With interest rates at an all-time low, now might be the best time to refinance your student loan. However, more and more people are finding it hard to qualify for refinance loans, also referred to as private student loan consolidation. If you're considering this option or have already applied for a refinance loan and were denied, here we'll shed some light on why that may have happened.
As student debt becomes more and more common, it is critical that borrowers understand how much student loan interest rates can affect the total payment over the life of a loan. For example, if you took out a 15-year, $50,000 loan at 5 percent interest, a 2 percentage point increase could cost you almost $10,000 in additional interest charges." —The Credible team
One of the main reasons borrowers seek refinancing is to obtain a lower annual percentage rate (APR), which can substantially decrease what they pay toward interest charges over the life of their loans. However, qualifying for a private student loan or refinance loan may be easier said than done. Private lenders set stricter eligibility requirements to minimize the risk of lending to borrowers who may default and leave their debt unpaid. Further aggravating this issue is the fact that fintech companies entering the market are shifting underwriting models to favor applicants that fall into a very particular credit profile. SoFi, for example, extends loan products to "high-earning" applicants who have not only good credit scores, but also have low debt-to-income ratios, sufficient estimated cash flow, promising careers, and college degrees. This selective approach is being adopted by lenders across the market, making it harder for those who don't meet all the eligibility criteria to qualify for favorable rates and loan terms. There are some things you may be able to do to improve your chances of qualifying for student loan refinance. But first, let's go over some of the most common reasons why applications for student loan refinancing or consolidation are denied.
What's Your Score?
Your credit score is one of the main factors that will determine the interest rate on your loan. Lenders want to know how creditworthy you are, measuring your ability to repay what you owe based on your history as a borrower. Your credit history is summarized in a three-digit number called a credit score, and that's one of the things lenders and credit card companies will look at when ascertaining the risk of lending to you. Most student borrowers don't have sufficient credit history to qualify for a private student loan without a cosigner, a creditworthy individual who pledges to repay the loan in the event the main borrower defaults. If you don't have a creditworthy cosigner who meets the lender’s requirements, you can improve your credit score by sticking to a few simple rules.
To maximize your chances for approval, you should aim for a credit score of 700 or higher. However, lenders will refinance student loans for borrowers with credit scores starting at about 650." —Zack Friedman, Forbes contributor
- Pay your bills on time — This tip may sound obvious, but it’s something a lot of people have a hard time following. If need be, use calendaring apps and event reminders to help you keep up with your monthly obligations. Payment history makes up 35% of your credit score, so don't take repayments lightly.
- Apply for a credit card — Consider taking out a credit card and using it to develop your credit history slowly and steadily. There are numerous credit card companies out there marketing these products to students, which have lower credit score requirements and additional perks like rewards and discounts for good grades. If you use your card right, it can be an excellent credit-building tool; just remember to make timely payments and never use more than what you can repay at the end of the month. If you pay a fixed monthly amount for something like your Netflix or Hulu account, you can use your credit card to cover the expense and set a reminder on your phone to pay it off as soon as possible. Accounts you currently owe money on make up 30% of your credit score.
- Leave old debt on your credit report — The length of your credit history makes up 15% of your credit score, so don't be in a hurry to remove old accounts from your credit report once you've finished paying them off. Having a diversified credit pool makes up 10% of your credit score.
- Apply for new credit — Having recently opened credit accounts makes up another 10% of your credit score, so apply for new credit but be mindful of how often you do it. Multiple credit inquiries over a long period could negatively affect your score, but applying for the same type of loan or short-term debt instrument in a 14– to 45-day period shouldn't impact your credit.
You can get a free annual copy of each of your credit reports from TransUnion, Experian, and Equifax from annualcreditreport.com, yet these won't contain your FICO credit score, which is the credit scoring model most widely used by lenders and financial institutions. There are free online personal finance management apps and services like Mint and Credit Karma that can provide you with an estimated credit score, which might differ from your actual FICO score. If you're interested in checking your score, you may do so through the webpage of one of the three credit bureaus—for a fee—or apply for a student credit card through a company that offers free FICO scores as part of their service.
How High is Your Debt-to-Income Ratio?
Your debt-to-income ratio (DTI) is the total amount of your monthly debt divided by your gross monthly income, and it's another factor that can affect your ability to qualify for a refinance loan. Lenders and refinancing companies want to make sure you can afford your payments, so having more debt than what you earn on a monthly basis could be a deal breaker for these entities. Finding other sources of income will be essential for those wanting to decrease their debt-to-income ratio to under 43%, which is the highest DTI ratio most lenders are willing to work with. To calculate your DTI ratio, add all your monthly responsibilities and divide them by your monthly income. If, for example, your student loan, credit card, and auto loan payments amount to $1,000 a month and your total monthly income is $2,500, your DTI is 40% (1,000 ÷ 2,500 = 0.40).
When you have a regular job and salary, refinancing your student loans is relatively straightforward. But some lenders might not consider you for a loan if your income differs from month to month; others don’t work with self-employed individuals at all." —Kat Tretina for Entrepreneur Magazine
Do You Have Sufficient Employment History?
Besides your credit history, total monthly debt, and gross monthly income, lenders will inquire into your employment history to determine whether or not to approve your financing application. Most lenders find ideal applicants in those who have been working for the same employer for a number of years and are more likely to maintain that steady source of income in the future. Student borrowers who are unemployed might find it very difficult to qualify for a refinance loan, or any other type of loan, without a cosigner. However, those who are self-employed may still have a good chance of qualifying for refinancing through lenders like Earnest and CommonBond. One thing to keep in mind, though, is that these companies will require proof of income through tax returns.
These are only some of the most common reasons why borrowers are denied refinancing, yet there may be other factors affecting your chances of getting one of these loans. Look through your credit reports and dispute any errors or incorrect information such as accounts that are not your own and unauthorized credit inquiries. Remember that credit can be improved over time and that you can increase your chances of qualifying for a private student consolidation loan by applying with a creditworthy cosigner. Another excellent alternative is applying for student loan refinancing through small community banks and credit unions, which might even be offering better rates and terms. Perhaps you haven't found a lender with eligibility requirements to fit your needs, so keep trying and take a look at our top 10 student loan refinance companies of the year.