Home > Student Loans > 5 Reasons Why You Might Not Want to Refinance Your Federal Student Loans

Comments 4 Comments

Many private student lenders are making a big push for a piece of the student loan refinancing pie.

Banks and venture capital-backed nonbank financial services companies are hard at work slicing and dicing that trillion-dollar market into bite-size, demographically based refinancing opportunities. Their primary targets? Borrowers who have the best longer-term earnings potential because of the schools they attend, their areas of study or for other reasons.

The lure is in the form of seemingly lower rates and streamlined documentation processes, which, on the surface, presents a good deal of appeal. That is, for borrowers with higher-priced private student loans and perhaps state-sponsored debts as well.

Those who’ve funded their higher educational pursuits with government-backed loans, however, may want to think twice, for the following five reasons.

1. Credit Underwriting

Despite the fact that all education-related loans — public and private alike — are virtually impossible to discharge in bankruptcy (thanks to the successful lobbying efforts on the part of the financial services industry in 2005, atop an anti anti-establishment scheme that dates back to the mid-1970s), today’s private lenders aren’t taking that invulnerability for granted. And they shouldn’t. Not with so many consumer advocates who are calling for the restoration of the bankruptcy code with regard to this form of debt.

So unlike the federal government, which blithely continues to process loan requests as it has before, private-sector lenders are looking more carefully at a prospective borrower’s ability to service the loan he or she is requesting. Things like historical earnings, debt levels, leverage and credit scores. And when these aren’t enough (or too much, as the case may be), they’re asking for family members and others who are financially better situated to co-sign the loan.

Pity the co-signer, though, when that occurs, because they will have a heck of a time getting out from under that responsibility, even after the primary borrower’s economic outlook improves to the point of self-sustainment.

2. Fixed Versus Floating Rate Loans

Also unlike the government-backed loan programs, some private lenders are tempting debtors with what amounts to low introductory-rate financing, much the same way that some banks and private mortgage lenders tempt other consumers with adjustable rate mortgages (ARMs).

In both instances, interest-rate risk is effectively transferred to the borrower from the lender. In other words, when rates move up, so will the amount of the loan payment. When rates move down, however, you may well find the payment amount will not decline below a certain point.

Certainly, there are those who are comfortable rolling this pair of dice. The question is, is it worth the gamble in the first place?

The average level of per capita student debt is roughly $35,000 as of 2015. At 2% interest — not an uncommon introductory rate — the monthly payment on a 10-year education loan amounts to $322. In contrast, that same loan would run $350 per month under the Federal Direct program, which charges 3.76% interest at present.

I don’t know about you, but I’m not willing to wager on the direction of interest rates for $336 per year.

3. Prepayment Penalties

And then there’s the matter of loan pre-payability.

Federal student loan borrowers have the right to pay off their debt in full or in part at any time, without penalty. That means, whatever interest the borrower would have been charged over the remaining term of his or her loan is waived when the debt is fully paid off, or discounted when the loan balance is reduced quicker than it otherwise would have been.

Not necessarily so in the private sector.

Depending on the terms of the refinancing agreement, the lender may require its borrower to pay a premium — a word that the financial services industry prefers to fee — to retire their loan ahead of time.

4. Superior Relief

Perhaps the key difference between public and private higher-education loans is the quality, quantity and active promotion of the relief programs that are available to financially distressed borrowers.

Setting aside for the moment the problems that the government is attempting to remedy with the loan-servicing companies to which the Department of Education subcontracts the administration of the student loans it originates, no other lender is as willing to accommodate both temporary and longer-term hardships than the federal government.

Whether you chalk that up to Uncle Sam’s sincere desire to assist troubled debtors or to protect the taxpayers who will ultimately be left holding the bag on this financing program, hands down, the government’s income-based, income-contingent and public-service debt-forgiveness plans are superior to all others.

5. No Going Back

Last but not least, there are no round-trip tickets when it comes to financing government-backed student loans that were refinanced by private lenders. Once these loans are off the government’s books — what happens when a loan that’s made by one lender is financed at a later date by another — they are no longer eligible to be refinanced under any of the government’s standard or distressed-borrower relief programs.

With all this in mind, while it could make sense to refinance existing education-related debts that were originated in the private sector — provided you’re not being asked to give up more in the form of co-signors, prepayment penalties and so forth in exchange for that consideration — it’s hard to justify refinancing your government-backed debts in this manner.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.

Image: BraunS

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

  • https://www.credible.com/ Credible

    Hi Mitchell, the points you raise are all valid issues that anyone looking into refinancing student loan debt should consider.

    It’s worth keeping in mind that when it comes to variable-rate loans, most lenders who refinance student loan debt DO offer borrowers a choice of a fixed-rate or variable-rate loan.

    Many borrowers are paying off older government loans issued with interest rates in the 7s, 8s, or more. These borrowers can often qualify to refinance into fixed-rate loans at considerably lower rates — in the 4s or 5s if they’re looking at 10-year fixed-rate loans.

    The potential savings from refinancing high-interest student loan debt can be in the tens of thousands of dollars, so many borrowers end up deciding it’s worth giving up access to government programs for financially distressed borrowers.

    I think most financial advisors would agree that your hypothetical borrower with $35,000 in loans at 3.76% would not be a good candidate for refinancing. But it should be noted that no borrower has ever taken out $35,000 in government loans at 3.76%. That is the new rate for subsidized and unsubsidized direct loans for undergraduates as of July 1. The rate for those loans — the cheapest available from the government — was 4.29% for loans issued last year, and 4.66% in 2014-2015.


    If you are a dependent student, you can only take out $5,500 to $7,500 a year in subsidized and unsubsidized ungergraduate loans, with a lifeftime limit of $31,000. After that, you must turn to more expensive PLUS loans or private loans to fill any funding gaps (undergraduate students who are independent, or whose parents can’t take out plus loans, can take out up to $57,500 in subsidized and unsubsidized direct loans).


    Even in today’s low-rate environment, if you take out a PLUS loan today you’ll be paying 6.31 percent interest. Once you tack on the 4.27 percent up-front fee on PLUS loans, you’re looking at an APR that’s close to 7.3 percent, depending on the repayment plan you choose.

    Graduate students also take on government loans that can be good candidates for refinancing, because they also pay higher rates (direct unsubsidized loans for gradate or professional students are currently 5.31 percent, and were 6.8 percent as recently as 2012).

    Your conclusion — that it “could make sense to refinance existing education-related debts that were originated in the private sector … [but that] it’s hard to justify refinancing your government-backed debts in this manner” — does not seem to take all of the facts into consideration.

    • Mitchell D. Weiss

      A few things to keep in mind in this regard. First, Stafford and Federal
      Direct borrowers with rates that are in the 6’s and 7’s have had their loans in
      place since before the 2013 legislation that downwardly adjusted interest. As such, the argument for refinancing a loan that has already amortized by 30% or more (3 out of 10 years) is tenuous, at best. Second, I am aware that some lenders offer fixed-rate along AND variable-rate loans, which, of course, must be factored into decisions that are purely math-based. (Note: I just checked the rates currently offered by two banks that are active in this space. The first was roughly 300bp higher than that of the current Federal Direct’s, and the second’s fixed rate offering started at roughly 50bp less than first. In both cases, these rates are reserved for excellent credits. Hardly a compelling argument.) Third, the principal issue I have with refinancing ANY government-backed loan is the uncertainty of one’s future circumstances. Should a borrower encounter financial difficulties within a month, a year or later into the remaining term of his or her loan, no private lender at this time offers a relief program that comes close to providing the flexibility that is implicit within the government’s own. In my view, it’s not worth the questionable savings. Finally, as to the point about pursuing financing above and beyond that which is available under the primary Federal Direct loan program, I am loathe to recommend to any borrower that they undertake as much debt as they are in a position to secure. As I’d written in an earlier article, the ratio of current total education-related debt (~$35K) to current average first-year salary levels (~$45K) is reasonably manageable at less than 10%. More than that will make it difficult for recent grads to live the lives they planned.

  • http://www.mycreditcounselor.net Andrew Weber Certified SLC

    Excellent article. In my opinion, the “outside refinance” lenders gloss over the negatives of refinancing federal loans in many of their marketing materials and ads. For example, one of the major refinance “marketplaces” has an option to click “lower your payments” on their homepage.

    Yet, it just leads to more info about refinance and does not let them know that they can reduce monthly payments within the federal loan system. I think refinancing a federal loan into a private loan can be a good option for very high earners with very good profiles, but that does not seem to be the way these products are marketed. It will be interesting to see if refinance becomes available within the federal loan system, which at best will severely damage the “outside refinance” industry and may just put it completely down for the count. It’s great to see more articles giving an objective view of outside refinance, without the rose colored glasses.

    • https://www.credible.com/ Credible

      Hi Andrew,

      The Credible homepage gives users three options: “Lower monthly payment,” “Lower interest rate,” “Research or explore rates.”

      By allowing borrowers to see the actual rates they can qualify for with multiple lenders, we’re helping them explore their options. You can’t get a handle on how much you could save by refinancing without seeing those rates.

      Rather than push refinancing, we encourage borrowers to gather the information they need to decide what makes sense for their own, unique circumstances.

      There is no question that refinancing is not the right choice for everyone. The points Mitchell raises are all valid, and we do bring them to our users’ attention.

      We do make it clear to borrowers that they can reduce monthly payments on government loans in an income-driven repayment program, and that they will lose access to those programs if they refinance with a private lender. On our blog, we provide a wealth of information about options like income-driven repayment programs such as PAYE and REPAYE.

      We also provide resources for understanding characteristics of private loans, such as repayment plans, cosigners and variable-rate loans.

      One issue with REPAYE and other IDR programs that borrowers don’t always realize is that when you stretch out your payments over a longer period without an interest rate reduction, you may end up increasing your total repayment costs considerably. While these plans can be a lifesaver for struggling borrowers — particularly those who will qualify for loan forgiveness after 10, 20 or 25 years of payments — they’re also not the best choice for everybody.

Credit.com receives compensation for the financial products and services advertised on this site if our users apply for and sign up for any of them.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team