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Save thousands with this student debt strategy

U.S. Sen. Elizabeth Warren has said "borrowers should be able to refinance their student loans to take advantage of lower interest rates, the same way people refinance a mortgage."

Actually, some borrowers, especially those with good credit and income, already have refinanced their student loans to reduce their interest rates and save thousands of dollars over the life of their loans with private lenders.

And greater competition among private lenders recently has made student loan refinancing more accessible to borrowers.

The average borrower can save nearly $14,000 by refinancing their student loans, according to calculations by Credible, an online marketplace for lenders that offer student loan refinancing.

The savings do come with some drawbacks. Borrowers who refinance with private lenders can't take advantage of income-based repayment plans and public service loan forgiveness provided by federal loans. Though some private lenders offer forbearance if borrowers can't make their payments, those benefits aren't as robust as those with federal loans.

"Student loan refinancing is a relatively new concept and we've seen real increases in volume over the past 12 months," said Nick Clements, co-founder of price comparison website MagnifyMoney, which tracks private lenders that provide student loan refinancing.

Early days

Social Finance, known as SoFi, sparked the latest boom in student loan refinancing in 2011, Clements said. The market had been in the doldrums since the financial crisis as investors lost their appetite for securities backed by private student loans.

Armed with millions in venture capital and a tech-friendly application process, SoFi focused on professionals, such as doctors, lawyers and MBAs, with high income and large amounts of student loan debt.

For example, in a student loan portfolio SoFi securitized last year, the average borrower had more than $143,000 in income and a FICO score of 770. (The average FICO score is 695.)

Following SoFi's lead, more lenders entered the market. "When I started Credible in 2012, there were only two online lenders doing student loan refinancing," said Stephen Dash, the online marketplace's founder. "Now there are 10 to 15 lenders."

"Each lender has a different underwriting model. Your rate may vary widely depending on which one you go with." -Nick Clements, co-founder of MagnifyMoney

Rising competition has made student loan refinancing a better option for people who aren't what the industry calls HENRYs, high earners, not rich yet.

Annual income averaged $88,627 among super-prime borrowers, those with a credit score of 740 or above, who accepted refinancing offers through the Credible platform in the past nine months. That average income is lower than the borrowers with six-figure salaries online lenders initially pursued.

MagnifyMoney's Clements said he expects student refinancing will be available to more borrowers as the industry looks to grow.

Some lenders will provide offers to borrowers with a credit score as low as 620 as long as they have an eligible co-signer. Among these borrowers who refinanced at Credible, average annual income was $73,000.

Online lenders have refinanced about $6 billion in student loans since 2011. "It's still early days," Dash said.

In 2015, Goldman Sachs estimated that $211 billion in student loans could benefit from refinancing. Using that same methodology, Dash said that figure is closer to $230 billion today given the current volume of student loan debt.

What you need to refinance

It pays to shop around for the lowest rate with student loan refinancing.

"Each lender has a different underwriting model. Your rate may vary widely depending on which one you go with," Clements said. Most lenders use FICO as well as a cash flow analysis to determine whether they will offer a borrower a loan.

Fair Isaac Corp., which calculates and sells FICO scores, said rate shopping for student loan lenders will not affect your credit score as long as you do it within a 30-day period.

Here's what to know when you're looking to refinance your student loans:

  • Geography and cash flow matter. Someone who is making $60,000 a year in Omaha, Nebraska, would likely be viewed more favorably by lenders than someone making $60,000 in San Francisco. Lenders also will evaluate borrowers' living expenses, not just income. So the better you budget, the better rate you may receive.
  • If you missed any payment in the past, you probably won't qualify without a co-signer. Borrowers who recently graduated may not have the best FICO scores yet. However, it's more important to show lenders that you pay your bills on time.
  • Know the trade-offs between fixed- and variable-rate loans. Currently, lenders are offering fixed-rate loans starting at 3.5 percent and variable-rate loans as low as 2.14 percent. The rate on a variable-rate loan will rise and fall based on a market benchmark, in most cases, the one-month Libor.
  • Avoid origination fees. Most lenders don't charge origination fees for student loan refinancing. If you find one that does, move on.
  • Sign up for automatic payments. Many lenders offer a 0.25 to 0.5 percent interest rate discount if borrowers automatically deduct student loans from their bank accounts.