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Why Now Is a Horrible Time to Refinance Student Loans

A chance to tap low rates has passed as borrowers prepare to make payments for the first time in years

Starting in October, tens of millions of student-loan borrowers will need to start making payments again. PHOTO: ALEX BRANDON/ASSOCIATED PRESS

Borrowers facing down the return of federal student-loan payments might be tempted to refinance their loans in an attempt to save money. For many, that is a terrible idea.

With the Federal Reserve pushing interest rates to a multidecade high and new government programs offering the promise of low payments and possible debt forgiveness, personal-finance experts say refinancing would benefit only a handful of borrowers. 

“It doesn’t make any sense to refi that because your costs are going to go up, not down,” said Jack Wallace, director of governmental and lender relations at Yrefy, a private student-loan company, speaking about those with undergraduate loans, the majority of student borrowers.

Starting in October, tens of millions of student-loan borrowers will need to make payments for the first time since the Education Department instituted a pause in March 2020.

Because federal student-loan payments and interest accrual were paused, few borrowers took advantage of the low rates earlier in the pandemic to refinance their loans, as many mortgage holders did. Sofi, a refinancing lender, said its volumes fell 90% when interest rates were set at zero. Now that the pause is ending, the window to refinance at low rates has closed.

That debt is no longer eligible for forgiveness through income-based repayment programs such as the Saving on a Valuable Education program, recently rolled out by the Biden administration.

Borrowers looking to refinance federal loans must combine all their loans and turn them into a single consolidated private loan, removing the debt from the federal system altogether. They can then shop around for a more attractive interest rate or choose to lengthen or shorten their repayment period. Generally, the better a person’s credit score, the lower the interest rate he or she can qualify for.

Those refinancing also would be left out of possible future mass debt-forgiveness plans, such as the one that was recently struck down by the Supreme Court. If the Education Department succeeds in its second attempt to cancel large amounts of debt for most borrowers, private loans wouldn’t be eligible. Any such effort is expected to be challenged in court. 

n addition, the cost of credit has increased substantially over the past year and a half. Early in the pandemic, the Fed cut interest rates to near zero to stimulate the economy. More recently, they have raised rates to a 22-year high to fight elevated inflation. 

The interest rate on federal student loans is set annually. For the most common undergraduate loans, this year’s rate is 5.5%, up from 2.75% in 2020. Different types of loans carry different interest rates: Undergraduate loans have lower rates than ones taken out by graduate and professional students or parents of students. Those loans are set at 7.05% and 8.05%, respectively.

“People that have excellent credit might be able to find introductory offers where there’s a bank that’s trying to recruit for their business that will also offer a low interest rate,” said Sarah Behr, a financial planner and founder of Simplify Financial in San Francisco. “If it’s not below 7%, I don’t see how it’s compelling.”

Refinancing could make sense for graduate borrowers

Graduate and parent loans are treated differently by the federal government, and the borrowers themselves have different profiles, too. Many non-undergrad loans don’t qualify for the most generous types of income-based repayment programs that could lead to forgiveness, and many professionals such as lawyers and doctors have incomes that make such programs unattractive. For these borrowers, refinancing might make sense.

Those borrowers are “in a good position to be able to get the refinance loan, they generally have good-to-very-good credit,” said Tom Graf, executive director of the Massachusetts Educational Financing Authority, a quasi-state nonprofit agency that handles college savings programs as well as loan refinancing. 

Some borrowers might want to refinance not just because of interest rates, but to extend the term of their loans and lower monthly payments, especially if they anticipate high earnings later in their careers. 

High rates now mean there could be a bumper crop for refinancing in the future. With economic activity stronger than anticipated, most Fed officials expect they would need to keep interest rates near their current level through next year before starting to cut. When the cost of credit eventually declines, borrowers who took out student loans with high interest rates, especially during the past year, could refinance. More than $100 billion in federal student loans are issued in a typical year.

“I can see rates coming down in a year and suddenly there being a real opportunity for refinancing,” said Behr, the financial planner.