The hidden costs of refinancing your student loans

It’s an incredible feeling to finally become free of student debt, to feel the financial weight lifted off your shoulders after years of worrying about making payments.

I’ve gotten to see this joy over the past year by helping people apply for debt cancellation through the government’s Public Service Loan Forgiveness temporary waiver. The PSLF program cancels federal student loans for people who work in public-service jobs for 10 years, and the impact of relief is profound. I’ve seen school principals finally be able to afford groceries and teachers weep in disbelief. Some, like my sister who is a social worker for the Department of Veterans Affairs, even get a refund check for overpayments in addition to full cancellation.

For the most part, my work has helped trigger celebrations, but not always. After several of her coworkers were already on track to get their loans canceled, Rosey Olivero wrote to me with troubling news. She got a letter from her loan servicer saying she didn’t qualify for cancellation. Rosey is a pediatric infectious-disease specialist who specializes in treating children with HIV. She’s exactly the kind of public servant that PSLF was intended for. After investigating, we discovered the problem: She had refinanced her federal student loans in 2017 with a private lender.

The vast majority of student loans, about $1.6 trillion worth, is owed directly to the federal government. But there are many private lenders that try to persuade borrowers to refinance with them. According to the Consumer Financial Protection Bureau, private lenders hold $128 billion in student-loan debt. These lenders lure people in with a barrage of marketing that promises thousands of dollars of savings through lower interest rates. Once someone agrees to refinance, the companies pay off their federal student loans in full and issue a brand-new private loan in the same amount but with different terms. In the process, borrowers forfeit many protections that come with federal student loans, including the chance to get their loans canceled.

According to the lender’s sales pitch, Rosey would save more than $100,000 over the long run by refinancing. At the time, that seemed like a good deal. But if she hadn’t refinanced, she would have gotten the entire loan canceled. Today, she still has $90,000 to pay off. The devastating news was a gut punch.

Most federal student-loan payments are still paused until later this summer. But once payments resume, millions of people will be bombarded with letters, emails, and phone calls from private companies trying to persuade them to refinance their student loans. One private lender is even suing the Department of Education to resume payments sooner since they can’t compete with a moratorium on student-loan payments. But reader, be forewarned: There are many reasons to avoid falling for their ploy.

Rise of refinancers

The student-loan-refinancing industry exploded in the wake of the 2008 financial crisis. Many suddenly unemployed workers went back to school in hopes that more education would make them more competitive in a recession. At the same time, states were drastically cutting funding for universities in an attempt to deal with their own fiscal problems, and universities raised tuition to make up for the shortfall. Total student debt surpassed $1 trillion for the first time in 2012. Sensing an untapped opportunity, a flurry of fintech startups cashed in with “innovations” that were little more than traditional predatory practices dressed up with new, internet-driven packaging.

Before 2010, federal student loans were created by private institutions like Sallie Mae but guaranteed by the federal government — so if a borrower couldn’t end up paying, the government would step in. Student debt was a moneymaking machine: Lenders would even package these guaranteed loans and sell them to investors. But it was a raw deal for the government, and in 2010, President Barack Obama cut out the intermediaries and had the government start issuing federal student loans directly. Private lenders refused to stand by and let their cash cow dry up, so they pivoted to refinancing student loans. Startups like SoFi, LendKey, and CommonBond were soon joined by more-traditional lenders like Discover. And Navient, which spun off from Sallie Mae, quickly became a major refinancer.

These private lenders have spent millions of dollars chasing down customers and lobbying against loan-assistance programs. In the first 1 ½ years of the pandemic, they collectively spent $6 million lobbying lawmakers to resume student-loan payments. And now, SoFi is suing the Department of Education to end the COVID payment pause. While data is sparse, SoFi spent $170 million in marketing in 2017, according to Fast Company, and planned to spend $200 million in 2018.

Refinancing companies are able to grab customers for one reason: interest rates. The high interest rates Congress has set on federal student loans have allowed refinancing companies to turn a quick profit by offering some borrowers much-lower interest rates and promising smaller monthly payments. While this offer may seem like a godsend for cash-strapped graduates, it comes with a slew of downsides.

If you refinance your student loans, you could pay more

Many people who refinance actually end up paying thousands of dollars more in interest over the long run. For example, someone with $100,000 in federal graduate student loans at the current 6.54% interest rate would make monthly payments of $1,138 on the standard 10-year plan and end up paying $36,502 in interest over the lifetime of the loan. But if they refinanced for a lower monthly payment of $660 at a lower interest rate of 5% over a 20-year repayment plan, it would cost them $58,390 in interest over the long term. 

People can also get enticed into a variable interest rate: Unlike federal loans, which have a locked-in interest rate from start to finish, privately refinanced loans might start out with a low rate, only to skyrocket years down the line because of changing market rates. In 2018, the Federal Trade Commission sued SoFi, alleging its marketing misled people about how much money they would save if they refinanced. In a comment given to CNBC at the time, a spokesperson for SoFi disputed the FTC’s characterization: “We have always been committed to giving our current and prospective members clear and complete information with which to make smart financial choices, and are pleased to have this matter resolved.”

But for many borrowers, the complicated and confusing terms of refinancing offers turn into a boondoggle. Nikki Giraffo is a teacher who felt like she was entering a hall of mirrors anytime she tried to explore her options. Every time she called Navient, her federal-loan servicer, she seemed to get a different answer. On one of those calls to Navient, the representative suggested refinancing her loans privately. Nikki ended up refinancing twice, first with Citizens Bank and then with NaviRefi, but did not end up saving any money. Nikki told me that she felt “lied to and pushed around” by the various loan companies. When I asked her whether she regretted refinancing, she told me “1,000%.” Nikki is not alone. In one survey, more than one-third of respondents who refinanced their federal student loans said they eventually came to regret it.

If you refinance your student loans, you risk losing out on government assistance

The Education Department offers various payment plans to ease the debt burden for borrowers. Income-driven plans allow borrowers to pay a percentage of their income toward the loans with no penalty — giving people the ability to pay little or nothing on their student loans when they can’t afford to. And the Biden administration has proposed changes that will allow millions more people to make $0 monthly payments while not accruing interest. This summer, the Education Department will also conduct a massive account adjustment that will cancel debt for millions of people and put millions more much closer to cancellation.

The most headline-grabbing piece of student-debt news over the past few years was Biden’s plan to cancel up to $10,000 in federal student loans ($20,000 for those with Pell Grants) for anyone making less than $125,000 a year. While the plan is under threat from lawsuits and could be overturned by the Supreme Court, if it’s upheld, roughly 20 million people will see all of their student loans canceled. But if you’re unlucky enough to have previously refinanced your loans with a private company, you will be screwed out of this cancellation.

Refinancing companies are telling people to leave $10,000 or $20,000 of federal student loans un-refinanced to stay eligible for Biden’s cancellation plan. But even if you do that, you are locking yourself into a long-term private loan that will prevent you from being eligible for any future cancellation. 

If you refinance your student loans, you can put your family at risk

To get approved and the lowest rates, most people who refinance their student loans are required to have a cosigner — someone who agrees to pay if you can’t. This is most often a spouse, parents, or children. If a borrower loses their job or isn’t able to work, the cosigner is still on the hook for the debt. If the cosigner can’t make the payments, either, it can destroy their credit and the lender can sue to garnish their wages. It’s also not uncommon for the terms of the loan to require a lump-sum payment if the cosigner dies or files for bankruptcy. Imagine being forced to come up with $400,000 with 30 days’ notice after the death of a close family member — when things go bad, they go very bad.

Federal student loans, by contrast, do not require a cosigner. If you get laid off or fall on hard times and can’t make a payment, none of your loved ones will be saddled with this debt. You can file paperwork that will lower or eliminate your payments. People undergoing cancer treatment, for example, can get their federal loans deferred. And if you die, your loans get discharged.

In my years of helping people buried in debt, the most painful conversations have surrounded cosigners. It’s bad enough to find your own life in financial ruin, but to be the cause of financial stress to those you love the most is heart-wrenching. Recent changes to the law require private student loans to be discharged if you die, but that isn’t the case with older loans. Since refinancing companies love to target doctors loaded up with medical-school debt, this became an additional source of stress during the worst of the COVID-19 crisis. As Andrew Tisser, an emergency-room doctor who refinanced with a private company, put it, “If I were to die from COVID right now, my family would be stuck with $433,000.” Most private student loans allow for some kind of “cosigner release” so no one else is on the hook for your loans. But in my experience, it’s hard to get these private lenders to honor their own policies.

Refinancing companies make the system worse for everyone

Private refinancing companies don’t just hand out their loans to anyone. The ideal targets for these companies are people who have a solid credit score, high income, and a large student-loan balance — in the hundreds of thousands. They typically target doctors, lawyers, and people with graduate degrees in STEM fields since they represent the lowest risk. 

While refinancing companies use “colorblind” metrics like income, the school you graduated from, and your major, it just so happens that the kind of people whom refinance companies approve turn out to be mostly well-off white men. A 2020 study by the Student Borrower Protection Center found students who attended historically Black colleges and universities got rejected more often and had higher rates when approved.

And by siphoning off the people most likely to pay off their whole loan balance, refinancing companies leave the government with the borrowers who are most likely to end up not being able to pay, which drives up the cost of higher education for everyone.

So who should consider refinancing their student loans?

There is one situation where it might make sense to refinance: if your student loans are already private. This is especially true for people with private loans from before legal protections were added in 2018. If refinancing a loan that is already private can get you a lower interest rate or release your cosigner, then it’s absolutely in your best interest to refinance. But since interest rates are rising, you’re unlikely to find a better deal anytime soon.

For everyone else, the risks of refinancing are almost always too high. Many of the well-paid student debtors targeted by refinancing companies might think that they have more financial security and can afford to take that risk. But as the recent wave of mass layoffs at Silicon Valley giants like Microsoft, Google, and Facebook show, a sudden job loss can happen to anyone. Most Americans are one slip on a banana peel away from bankruptcy. Millions of people are unable to work because of long COVID. You are much better off having the protections that come with federal student loans if you get laid off or have a sudden medical emergency. 

Private lenders are quick to swarm borrowers with tantalizing offers of large savings and may seem like a godsend for hardworking people living with the constant pressure of student loans. But if you fall for the pitch, you risk losing out on a whole lot of protections.

When I asked Nikki what advice she would give, she told me, “Trust no one. Hang up the phone. They are preying on literal desperation.”

Thomas Gokey is a co-founder of the Debt Collective, a union for debtors where he currently serves as a case worker and policy director.