Editors' pick: Originally published Dec. 8.
Does the market for refinancing student loans have room to expand? Several industry observers and lenders think it does.
In a March 2015 report, Goldman Sachs estimated that $211 billion in student loans could qualify for refinancing at lower interest rates. An April 2016 Citizens Bank survey found that more than half of student loan borrowers haven't looked into refinancing, suggesting the size of an untapped market.
In an analysis last month in its 2016 Student Loan Financing Report, San Francisco-based Credible, an aggregator of student loan refinance vendors, found that in the last year and a half, refinancing has expanded beyond graduates with six figure incomes and perfect credit scores. The report said that up to 8 million borrowers might be able to refinance their loans. Using Goldman's methodology, Credible says dollar amount for loans that could be eligible for refinance has grown to $242 billion.
Credible looked at refinanced loans from April 15, 2015 to September 21, 2016 and divided borrowers into four groups: recent grads age 27 and under, mid-career grads ages 28 to 40, borrowers 50 and older and high-debt borrowers who refinanced over $100,000 in loans, irrespective of age.
Recent graduates 27 and under are refinancing student loan balances that are nearly as large as their annual salaries--$49,379 in average debt against $54,200 in average salary--and were the most likely to refinance into loans with longer repayment terms, a strategy used by borrowers who are primarily interested in lowering their monthly payments.
Mid-career borrowers had higher incomes than recent graduates and were more likely to choose a loan with shorter repayment terms, even though both groups refinanced similar debt levels. Borrowers 50 and older, with higher incomes but lower student loan balances overall, obtained the largest interest rate reductions — 2.34 percentage points on average--when refinancing into loans with shorter repayment terms. Longer loan terms make monthly payments smaller but the loan becomes more expensive in the long run.
Borrowers with six-figure student loan debt were the most likely to refinance into loans with shorter repayment terms, helping them obtain the lowest interest rate and maximize overall savings. Credible determined that high-debt borrowers who took this approach can expect to save an average of $50,690 over the life of their new loan.
Federal student loans have standard repayment terms of ten years. Private refinanced loans can go out to 20 years. Nearly six in ten of the borrowers (58.5%) in Credible's analysis refinanced into a fixed rate loan--with the rest getting variable rates. Many borrowers don't realize that refinancing involves taking out a completely different loan -- trading a federal loan for a private one. In the bargain, they lose federal benefits, such as the ability to reduce payments in times of sickness or unemployment and access to income-driven repayment programs and Public Service Loan Forgiveness program available to all federal loans except, in certain circumstances, PLUS loans.
The variable interest rate on a refinanced loan is likely to go up over the term of the loan as economic conditions change. Rates are tied to interest rate benchmarks such as the Federal Reserve's prime rate.
Unlike federal loans, refinancing a student loan involves a credit check.
"The most important underwriting criteria for most lenders are debt-to-income ratio (DTI), credit history, and credit score," said Credible in its report. "Debt-to-income ratio is a metric that shows lenders how much of a borrower's monthly income is going to pay their bills, and their capacity to take on additional debt. A borrower's credit history and credit score provide insight into how well a borrower has managed debt in the past."
The Credible report suggested solutions for people whose refi apps are turned down. Borrowers who are turned down for refinancing or get offers that don't beat their existing rates can often still make refinancing work for them by lowering their debt-to-income ratio, improving their credit score, or asking a friend or relative to cosign their loan, Credible said. Some lenders offering refinancing through the Credible marketplace will make offers to borrowers with a credit score as low as 620 if they have an eligible cosigner.
Still, a significant number of people who want to refinance won't make the cut with lenders, even if terms have become easier.
"The demand from borrowers seeking refinance exceeds the supply of lenders with capacity for making new private consolidation loans," said Mark Kantrowtiz, senior vice president of strategy and publisher at Cappex.com, with low-risk borrowers getting most of the refi action. A lack of capital, he said, was the main bottleneck.
"Most of the lenders making private loans are banks, who can rely on deposits as a source of capital," Kantrowitz said. "Banks tend to be risk averse, so even if they have the capital, they are not going to bet all of it on student loans."