After Hiatus, Student Loan Refinancing Re-Emerges, But Should You Do it?

As the country’s outstanding student-loan debt tops $1 trillion, financial institutions are increasingly offering borrowers the chance to reduce their interest payments, a market that many borrowers have been afraid to enter.

The latest figures from the Federal Reserve of New York show the country’s student-loan debt hit $1.08 trillion in 2013, a 300% increase from $253 billion in aggregate debt in 2003.

Despite their growing delinquency rate, experts say there are hundreds of billions of student loans that would qualify for refinancing as banks search for additional revenue streams and higher returns.

The trend makes sense, according to Mark Kantrowitz, senior vice president of educational  resources company Edvisors Network. “It’s profitable. Even if a bank lowers the rate just by a few percentage points, it’s still a good deal for them and the consumer. It’s an easy sell.”

Credit unions have been leading the charge in both issuing and refinancing college loans since  2008, according to Vincent Passione, CEO of LendKey, a private student-loan program that helps credit unions underwrite and price student loans.

“If you underwrite these loans correctly, there is an attractive return," he says. "Lenders that want to look into refinancing student loans will have to look past the stigma. More than $80 billion of federal loans are not underwritten and the default rate on them is higher than 10%, but with private loans, it’s 2%.”

Kantrowitz says that before the 2008 financial crisis there were dozens of non-financial institutions issuing and refinancing student loans, but they were forced to stop when the credit markets froze. “They were dependent on the capital markets as a source of funding; they would securitize the loans and then make new ones. When the credit markets froze, they had to stop,” he says.

Brendan Coughlin, head of education and auto finance at RBS Citizens Financial Group, says  the bank entered the private student-loan market in 2009, and that qualified students can get their loans refinanced at a rate of around 4.75%. “Our loan terms are aggressive and are more favorable than what you can get before or right after graduation”

When students first take out their loans, they usually have little to no credit history and their score tends to decline during their time on campus as their credit utilization goes up as income remains flat or non-existent. They are an unproven asset to a lender.

“That means by the time they graduate, their loan interest rate is at its highest point, but then they get a job and behave responsibly and they’ve shifted to a proven asset and that presents an opportunity to a bank or another lender,” says Kantrowitz.

Passione says that like any banking product, student-loan refinancing is cyclical. “If you originated the loans between 2006 and 2009, and have been making payments, there is a very good chance that you can get around 200 basis points knocked off.”

He didn’t disclose refinancing eligibility requirements for propriety reasons, but he says his  company takes into account a borrower’s payment history, current FICO score, income, debt-to-income calculation and credit history.

Experts offer the following tips to indebted students on whether they should try to refinance their  loans:

A lower rate isn’t always better. When reviewing your options, make sure your monthly payments will be lower. Extending the repayment period could mean you pay more in the long run, despite the lower rate.

“Generally speaking, federal loans are still going to be cheaper because they are fixed rates; private loan rates are variable, and right now they have nowhere to go but up,” says Kantrowitz.

Know your current rates and compare. “If you have one loan at 4% and one at 10% and you can get them both at 7% that might not always be the best move,” says Kantrowitz. He says a more affordable option can be to refinance some loans and accelerate payments on the remaining loans.

Know what you’ll lose. Federal loans tend to come with more payment flexibility when you  can’t afford your monthly payments, and those options disappear when you refinance them, says Betsy Mayotte, director of regulatory compliance at American Student Assistance.

Identify fees. Make sure you know about any fees that might pop up during the process, suggests Passione. Some banks will add fees to the application, origination or disbursement process that can add up.