Why Student Loan Refinancing is a No-Brainer

Consider someone who bought a house in July of 2007, right before the housing market came crumbling down. Knowing that there were rumblings about a “housing bubble,” and hearing disturbing reports of exploding adjustable-rate mortgages, this responsible homeowner took out a garden variety 30-year fixed-rate mortgage, at a time when the interest rate was 6.7%.

Now fast-forward a few years. Assuming the homeowner didn’t lose the ability to make the mortgage payment—which, if he or she did, there would be bankruptcy and other protections at their disposal—he or she would have come out from under the recession staring at historically low interest rates. This homeowner figures, “what the heck,” and refinances sometime between 2012-2013, when interest rates hovered around 3.8%, saving hundreds of dollars a month and potentially tens of thousands of dollars over the life of the loan.

Now consider an individual who took out a student loan in recent years. This student attended a public institution (where ¾ of students go) while taking out a total of $25,000 (around the average debt for bachelor’s degree holders at public 4-year schools) in unsubsidized loans at 6.8% (the unsubsidized rate[1]  from 2006-2013) to cover tuition and living expenses. After graduation, like many recent grads, she struggles initially to find employment. She makes no payments during the six-month grace period after graduation (when borrowers do not have to make payments on loans), and also applies for a forbearance, allowing her to get on her feet before payments come due. Twelve months after graduation, her loan balance is $26,754, at which point she finally begins paying back her loans. Her monthly payment on a standard, 10-year plan comes out to $308 a month and nearly $37,000 over the life of the loan (or $3,700 annually).

Around the time when she starts repaying, she notices that interest rates on unsubsidized federal student loans are at 3.86% due to a Congressional deal struck in 2013, coming in at just under 3 percentage points lower than the loans she took out while in school. Instead of being able to take advantage of this, she is instead automatically placed in a rigid, 10-year payment plan. Sure, she can possibly take advantage of one of the several different income-based repayment (IBR) options for federal borrowers, but if she does so, she’s likely to see the total amount she pays over the life of the loan increase by the thousands.

Now consider if this (again, typical) student were able to refinance her loan at the outset of her repayment down to the current subsidized/unsubsidized rate of 3.86%. All of a sudden, her 10-year monthly payment drops to $269 a month and her total payments drop by over $4,650 over the life of the loan. Simply by being allowed to take advantage of current interest rates—again, not receiving any government benefit that current students can’t already take advantage of—she can cut her total loan payments by around 12%.

Some critics claim that student loans and mortgages are fundamentally different, and they’re right—but maybe not for the reasons you’d think. In arguing against lowering student loan interest rates (or making refinancing available) vis a vis mortgages, some argue that mortgages are a less risky investment for financial institutions (currently, 90+ day delinquency rates on residential mortgages are at 8.21%, while 11.5% of student loan balances are 90+ days delinquent). Additionally, when a mortgage defaults, a bank can seize a home and recoup a substantial portion of its losses, whereas a student borrower in default has far less in the way of collateral. And because banks can be discerning and deny borrowers a home loan, while the government cannot, high student loan interest rates simply reflect the cost of doing business.

This argument misses in several ways. First, people often buy houses at a point when they are most able to pay for it—otherwise they would be less likely to receive the loan in the first place. But the flip side is also true—that student loan borrowers are forced to start repaying their loans after graduation—in other words, at the point when they are least likely to be able to afford it. If a bank were lender in both cases, there's justification in charging the student more than the homeowner.

But in the federal student loan market, the government is the lender, and therefore is in a position to reduce the overall burden on the borrower, either because it does not have to maximize gain, or simply to achieve a broader public policy goal. In the case of refinancing, that policy goal would be either lowering the total cost of college that a student incurs, or providing more money into the hands of those bogged down by debt—those who may want to actually save up to buy a home, for example. But even if this weren’t true, we’re still simply talking about allowing borrowers with very similar risk profiles—those who are just beginning to repay, and those who are just entering school—be able to utilize the same rates.

Second, defaulted student loans are nearly impossible to discharge in bankruptcy, meaning the Federal Government (or its contractors) can use some pretty draconian tactics in order to shake down borrowers in default for their money (including wage and social security garnishment). Not only does this diverge from home mortgages, but some cancelled mortgage debt is even untaxable (not true for student loan forgiveness under IBR). In short, a homeowner in the most dire straits has a lot more tools at his or her disposal than a student loan borrower.

Finally, refinancing would be one of the few ways that the government could reduce the total cost to borrowers on the back end. Currently, many of the protections the government offers in the way of repayment—forbearance, extended repayment, income-based repayment[2]—actually mean that students can pay more overall even if they receive some needed monthly reprieve (and even in deferment, interest doesn’t accumulate, but it isn’t reduced). By offering refinancing, the government could actually reduce both monthly payments and overall payments, all by aligning the benefits that current borrowers receive.

It’s important to remember that students don’t have the option of time when it comes to interest rates. Whereas savvy potential homeowners can save money by renting for a few years while trying to time the mortgage market, it doesn’t really work that way for those wanting to go to college. So even if this were a one-time shot for all forms of debt, student borrowers would still be getting a raw deal. But the point is that it’s not a one-time shot for mortgages—if a homeowner has an outdated rate that reflects the market at the time he or she bought a house, they are free to refinance to reflect the current market. Students, obviously, have no recourse to do so.