Debtors with high interest rates on their federal student loans would refinance into cheaper loans under proposed legislation to be unveiled this week, in a move that would lower borrowers’ burdens and potentially hurt private lenders and investors.
The plan sponsored by Sen. Kirsten Gillibrand (D-N.Y.) would force the U.S. Secretary of Education to automatically refinance most government loans carrying interest rates above 4 percent into fixed, 4-percent loans. Roughly nine of 10 federally-backed loans would be affected, saving nearly 37 million borrowers billions of dollars in annual interest payments.
“At a time when corporations, homeowners and even local governments are refinancing at historically low interest rates and saving millions of dollars, students and families who take out loans to pay for college are getting left behind," Gillibrand said. "Ensuring that our graduates are not saddled with unmanageable debt by keeping interest rates low is just common sense."
The proposal targets loans funded and owned by the Education Department through the Direct Loan program, as well as government-guaranteed debt owned by the government and the private sector under the Federal Family Education Loan program, an initiative that was ended as part of President Barack Obama’s healthcare overhaul. The bill calls on the Education Secretary to devise a process that would refinance FFEL loans owned by private lenders and investors.
If passed, the legislation would immediately aid borrowers who cumulatively hold nearly $1.1 trillion in student debt. Financial regulators and Obama administration officials in recent months have warned that record student debt levels risk undermining economic growth, as burdened households are likely to reduce consumption and other types of borrowings that would be used to finance big-ticket items such as houses and new cars.
The bill may hurt companies like Sallie Mae, the nation’s largest student loan company, which owns about $119 billion in FFEL debt and derives most of its income from that program, according to securities filings. Investors in securitized FFEL debt also may suffer as the loans underlying their securities would be repaid, denying them the interest income they had been counting on.
Sallie Mae estimated in its most recent presentation to investors that the Education Department owns $494 billion in Direct Loans and $147 billion in FFEL loans. The student loan company estimates private lenders and investors own about $291 billion in FFEL debt.
The Center for American Progress, a left-leaning policy and advocacy group, estimates that Gillibrand’s proposal in its first year would save borrowers about $14.5 billion off their student loan payments, boosting U.S. economic activity by $21.7 billion.
Her bill would help struggling debtors such as Alex Newman, a 2009 graduate of the State University of New York at Plattsburgh who joined Gillibrand at a Sunday news conference. Newman, a Harlem teacher, said he has about $20,000 in federal student loans and little money left over after monthly expenses and debt payments to plan for his future.
“I hope to one day have a family, buy a house, and pay for my child's education -- but with interest rates where they are, I have no ability to save,” Newman said.
It’s unclear how much taxpayers would lose in forgone interest income if tens of millions of borrowers had their high-rate debt refinanced into cheaper loans. Gillibrand’s aides said they will ask the Congressional Budget Office to estimate the proposal’s price tag, and would then figure out how to pay for it.
Her legislation does not yet have any cosponsors, though she aims to rally support for the bill by this fall, when Congress is expected to reauthorize the Higher Education Act.
The New York Democrat joins a growing list of lawmakers who have proposed legislation in recent years to help borrowers refinance student loans carrying record relative interest rates, including Sens. Jack Reed (D-R.I.) and Sherrod Brown (D-Ohio).
Washington’s increased interest in student loan issues comes as the Education Department is forecast to generate a $51 billion profit this year from lending to college students and their families, a figure higher than the 2012 earnings of Exxon Mobil, the nation’s most profitable company, and roughly equal to the combined net income of the four largest U.S. banks by assets.
The Obama administration’s profits are due to the historically high gap between what it costs the U.S. government to borrow and what students and their families pay to borrow from the Education Department.
Interest rates are set by Congress. About three-fourths of all federal student loan dollars disbursed this year carry interest rates of either 6.8 or 7.9 percent, according to Education Department budget documents.
The rates have not been reduced despite the broader decrease in borrowing costs across the economy. For example, when Congress set today’s rates in 2007, the average new 30-year, fixed-rate mortgage could be had for about 6.3 percent, according to Freddie Mac, the government-backed mortgage financier. This month, the average new 30-year, fixed-rate mortgage carries a 3.5 percent interest rate.
Thanks to efforts by the Federal Reserve, it’s never been cheaper for homeowners, car buyers, businesses or investors to obtain financing. Students who borrow from the federal government, however, have not benefited from the historically low rate environment.
"Corporate entities, homeowners, and many others have been able to refinance debt at quite low rates, and student loan borrowers are wondering why they can't do the same," Rohit Chopra, the Consumer Financial Protection Bureau’s top student loan official, has said.
The CFPB has noted the dearth of refinancings for student loan borrowers and is working to increase debt refinancings and loan modifications for those who are struggling. Policymakers reckon that high-rate student debt may be having a "domino effect" on the U.S. economy, causing younger Americans to purchase fewer homes.
In a report this month, the consumer bureau suggested a refinancing program that could rely on the Federal Financing Bank, a government corporation that borrows from the Treasury and lends to agencies and borrowers with government guarantees, to provide funding.