significant amount of interest every month.   Now that you’ve graduated and have a steady income, it might make sense to consider refinancing these private loans to secure a lower interest rate. Remember, private loans don’t offer the benefits of federal loans, so you’re not walking away from those advantages, which makes your refinance a less risky endeavor.   Your goal in refinancing should be finding a new loan at a lower rate. Before you commit to your new lender, carefully review the details of your new loan. Your lower monthly payment might be caused by a longer loan term, not a lower interest rate. Try to secure a lower fixed interest rate that ensures you pay your loan off in the same amount of time, or even a shorter amount of time (if you can afford the payments). The savings can be substantial.  

Eligibility requirements

Anyone with a student loan is eligible to refinance their existing federal or private loans. However, that doesn’t mean that everyone should or can. To be an appealing refinancing candidate, you need to have a strong financial profile that makes you seem like a low-risk borrower.    Evaluate your financial situation by considering these factors:
  • Credit score. A good to excellent credit score shows potential lenders that you are a responsible borrower who will pay on time every month.
  • Steady income. Full-time employment promises a steady income, which indicates that you’re capable of covering your student loan payment every month.
  • On-time payments. A record of on-time student loan payments also indicates you are a low risk to lenders.
  • Debt-to-income ratio. A low debt-to-income ratio of less than 43% also makes you appealing to lenders because it indicates that you have the funds on hand to cover your payments every month.
  Photo by Pepi Stojanovski


Refinancing doesn’t need to happen as soon as you graduate, timing your student loan refinancing is equally as important as the deal you score. In fact, it’s a smarter decision to refinance after you’ve built your profile as a responsible borrower who has the income to take on a new loan. Once you’ve met the eligibility criteria above, consider the current economic climate before refinancing.   If interest rates are high, chances are you can’t do much better than you’re doing now. The private loan interest rate that you got when you started college probably isn’t going to go down substantially if rates are high. Even more, high rates can’t compete with whatever rate you are paying on federal loans.   On the other hand, if interest rates are low and you’re in good financial standing with a steady income and high credit score, you might want to start shopping for a new loan. This combination of factors gives you the best chance at lowering your monthly payment with an interest rate that leaves you paying less interest over the life of the loan. Until you can achieve that lower payment and lower interest rate, you should put refinancing on the back burner.  

How to refinance your student loan

If the economic climate and your personal financial situation are right for refinancing, follow these tips to ensure you’re securing the best rates that you can:
  1. Check your credit report. Before you start applying for loans, check your credit report to ensure your score is accurate and there aren’t any errors on it that can damage your profile and score.
  2. Explore different lenders. Check out interest rates and options at various lenders to ensure you’re getting the best loan that you can. Remember to compare fees and find out if there are prepayment penalties. You want to be able to make higher payments when you have the money without being penalized.
  3. Calculate savings. Don’t just take your lender’s word for it. Calculate your new monthly payment and overall interest paid to ensure that you’re signing up for a better deal. Don’t forget to compare the length of the loan to make certain you’re not just reducing your monthly payments by getting a longer loan.
  4. Consolidate your loans. If you’re currently paying multiple student loans, now is the time to consolidate them into one payment every month. This method is easier for budgeting and managing your payments.
  5. Get a fixed interest rate. Don’t fall for the allure of a variable interest rate that’s especially low right now. That rate will change over time and can result in a significantly higher monthly payment if the rate skyrockets.
  Student loan refinancing turns your existing federal or private student loans into one private loan. To refinance successfully, you want to be an appealing borrower and secure a low monthly payment that will leave more money in your budget every month.