Game of Loans: Refinancing Student Debt

Brendan Coughlin, who runs the student loan refinancing unit for a major bank, is very upfront about this: some young adults should not refinance their loans.

One example is a graduate new to the labor force who doesn’t feel stable yet in his or her job. Refinancing a federal student loan with a high interest rate can make sense and saves money. But one reason not to refinance federal loans is that they have a major advantage over loans refinanced by private lenders: flexible repayment options for those who might have difficulty meeting their monthly payments later.

Another reason not to refinance is that the government forgives the debt after five or 10 years for certain types of teachers and public service workers.

Understanding whether to refinance is so important that Coughlin, as president of Citizens Bank’s consumer lending unit, instructs the bank’s loan officers to talk prospective customers through the pros and cons three or four times – to make sure they’re clear about what’s at stake.

“We really don’t want to have a customer swap out their loans and have a surprise. We want to make sure they’re making the right decision,” he said.

If you clear the hurdles, however, it might be time to refinance into bank loans with lower interest rates than the steep 6.8 percent currently charged for some federal student loans – and the double-digit rates on some private loans. Citizens Bank estimates that more than 40 percent of the $1.3 trillion in student loan debt outstanding is both held by someone who could qualify for refinancing and has interest rates high enough to potentially make it worthwhile.

The best refinancing rates at banks or online lenders such as Sofi.com can go as low as about 2 percent for some variable-rate loans and 4.74 percent for fixed-rate loans for individuals with high credit ratings. Citizens Bank estimates that its average student loan refinancing reduces the customer’s annual percentage rate by 1.5 points, saving $147 per month.

For young adults considering refinancing their college debt, here are five tips:

• The most important reason to refinance is to save money by getting a lower interest rate. For example, reducing the rate on $40,000 in debt from 6.8 percent to 4.7 percent saves nearly $50 per month – and more than $10,000 in total over a 20-year loan term. But making the best deal requires doing a lot of homework to compare the specific terms that various lenders are offering you – and not just the advertised rate.

• A steady job with a regular paycheck is required. Young adults who have not graduated but are solidly employed can apply at Citizens, for example. Decisions about whether to approve loan applications are based on the applicant’s income, the amount of their debt, and how much they can afford to pay – and not whether they’ve graduated.
• Good credit is a must. The minimum credit score for refinancing a student loan varies among lenders, but it is 660 at Citizens.

• It becomes much more difficult to refinance after late payments or a loan default, which hurt one’s credit score. Coughlin advises recent graduates who are still looking for a job and want to preserve refinancing as a future option to “take full advantage of the grace periods offered” on student loans – and using the grace period does not hurt a credit score, he said.

• Credit card debt isn’t necessarily an obstacle to refinancing – if the balances are within reason. Every lender is different, but the ratio of total debt payments (credit cards, car loan and other debt payments) to gross income is between 30 percent and 40 percent for the average borrower; the maximum ratio is 65 percent in unusual cases.

Properly refinancing a student loan requires a lot of legwork. But many young adults, especially college graduates, have one thing in their favor: bright futures, which are attractive to lenders.

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