Chris Winiarz, a 31-year-old money manager with a Northwestern MBA, jumped at a student-loan deal of a lifetime.
A startup called SoFi offered to refinance his $45,000 in federal debt, slashing his interest rate to 2.69 percent from 6.55 percent. Winiarz will pay off his obligation three years early, saving about $9,500 and helping pay for an engagement ring for his girlfriend. The company even threw in a free bottle of artisan olive oil.
In a growing refinancing boom, a new generation of private lenders – backed by hedge-fund billionaires and Silicon Valley royalty – is targeting successful graduates with professional degrees and student loans. For the borrowers, “it’s an uncashed lottery ticket,” said Brendan Coughlin, head of education finance for Citizens Financial Group Inc.
There’s a catch. Their good fortune could cost taxpayers billions and damage the credit quality of the government’s $1.2 trillion student-loan portfolio, the biggest pool of U.S. debt, except for mortgages. That’s because professional-school graduates and other borrowers with successful careers subsidize the less fortunate, who are more likely to default.
“Cream-skimming by private lenders will remove these profitable loans and leave mainly – or only – the more risky loans,” said James McAndrews, executive vice president and director of research at the Federal Reserve Bank of New York.
Traditionally, the student-loan program returns money to the U.S. Treasury. Now, the exodus of its most reliable customers could lead to losses.
“This is one of those looming financial bills that is going to come due,” said Jaret Seiberg, a Guggenheim Securities analyst. “If the best borrowers leave, taxpayers are going to have to ante up even more cash.”
Borrowers holding about $150 billion in federal loans have strong enough credit that private lenders could offer a cheaper rate, Goldman Sachs Group Inc. estimated in a March report.
Refinancings are likely to reduce by as much as $10 billion to $20 billion the value of the federal portfolio because of lower income from loan payments, primarily for graduate school, according to Deborah Lucas, former chief economist at the Congressional Budget Office and now a Massachusetts Institute of Technology finance professor. Education Department spokeswoman Denise Horn said prepayments aren’t yet significant, and the student-loan program’s goal isn’t to turn a profit for the government.
The situation is another consequence of historically low-interest rates, as well as a peculiarity of higher-education finance. Congress sets federal student-loan rates, and older obligations now demand as much as 8.5 percent annually. For decades, government loans undercut the private sector. Now it’s the other way around.
Congress could let all federal student borrowers refinance at lower rates through the government itself, as Democratic Sen. Elizabeth Warren of Massachusetts has twice proposed in the last year, to no avail. Republican opponents said the bill did nothing to curb the current and future cost of college.
That leaves an opening for newcomers like SoFi, formally known as Social Finance Inc., and established players such as Citizens Financial. Private lenders have refinanced about $3 billion to $4 billion so far, according to Stephen Dash, chief executive officer of Credible.com, a website that compares refinancing rates.