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Record low rates make it a good time to refinance student loans, but avoid these pitfalls

Key Points
  • The Fed Funds Rate is at 0.25%, and record low rates offer an opportunity to consolidate and refinance student loans. 
  • Americans are holding $1.6 trillion in student debt.
  • The CARES Act has eased the burden on paying federal loans, but it still makes sense to pursue refinancing for private loans. 
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In response to the Covid-19 pandemic, the Federal Reserve has cut interest rates to historic lows. Currently, the Fed Funds Rate sits at 0.25%, making loans cheaper for Americans. For some, these low rates offer an opportunity to consolidate and refinance their student loans. 

It's well known that many Americans are burdened by student debt; collectively Americans owe over $1.6 trillion.

If you qualify for a refinancing, a lender will pay off your existing loans and offer you a new one at a lower interest rate. Here is what you need to know in order to refinance. 

Don't refinance your federal loan

Amid the unprecedented job losses across the country, the federal government passed the CARES Act, which among other things, provides relief on federal student loans. 

"The government put automatic forbearance on federal loans. Payments will not be due until the end of September. They are also waiving interest on federal student loans so it doesn't make sense to make payments on federal loans," said Lauryn Williams, a certified financial planner and co-founder of financial advisory firm Worth Winning in Dallas, Texas. Williams is also the first American woman to win a medal in the Winter and Summer Olympics. 

If you have private student loans, you still have to make payments, but now is a great time to refinance, Williams said. 

Private loans

Not everyone will be able to refinance their private loans. Lenders have become risk-averse as the economic impact of the pandemic worsens. People with good credit scores and a steady income are the likeliest to be approved. Williams noted that the average credit score for accepted borrowers is about 700. 

Start by researching lenders. Once you identify a few lenders that meet your needs, get rate estimates from them. Some sites allow you to compare multiple rates at once. Ultimately, the best option is the lender that offers you the shortest repayment period you can afford, according to Williams. 

It's worth noting that some lenders will ask to run a soft credit check as part of pre-qualification and to help make rate determinations for your offer. A soft credit check will not affect your credit score. However, an actual application will require a hard credit check and could temporarily lower your credit score by around 10 points. 

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Williams warns about applying too often for refinancing. "That strategy tends to be for people who are aggressively trying to pay down debt and have a steady income. There is no limit to the number of times you refinance, but it could affect your credit score."

Lenders will typically offer a fixed and variable interest rate and a duration of the repayment period. "Every situation is different, and people need to choose what is best for them. But most of the time, a fixed rate with the shortest repayment that is affordable will save the most money," the financial advisor said.

Variable rates should be avoided. "It is better to lock in a rate you know you can pay, then have one that will fluctuate with the market," Williams said.

Also, a lower monthly payment with an unchanged interest rate may cost you more in the longer run, she said. "If you're paying less on the monthly payment but the loan duration has increased by 18 months, you could end up paying more in interest."

If you're denied 

If you are unable to refinance your loans, it could be because of other outstanding debt. "If you are rejected it could be because your debt-to-income ratio is too high," Williams said. 

She encourages people to take stock of their situation. If you have the resources to do so, start paying down other debt and try to improve your credit score. However, sometimes you have too much debt and some lenders may view you as high risk. 

You can also work with private lenders to pause payments for up to 12 months. Contact your lender to find out what options are available 

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