Why Can’t People with Student Loans Refinance at Better Rates?

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One of the few silver linings of the Great Recession has been a sharp drop in interest rates that has lowered the cost of borrowing for millions of consumers. The historic decline in rates, however, has done almost nothing for folks with a student loan.

Those with college debt have largely missed the refinance boom. Why? Congress—not the free market—sets the interest rate on the vast majority of student debt, and because these loans are not secured by collateral private lenders are loath to undercut the federal government’s terms.

Borrowers with decent credit have gotten relief in virtually every other sphere. By one estimate, low rates are saving the typical household $3,100 a year. Americans now spend 5.8% of after-tax income on consumer interest, the smallest share in 34 years and a sharp drop from 9.1% before the recession. Mortgage interest payments alone are down 30%.

Corporations and government have benefited from the refi boom as well. Companies with a stellar credit rating sold more than a $1 trillion of bonds last year, a record, and most of the proceeds were used to replace higher cost debt. Meanwhile, the federal government’s debt service has remained about the same since the onset of the recession—but only because debt outstanding has doubled.

Lower rates have not rescued all borrowers. Many who have poor credit or little or no home equity haven’t been invited to the refi party. And low rates have been anything but a boon to savers, who must settle for paltry rates of return on secure fixed-income investments.

But does it make sense to shut student borrowers out of the refi bonanza? Student loan debt is at $1 trillion—of that, the federal government backs $864 billion. Most of this debt is at an interest rate higher than 6%, according to a new report from the left-leaning think tank Center for American Progress. That’s almost twice the rate of an average 30-year mortgage — and, more to the point, it is three times what it costs the federal government to borrow.

In other words, the government—standing behind these loans anyway—could refinance them at a lower rate without losing money on the loans. That doesn’t mean there wouldn’t be a cost. The government will show a profit this year of nearly $34 billion on these loans, the Center reports. This is a tough budget environment to ask Congress to kiss off a cash cow.

According to the Center, applying a 5% rate to all federal student loans with a rate higher than that would save individual borrowers $14 billion in 2013 alone. “We have options,” says Tobin Van Ostern, deputy director of the Center’s youth-focused division, Campus Progress. “We need to start the conversation and keep up the pressure for action.”

Some 37 million Americans owe money for their education. Many are older than 30 and 15% are 50-plus. A growing portion is sinking beneath their debts. More than 13% of students whose loans came due in 2009 defaulted on the debt within three years, the Center reports. Another 26% fell behind in payments, the first step towards default.

Many borrowers haven’t done all they can to keep costs down. The majority of those who have student debt have at least some expensive private debt even though they have yet to exhaust their limit of low-cost federal loans. Many also treat these loans as free money, tapping them for non-school expenses or deferring payments and letting interest expense build.

But we’re not talking about forgiving student loans here—only giving borrowers the chance to refi at a lower rate. It makes little sense for the federal government to protect its profit when the Feds also must absorb losses that flow from high rates pushing borrowers into default.

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