Why is it so difficult to lower my student loan interest rates by consolidation or refinancing?

Michael Lux Best Of, Blog, Consolidation, Student Loans 0 Comments

It should be easy.

Interest rates are near all time lows.  A person with decent credit and a decent job can get a 30 year mortgage with an interest rate at just a hair over 4%.  Homes with negative equity can even be refinanced.  With credit seemingly so easy to get, why is it so hard to lower the interest rate on student loans?

Some might argue that it is because lending for student loans is riskier than other types of credit.

They would be wrong.  Sure you can’t foreclose or repossess a student loan, but that doesn’t make them a bad bet.  In fact, with student loans nearly impossible to dispose in bankruptcy, they are quite secure.

Then why is it so hard to reduce student loan interest rates?

The answer, like the answer to many student loan questions, depends upon whether or not you have federal government loans, or private loans.

Federal Loans

Unlike interest rates for mortgages, car loans, and credit cards; federal student loan interest rates are set by Congress.  Though Congress recently passed legislation tying student loan interest rates to the market, the markup on the loans means they will continue to only be available at higher interest rates.

Further Reading: Private loans vs. Federal government loans

Where interest rates get really strange with the federal government is when you consolidate your student loans.  With nearly all other types of refinancing and consolidation, the process is an opportunity to lock in lower interest rates.  Federal student loan consolidation is the exception.  Rather than offering consolidation at market rates, when the federal government consolidates student loans, the interest rate is set based upon a weighted average of all of your loans… which means your effective interest rate stays the same.

Further Reading: The Golden Rule of Student Loan Consolidation

Private Loans

Refinancing and consolidating your private loans are where things get especially strange.  Banks and other lenders do not need an act of Congress to make competitive interest rates, and there seems to be no shortage of demand for these financial products.

Unfortunately for people looking to consolidate, only about half a dozen companies offer private student loan consolidation.  In fact, in recent years, the numbers of companies offering student loan consolidation shrunk.

With so few lenders in the market, the requirements for borrowers to secure consolidation have become rather strict.  Without excellent credit and/or a cosigner, traditional consolidation has become very difficult.

What other alternatives are available?

Many students have resorted to the bank of mom and dad.  Rather than going through traditional student loan consolidation, many parents are taking out home equity loans to secure the funds necessary to pay off student loans.  With the lower interest rates of the home equity loans, their children have an easier time paying off the debt.  However, for most people, this option is not viable.

Another option explored by many borrowers is Peer to Peer Lending.  Getting a personal loan crowd funded allows the student to pay off the existing loan and lock in a lower interest rate.

Similarly, some borrowers are working with not-for-profit credit unions to consolidate or refinance their student loans.  These loans have many of the advantages of the peer to peer funding, and slightly lower interest rates.  Unfortunately, the need for decent credit or a cosigner still exists.

The Bottom Line

Finding opportunities to lower the interest rates on your student loans is difficult.  Even with ideal credit qualifications, it is tricky, and as your creditworthiness drops, your odds of securing a lower interest rate similarly drop.