CAP Recommends Refinancing Options For Student Loan Borrowers

Analysis by the Center for American Progress estimates that student-loan borrowers who currently face rates greater than 5% could save as much as $14 billion per year, resulting in significantly reduced monthly payments, if they are able to refinance their student loans. The growing amount of student loans entering repayment has opened a critical window to provide refinancing options for student loan borrowers, writes David A. Bergeron of Center for American Progress.

Bergeron, who is vice president for postsecondary education at the Center for American Progress, writes that these borrowers likely would spend or save for larger purchases, increasing economic activity overall by as much as $21 billion. Bergeron wants Congress to move quickly to create opportunities for refinancing student loans while the cost of capital remains low.

Students enrolled in nation's colleges and universities are borrowing at record rates to meet growing educational expenses. As college costs rise, so too does the amount each student is borrowing. While federal student loans can be consolidated, these and private loans cannot be refinanced, according to Bergeron.

If refinancing of student loans were available, borrowers could see significantly reduced monthly payments; lenders—including the federal government—could see increased repayment rates; and we all could see more economic activity, as a portion of each student-loan borrower's income could be spent in other sectors of the economy or saved for larger purchases, Bergeron writes.

Bergeron reviewed a number of proposals pending before Congress and recommend a number of elements that need to be included in a plan to permit student loan refinancing. Fluctuations in student interest rates and growing evidence of borrower distress in federal student loan programs and the portfolios of private loan providers suggest that new and aggressive policy solutions should be enacted, ensuring that repayment terms remain manageable and students are able to make progress in retiring their debt, Bergeron writes.

Allowing students to refinance their loan debt and take advantage of newly established lower rates could reduce the number of students in distress. The Federal Reserve Bank of New York has become increasingly concerned about the levels of student-loan debt. In addition to the $1 trillion in outstanding federal student loans, the bank estimates that more than $200 billion in private education loans are outstanding.

Student loan interest rates have significantly fluctuated in recent years, and this fluctuation reflects the changes in the cost of capital and in servicing student loan debt overtime. CAP suggested that refinancing options could be provided to permit existing borrowers to move into the new approach to setting interest rates. This would allow borrowers that currently have interest rates as high as 8.25% to move down to the newly established rate.

"We suggested that it would be possible to defray some of the cost of refinancing by assessing borrowers a one-time fee or charging a slightly higher interest rate, similar to the current consolidation loans. Our recommendation was consistent with a report issued by CAP earlier this year in which we pointed out that homeowners, corporations, and state and local governments were taking advantage of the current historically low interest rates by refinancing their debt," Bergeron writes.

Permitting refinancing of student loans will lower returns for taxpayers in the case of federal loans, and for investors in the case of private loans, in the short term.

As the New York Federal Reserve Bank concluded with regard to home mortgages, however, the macroeconomic effects of additional money in student-loan borrowers' pockets will more than offset those losses.

As a result, student loan refinancing will likely not simply be a zero-sum transfer from taxpayers and investors to borrowers. Indeed, the evidence the New York Federal Reserve Bank has developed related to home mortgage loans has direct applicability; with respect to student loans, it means that borrowers relieved of some interest expenses will spend or invest those savings, stimulating economic growth, Bergeron writes.

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