On March 3, 2020, the Federal Reserve announced an emergency rate cut in response to the novel coronavirus. The cut, which drops the federal funds rate to a target range of 1.00-1.25 percent, is the first emergency move to lower interest rates since 2008.
While the purpose of the Fed's move was to stimulate the economy, it could also be a boon to student loan borrowers who take advantage to refinance their student loans.
Why are student loan refinancing rates going down?When the Federal Reserve announces a rate cut, it doesn't affect the rate of federal student loans.
"These are tied to the 10-Year-Treasury, whereas the federal funds rate that we all hear about -- and that was just recently lowered -- is simply the overnight lending rate banks charge other banks for borrowing," explained Clint Haynes, a Certified Financial Planner, financial advisor, and owner of NextGen Wealth in Kansas City, Missouri.
Refinance loans, however, are made by private lenders that generally reduce rates they charge consumers when a rate cut occurs. "When the Fed lowers interest rates, banks can borrow at lower interest rates which, hopefully, will entail them lowering interest rates for borrowing for their customers," Haynes explained. Although Haynes warned it's not always a perfect correlation, interest rates offered on refinance loans do tend to go down due to Fed rate cuts.
And while federal student loans always have fixed rates, which means current borrowers won't see their rate change no matter what, private lenders often offer the option of variable rate loans. These are tied to a financial index with many lenders using the 1-Month LIBOR rate, which often moves in the same direction as the federal funds rate.
Even before the Fed rate cut in early March, student loan refinance rates were at or near record lows. With this additional rate cut, refinancing may become an even better deal. Borrowers with fixed-rate loans who won't otherwise benefit from current low rates may wish to refinance. And those with variable rate loans may also opt to refinance to a new fixed-rate loan at current low rates to provide more certainty going forward in case rates rise again.
How do you refinance your student loans?
Student loan refinancing is available only from private lenders, although both federal and private student loans can be refinanced. And unlike with federal loans, different private refinance lenders offer varying interest rates and repayment terms and some have more stringent qualifying requirements.
All private lenders consider credit and income when determining loan eligibility, though, and borrowers without a high credit score or sufficient income may need a cosigner or may be denied a loan. And while private lenders often offer very low advertised rates, these rates are generally reserved for the most qualified customers.
Because rates and terms vary, borrowers should get quotes from multiple lenders to find banks with the best rates. Ideally, they'll be lenders offering pre-qualification with a soft credit check, as multiple hard inquiries can have an adverse credit impact. Those able to qualify for a refinance loan at a lower rate than their current educational debt can choose the lender offering the best terms and move forward with the refinance process.
When a borrower signs a promissory note, the refinance lender repays the existing debt included in the refinance. Borrowers don't have to include every loan they have, although they can. If federal loans are included, this means giving up key protections, including income-driven payment plans, flexibility around changing or suspending payments, and any possibility of loan forgiveness. But refinancing federal loans is the only way to lower their rate.
What to know before refinancing your student loans
Refinancing private loans almost always makes sense for borrowers who can qualify for a new loan at a lower rate. The application process can be completed online and there are often no origination fees or upfront costs. And no borrower protections are typically lost since loans are just changing from one private lender to another.
However, it's important to consider the reputation of the lender and the new loan terms. Extending the repayment timeline can raise total costs, even if the interest rate is lower, while a shorter timeline means higher monthly payments. And some lenders offer better customer service than others. Before refinancing federal loans, borrowers also need to consider whether they're giving up flexibility they may someday need.
Ultimately, while low-interest rates make it an ideal time to refinance, every borrower needs to decide whether conditions are right for them personally before moving forward with a refinance loan to pay off existing student debt.