Should You Refinance Your Student Loans During COVID-19?

The COVID-19 pandemic has created economic and emotional challenges for many Americans. Sometimes those are intertwined, especially in recent graduates who may have entered the workforce just before this pandemic hit. While there is an emotional burden wondering about your career, future, and what life will be like in a post-corona world, there are also financial issues. Young professionals, particularly those who recently entered their careers and are making healthy sums of money, would be wise to consider ways to reduce costs in the event of wage stagnation or layoffs due to this pandemic.

A study in 2019 by TD Bank found that student loan holders paid an average of 20% of their takehome pay on this debt. To put this into context, consider a hypothetical young professional who is also a recent graduate. Let’s suppose they receive a $100,000 a year job, taking home approximately $6,500 a month. That graduate would spend, on average, $1,300 a month on student loans, leaving them with just $5,200 on which to live. As a high-income person, that percentage might be less, but the point remains the same: young professionals spend a large portion of their income repaying these educational debts.

COVID-19 presents a unique opportunity, though, to lower these debts and have them paid off faster! Let’s look at what you can do to get debt-free quicker and be on your way towards financial independence.

Interest Rates Have Plummeted

You may have heard on the news that mortgage rates have plummeted. This statement is true. What’s also true is that it is not the only loan category affected by the coronavirus pandemic. Student loans have low rates too.

In June 2020, rates came down to a historic low of 2.75%. One year ago, they were 4.53%. Those are the federal rates for new loans. However, young professionals who have just entered the workforce would not be getting a loan now. They would have gotten one a few years ago. For unsubsidized loans, rates have ranged from a minimum of 3.76% to 6.8% at the high end. Subsidized loans have a range of 3.4% to 5.05%.

For refinances, these rates start at 3.2% now for a fixed refinance and 1.99% for a variable rate. Given that the Fed typically targets inflation at approximately 2-3% per year, these interest rates mean that you can refinance these loans for inflation!

How Does This Translate to Savings?

Having a lower interest rate always translates into savings and being able to pay off your loan faster. It’s easiest to illustrate this concept with an example.

Let’s suppose you have $50,000 in unsubsidized loans. If you graduated from the school in the spring of 2019, you would have entered college in 2015. Since you’ve been out in the workforce for over six months, you have to repay your loans. At that time, interest rates were 4.29% for federal loans and even higher for private ones. On $50,000 over ten years, those loans would accrue at least $11,577 in interest.

With interest rates as low as 1.99% (variable), if you refinanced those loans, you could pay as little as $5,181 in interest – a savings of up to $6,396! If you’d rather have that money in your pocket, it might be a great time to refinance.

Are There Other Ways to Pay Off Student Debt Faster?

Refinancing will give you the option to pay less in interest over the same number of years. However, the best approach is to be debt-free. Here are three tips to get out of student debt faster.

First, refinance but keep the same monthly payment. A $50,000 10-year loan at 4.29% has a monthly cost of $513.15. If you retain the same payment amount (i.e., pay $513.15 every month instead of the minimum due) but refinance to a 1.99% loan, you’ll be able to pay off your student loan in eight years, ten months.

Second, check out the student debt forgiveness options that are available. If you work for a non-profit or government organization, you may be eligible to have some or all of your student debt forgiven. If you’re a teacher, you may be able to reduce the amount you have to pay by $17,500. Other niche programs can pay off or minimize student debt, as well.

Finally, since student debt is so cheap now – especially if you refinance – there’s a unique opportunity to take advantage of interest spreads and “make” money to pay your debt down faster. There’s some risk but consider the following scenario. Imagine you have $10,000. You make your minimum monthly payments on your $50,000 loan. The stock market returned an average of 7% throughout history. If you put $10,000 in some wise investments, it could be worth $16,057.81 (7% compounded) in seven years. Your loan balance would be less than $16,000, so you could wipe it out and still have a little bit left in seven years instead of ten by putting that money in quality investments.

How Can I Improve My Credit Score?

Of course, if you refinance your student debt, you’ll need an excellent credit score to qualify for the lowest rates. There are three things you should consider to boost your credit score.

Pay down credit card debt. Ideally, you’d want to use less than 30% of your available credit card limits. So if you have two cards with a combined limit of $10,000, you should never have a balance of more than $3,000 between them.
Keep making payments. The worst thing you can do for your credit score is missing a monthly remittance. If you’re looking to refinance soon, make sure you keep those payments coming.
Do not apply for new credit. Applying for a new loan can take your score down a few points. It’s not a big ding, but if you’re looking to refinance soon, save your inquiry for that!

Also, get a copy of your credit report and score before you submit any applications! Sites like Credit Karma and Free Credit Report offer you your free score, so check those out.

Save Money and Refinance Your Student Loans During COVID-19

COVID-19 presents a unique opportunity to take advantage of incredibly low interest rates. Young professionals, in particular, who just graduated from college, would be well-advised to refinance any debt they may have (which is often mostly student debt). Those thousands you save early on in your career can make your future years (your 30s, 40s, etc.) much more comfortable as you move one step closer to a debt-free life.