Despite today’s low borrowing costs, many gainfully employed college graduates are finding that they cannot refinance student loans taken out under higher interest rates than they’d be eligible for today.
Student loans are an investment in human capital. You can’t repossess an education. And even a good education may not immediately pay off in a bad economic climate, increasing the loan risk through no fault of the borrowers. With interest rates expected to rise, there’s little incentive to lower interest rates incurred when today’s graduates were college freshmen.
“My understanding is that there is nothing in the federal consumer financial laws which prevents principal reduction or other loan modifications,” said Rohit Chopra, student loan ombudsman for the Consumer Financial Protection Bureau (CFPB). “Banks may need to comply with accounting guidance prescribed by state and federal prudential regulators.”
He said comments received from market participants, policy experts and individual borrowers suggest that refinance options on private student loan could offer relief for responsible borrowers – those with high-rate private student loans who have dutifully made their payments on time, with consequent improvement in their credit scores since their first borrowing.
However, “when borrowers graduate and find a job, they may be unable to find a refinance option with a lower rate that reflects the strong likelihood they will fully be able to pay back their loan,” Chopra said.
Comments suggest that policymakers can play a role to jumpstart a refinance market, allowing eligible borrowers to refinance their debt at lower interest rates, potentially saving thousands of dollars in the process.
A Lack Of Competition
Mark Kantrowitz, senior vice president and publisher at Las Vegas-based Edvisors.com, part of Edvisors Network Inc., noted that student borrowers’ credit score while they are still in school gets lower the closer they are to graduation, so their interest rate gets higher. If students repay responsibly for two years they become a proven asset, with a better credit score than when they came in as freshmen. There should be a good market for them in income-based repayment, but that hasn’t occurred on a widespread basis. And without market competition, there’s little incentive, in a low interest rate market, to lower a borrower’s interest rate from pre-graduation highs.
“Unlike other asset classes, there are very few servicers in the student loan business,” said Perry O’Grady, principal of Silver Sword Capital Partners, a Newton, Mass.-based business-to-business financial products marketing firm. Silver Sword represents Sallie Mae to financial institutions seeking to add a student loan product to offer their existing customers. Sallie Mae originates and services the loans in the partner institution’s name and the partner institution earns a fee at origination, providing a risk-free option to the bank that delivers incremental fee income. But the bank has no discretion in refinancing the loan, because the loan is owned by Sallie Mae and is carried on Sallie’s balance sheet.
The loan servicing environment is dominated mostly by big players, because without scale, loan servicing isn’t a profitable business, O’Grady said.
Salem Five Bank offers products through partnering with Sallie Mae. Its website offers both variable interest rates and fixed interest rates, rewards for paying on time, and a 0.25 percent interest rate reduction while in school for making scheduled payments by automatic debits. Students can borrow up to 100 percent of their school-certified costs, and can choose from deferred repayment, fixed repayment or interest repayment.
Wells Fargo, one of the largest bank institutions in the student-loan business, offers a private product for parents of undergraduate students. Regions Bank, Commerce Bank and Fifth Third are also super-regionals in the student loan arena.
Private loans can be refinanced, although few lenders do refinancing, and if they do, it’s often only with their own loans. “There are some refinancing options available, but it is a tremendously underserved market,” O’Grady said.
The Next Bubble?
Loan securitization has historically been an efficient way to put risky financial obligations into a more liquid market, at a reduction of risk, but as was learned from the mortgage debacle, it’s easier to place a loan into securitization than to rework it when things go wrong.
“Once a loan is securitized, the ability to refinance is limited,” said Kantrowitz. Investors don’t want to refinance and lose their expected profit; there’s more incentive to change the repayment terms of what’s already on the balance sheet, by extending the repayment period, for example.
Modification of the principle balance on federal loans is not a possibility unless the borrower has been in default. This appears to invite the same moral hazard as did the recent problems in the mortgage industry.
Many consumer finance options are available through specialty lenders, including non-banks such as Social Finance (SoFi). They target professionals with high education costs but also high earnings potential. But straight student loan refinancing options continue to be scarce. O’Grady said that’s why Silver Sword’s partners often insist that borrowers first exhaust other financing options such as grants, scholarships and federal aid, before seeking a private loan.
The prognostication is that banks will by and large stay away from the refinancing sphere because it won’t provide them the yield that they seek. That opens up the arena for investors. SoFi is planning its first loan securitization offering. However, with interest rates set to rise, the meter is running on how long the investments will be attractive.
Email: coneill@thewarrengroup.com
