By Dustin Weeden
Several presidential candidates have endorsed policy proposals that would allow students to refinance their student loans at lower interest rates. If home owners can refinance their mortgages for lower rates, why can’t students refinance their loans?
As states become more proactive in addressing student debt, several have already enacted legislation or are moving forward with programs to refinance student loans. California, Connecticut, Maine, Minnesota, and North Dakota all passed legislation related to refinancing programs while Iowa and Rhode Island have started programs without needing legislative authorization. These programs, in the early stages of implementation, are designed to offer lower interest rates, which allow borrowers to repay loans at a lower total cost.
In general, the programs are designed to be self-sustaining and not need additional support through annual appropriations. To start refinancing programs, states are granting existing student loan authorities the power to refinance loans. Many states created student loan authorities in the 1980s to issue loans and act as a guarantee agency for federal loans. These authorities tend to be self-sustaining entities and finance their loan portfolios through tax-exempt revenue bonds. However, under current federal law, state loan authorities face restrictions on the types of loans eligible for refinancing using tax-exempt bond revenue.
Before starting a refinancing program, states may want to consider a number of factors. One of the most important questions is which loans will be eligible to refinancing? It's unlikely state programs will be able to match the current federal interest rate for undergraduate student loans. As a result, the pool of borrowers will likely be limited to students who took out private loans, as well as graduate students, and parents with federal loans—these loans tend to carry higher interest rates.
States should also consider the amount of risk they are willing to accept. Borrowers with high interest rate private loans would be among the greatest beneficiaries of a refinancing program, but they also likely represent the greatest credit risk. Selectively choosing graduate students with high incomes and stable employment would make a state program financially healthy but do little to help students struggling to make payments.
The current low-interest rate environment has also led to a fairly robust private market for refinancing loans. Private lenders use underwriting standards and even the reputation of a student’s institution to determine if a borrower is eligible to refinance and at what interest rate. State programs would have to compete with the interest rates provided by these private lenders.
Finally, graduate students who refinance federal loans will lose access to the deferment and forbearance protections built into the federal programs. As a result, states may also want to consider offering similar protections to the borrowers who refinance through state programs.
Dustin Weeden is a policy specialist in NCSL's education program. Email Dustin.