We Already Cleaned up the Student Loan Mess—Let’s Not Do It Again
At the height of the financial crisis in 2008, the U.S. federal government quietly began purchasing federally guaranteed student loans made by private lenders. These lenders believed that they could no longer make a profit; they either could not raise the capital necessary to hold the loans or had to pay too much for that capital. To prevent students from being forced to drop out of school because they could not pay their tuition and fees—as well as allow colleges and universities that were dependent on tuition and fees to remain open—Congress passed the Ensuring Continued Access to Student Loans Act, which authorized the U.S. Department of Education to acquire newly made student loans. In the end, the federal government committed to purchase or outright acquire $150 billion in student loans that were originally made by private lenders between 2007 and 2009, or 85 percent of all student loans made by private lenders during those years.
In retrospect, the unprecedented acquisition of student loans by the federal government was the beginning of the end of the Federal Family Education Loan, or FFEL, Program, which relied on private lenders to raise capital to make student loans. The U.S. Department of Education being forced to buy loans from private lenders laid bare a simple and undeniable fact: Lenders abandoned students when they could no longer profit from them. In the face of this reality, political support for the FFEL Program crumbled. On March 30, 2010, President Barack Obama signed into law the Health Care and Education Reconciliation Act of 2010, which eliminated the program. Just a few months later, on July 1, the Department of Education began to make new federal loans exclusively through the direct student loan program.
Concentrating federal student loans in the direct loan program has had significant benefits for both students and taxpayers. The William D. Ford Federal Direct Loan Program delivers the same amount of federal student loans, with the same terms and conditions, at a substantially lower cost to taxpayers. Indeed, under the direct loan program today, federal taxpayers do not contribute to the cost of the program at all because the borrowers are paying more than the program costs to administer. This has allowed the federal government to simultaneously increase funding for Pell Grants, expand repayment through service, and make income-based repayment more accessible with better terms.
Now, however, it appears that some members of Congress have amnesia and want to reverse the process by selling federal student loans—both federally owned FFEL loans and federal direct student loans—to private lenders. They would facilitate the sale of these federal assets, ironically, by allowing borrowers to get a lower interest rate than the one Congress has set by formula in law.
Creating a mechanism for refinancing within the existing federal student loan programs would be a far easier and more cost-effective option for both borrowers and taxpayers. For years, the Center for American Progress and its Millennial advocacy arm, Generation Progress, have advocated for the ability to refinance student loans in order to allow borrowers to take advantage of the historically low interest rate environment. Indeed, if all Congress wanted to do was lower interest rates for student borrowers, it could simply change the rates for existing loans while retaining all the benefits and protections that the federal direct student loan program currently provides.
Instead, under legislation introduced last month by Sens. Kelly Ayotte (R-NH) and Shelley Moore Capito (R-WV), borrowers would have to refinance their federal student loans with a private lender in order to obtain an unspecified lower interest rate. Lenders could pick and choose which borrowers would have access to lower interest rates and would likely provide the best rates only to the most economically stable, highest-earning borrowers—in other words, the borrowers who need help the least. Private lenders would also have to market their loan products to borrowers, service the loans they acquire, and still make a profit. How much, then, could a borrower expect to save?
The idea proposed in this legislation is nothing new; it happens every day. Some lenders have already taken advantage of borrowers’ ability to pay off a direct loan—SoFi, for example, has already made $4 billion in student loans—by refinancing the best-performing loans for the borrowers with the greatest ability to pay. However, because the current interest-rate reduction is not enough of an incentive for most borrowers to want to give up the benefits available in the federal programs, advocates for the private loan industry want the federal government to facilitate these transactions by permitting the refinanced student loans to be repaid with pre-tax income. If a student borrower could not find a private lender willing to make them a loan, they would be out of luck: no lower interest rate and no tax break. Only borrowers with large debts and great income potential would benefit from this giveaway of federal assets.
Federal student loans are valuable assets, and assets of the federal government should not be sold at a loss. If federal student loans are to be sold into the private marketplace, they should only be sold through a competitive bidding process that establishes the true value of the asset. Providing a benefit for refinancing with a private lender, however—such as permitting pre-tax income to be used to repay a refinanced federal student loan—would encourage borrowers to take their loans out of the federal programs, which would essentially facilitate the process of private lenders acquiring federal assets for less than their true value. But in fact, those assets are worth substantially more than their face value. Why else would the lenders want to acquire them?
As bad as the legislation would be for taxpayers and borrowers in federal direct loan programs, it also has the potential to harm borrowers who take advantage of the refinancing option. In order to take advantage of refinancing under the proposed legislation, borrowers would have to give up important benefits that are assured under the federal student loan programs. These would undoubtedly include the ability to repay a loan through an income-contingent repayment plan, as well as the right to have any outstanding balance on a student loan cancelled after 10 years of public service with a nonprofit organization or government agency or after 20 years or 25 years generally.
Hopefully, teachers who are eligible to have their loans repaid through their teaching service would not fall for the refinancing sales pitch. But who would counsel these borrowers—or any borrower for that matter—on whether private refinancing is a good idea? Can the private lenders be trusted to do that? Can the federal government? Borrowers are also entitled to a variety of forbearances and deferments on their federal student loans. Who would know whether giving up these benefits is financially beneficial or not? Answering this question would require borrowers to accurately predict whether or not they will be unemployed or face other economic hardships in the future and whether benefits from the lender in these circumstances would be better or worse.
It is also unclear, under the proposed legislation, whether borrowers who refinance through a private lender would give up the right to have their loans discharged in the case of death or total disability. What is clear, however, is that these borrowers would give up their defense to repayment right, under which the Department of Education can discharge their student loans if the school they attended committed fraud or otherwise violated applicable state law related to student loans or educational services.
The federal government already permits borrowers to refinance federal student loans through private lenders. Congress should only consider providing special tax benefits and new loan guarantees if private lenders agree to offer all borrowers the same lower interest rate with the same terms and conditions. Until then, Congress should protect the taxpayers’ interests in federally held student loans. To do otherwise would only help the private student loan industry and the few wealthy borrowers who would never need to take advantage of loan forgiveness, income-based repayment, or other benefits that private lenders would deny them.
David Bergeron is a Senior Fellow at the Center for American Progress.
David A. Bergeron