In recent years, millions of homeowners have taken advantage of low interest rates to refinance their mortgages. Yet one area where most people haven't benefited from lower rates on long-term debt is with their student loans.
One government agency is looking to draw attention to the impact that student loans have on the overall economy and the potential economic boost that better student-loan refinancing options could have.
How Student Loans Hurt the Economy
The Consumer Financial Protection Bureau presented a report last week that detailed the negative impact of high student-loan debt on the U.S. economy. Home ownership, new business formation, reduced retirement savings, and labor shortages in lower-paying occupations were just a few of the effects that the report cited as problematic.
The CFPB specifically highlighted the inability of most student-loan borrowers to refinance their debt as a key cause of those bad economic effects. Because most student loans get marketed directly through schools, borrowers' access to information on student loans falls sharply once they graduate and leave campus. With most students having multiple loans outstanding, often from different sources, it can be very difficult to get a handle on overall indebtedness in considering potential refinancing options.
The lack of availability for refinancing is particularly problematic when you consider how much graduates should be able to save.
On the front end it makes sense that rates are higher on loans -- particularly private ones that don't have a federal guarantee. Banks take on huge amounts of risk when they extend credit to students who, at this point, lack any substantial credit history and have no assured future earnings to support repayment.
But by the time they graduate and get work, student-loan borrowers have much more extensive credit histories and financial resources that make them much less risky. Lenders should reward the boost in creditworthiness with lower interest rates. But the lack of an active and competitive market for refinancing student loans prevents borrowers from easily finding options to cut their payments.
A Possible Solution
The CFPB believes that one solution could involve using the Federal Financing Bank or another government-agency funding source to give student-loan lenders the ability to get capital more easily.
In essence, a program might work similarly to the way that mortgage agencies Fannie Mae and Freddie Mac provide money to banks in exchange for qualifying mortgage loans, which Fannie and Freddie then package into asset-backed securities. Tax-exempt funding from state and municipal sources could also spur greater activity.
On the other hand, regulators will need to be careful to avoid spurring too much activity in the student-loan refinancing market. Many blame Fannie and Freddie for helping to puff up the housing bubble by making it too easy for banks to make mortgage loans without worrying about credit quality.
In order to avoid a similar bubble in student loans, restrictions on access to capital need to be more stringent than they were for mortgages during the housing boom.
What to Watch For With Refinancing
At this point, though, loan consolidation and other refinancing options are available, although limited in scope. They also come with some potential pitfalls:
If you refinance or consolidate a federal student loan, you run the risk of losing many of the advantages that federal loans have over other types of student loans. In particular, deferment or loan forgiveness provisions are often available only for certain federal loans, and privately refinanced debt won't give you those same options.
One big draw of consolidation or refinancing is the chance to lower monthly payments. But many lenders do so not by cutting rates but rather by extending repayment periods. In other words, lower payments come at the price of having outstanding debt for years longer than you'd originally planned.
Given how low interest rates are right now, it's a smart time for those with substantial student debt obligations to look into ways to reduce their financing costs. As difficult as that is to do currently, the future could make things a lot easier for student-loan borrowers if the CFPB's vision becomes reality.