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For the last several years legislators have repeatedly introduced a bill that would allow student loan borrowers to refinance their private and federal student loans to the lower interest rates at which new loans are currently being issued. Although the legislation hasn’t managed to make it into law, that hasn’t stopped banks and credit unions from creating their own refinancing programs to help alleviate the debt burden for student loan borrowers.
Such was the case last month when Navy Federal Credit Union not only announced it would begin to issue private student loans, but would allow borrowers to refinance outstanding loans issued by other lenders and the federal government.
While many borrowers might jump at the prospect of refinancing their student loans, consumer advocates and federal regulators caution that there may be a downside that isn’t immediately obvious.
Maura Dundon, senior policy counsel for the Center for Responsible Lending, tells Consumerist that several years ago it may have been difficult for private student loans borrowers in good standing to refinance their loans, but more and more financial institutions are starting to offer the option.
These banks and credit unions stepping into the refinancing game often take two approaches: refinance private student loans into new private loans with lower interest rates or refinance federal student loans into private student loans with lower interest rates.
LOSING THE PROTECTIONS
It’s the second option – rolling federal loans into private loans – that creates the most concern for consumer advocates.
“The main issue is that you have to be really cautious,” Dundon says. “If you refinance a federal loan into a private loan, you lose the benefits of the federal loan program.”
Dundon, of course, is referring to the benefits that federal student loan borrowers receive , such as income-based repayment plans, loan forgiveness programs and certain loan discharge protections.
Income-driven plans like Pay As You Earn and others are designed to prevent borrowers from defaulting on their loans, a problem faced by about 20% of people repaying college debt.
Pay As You Earn allows borrowers to pay 10% a year of their discretionary income in monthly installments. The unpaid balances for consumers working in the public sector or for nonprofits are then forgiven after 10 years and those working in the private sector after 20 years.
Persis Yu, a staff attorney with the National Consumer Law Center, tells Consumerist that this type of refinancing can also strip borrowers of other important federal protections that most consumers don’t want to think about because they often are the result of unhappy life events.
“For a lot of people, these are things you don’t think about,” she says. “Some federal loans are dischargeable if you become disabled or they are dischargeable if you die. You also have federal rights to certain deferments and forbearance, that you don’t have on the private student loan side.”
Additionally, the Consumer Financial Protection Bureau warns active-duty servicemembers that refinancing federal loans into private loans could spell the end of pre-service obligations.
Under the Servicemembers Civil Relief Act, active duty servicemembers are eligible for an interest rate reduction for all federal and private student loans taken out prior to the start of their service.
“If you consolidate your loans while serving in the military, you will lose the ability to qualify for this benefit,” the CFPB says in a questionnaire on its website.
Because refinancing federal loans into a private loan is similar to taking out an entirely new loan, Yu says all those previous defenses simply go out the window.
FIXED OR VARIABLE RATE?
Another risk borrowers thinking of refinancing federal loans into private loans should consider is their new annual percentage rate.
“Part of the problem is that federal loans do have a fairly high interest rate compared to what might be on the private loan market,” Yu says of consumers desire to refinance.
The CFPB, which offers several resources for student loan borrowers, encourages consumers looking to refinance their loans to study up on the different rate categories: fixed and variable.
“Interest rates for most outstanding federal loans have fixed rates, which means that you never have to worry about your monthly payment going up when interest rates rise in the future,” the CFPB says on a portion of its website answering refinancing questions. “If you switch to a variable rate loan, know that your interest rate could rise higher than the original fixed rate loan over time.”
Yu tells Consumerist that while it might be difficult for borrowers to envision their financial situation five or ten years from now, but that’s exactly how they should treat these long-term products.
FEWER WORRIES BUT STILL RISKY
When it comes to borrowers refinancing private student loans, things are a bit different.
“Refinancing one private loan to another, there could be interest rate benefits to that,” Dundon tells Consumerist. “That’s more straight forward.”
But the more seamless nature of this refinancing option doesn’t mean there isn’t risk involved.
The CFPB advises consumers thinking of refinancing private student loans to consider several issues including APR categories and tax consequences.
Just like federal student loans, refinancing a private loan could mean a change in the nature of rates from fixed to variable.
“The monthly payment on your new loan might be lower, but the interest rate could be higher,” the CFPB says. “This can occur because the loan term might be spread out over more years.”
Additionally, newly refinanced loans may no longer be considered a student loan for the purposes of the student loan interest tax deduction.
While the availability and the benefit of refinancing both private and federal student loans varies depending on the borrower and their circumstances, one should be sure to fully consider all options before signing on the dotted line.
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