Joe Szczepaniak pays a 3.5 percent interest rate on the mortgage for his house in a Chicago suburb. His car loan is 1.79 percent. The federal education loans he took out to send his four sons to college? They’re all above 7 percent. “Student loans have been the big black holes of my budget,” he says. Szczepaniak, who calls himself “Mr. Quicken” because he carefully tracks his finances, questions why the $200,000-plus he owes on the student loans doesn’t “reflect reality” and today’s low rates.
The answer is that Congress, not the market, sets rates for federal loans—which account for 85 percent of the roughly $1 trillion in outstanding education debt—and refinancing to a lower rate is rarely an option. Now some lawmakers and private lenders are looking for ways to give education borrowers more repayment and refinancing options.
Congress set the rates in 2001, when overall rates were higher—and hasn’t changed them since. For parents such as Szczepaniak, the rate on federal education loans is 7.9 percent; for students, the rate is 6.8 percent. Needy undergrads can get federally subsidized loans at 3.4 percent, but that rate is set to double this summer unless Congress acts. Private loans historically have been more expensive than federal ones. Though rates have been coming down, they’ll never be as low as those on mortgages or car loans, which are tied to physical assets that lenders can repossess if a borrower defaults.
While borrowers who have multiple federal loans can consolidate them, the rate on the new loan is just the weighted average of the existing loans. Borrowers with private loans can consolidate in theory, but few private lenders offer that option. Overall, 7 out of 10 outstanding federal loans are set at more than 5 percent interest, according to an analysis by the Center for American Progress. The Federal Reserve Bank of New York estimates that more than 30 percent of borrowers who have begun repaying their loans are at least 90 days behind.
Although they can’t refinance, borrowers with federal loans have ways to reduce the burden. Congress has mandated several options—seven to be exact—including income-based repayment and a “pay as you earn” plan. Private lenders offer less flexibility, in part because of accounting regulations that force lenders to write down modified loans. P.K. Parekh, vice president of Discover Student Loans (DFS), the third-largest private lender, says that causes lenders to be cautious, adding: “You never want to run afoul of your regulator.”
On March 1, six senators headed by Dick Durbin (D-Ill.) called on private lenders and bank regulators to work together to create more repayment options for borrowers. On March 27, the Consumer Bankers Association wrote a letter to the primary bank regulators asking for “greater flexibility” in what lenders can do before they have to write off the loans. In particular, banks want the go-ahead to offer plans in which the payments gradually increase over time and ones in which borrowers pay only interest in the first three or four years. They also want to be able to offer forbearance—allowing the borrower to stop making payments temporarily—more often and for longer periods. (Currently, they’re limited to one three-month forbearance every 12 months.)
The Consumer Financial Protection Bureau also has solicited suggestions from the public and lenders on how to make payments more affordable and create a refinancing market. Early submissions by some think tanks proposed that the government create a fund which could be used to modify loans to lower payments.
Szczepaniak is grateful to have been able to borrow to send his sons to school—“We will be a better country because of it, even if they are actors and musicians”—but with his 60th birthday coming this year, he wonders how he’ll afford retirement with student loan payments of $2,086 a month. “I would repay this sooner,” he says, “if the rate was reasonable.”