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Out Today: In the Interest of the Few

First championed by Senator Elizabeth Warren, and later integrated into Hillary Clinton’s 2016 presidential run, student loan refinancing would allow borrowers to lower their interest rates to match those offered to current students, which are near historic lows. And the concept may have also found a few unlikely allies among congressional Republicans, and even President Donald Trump, who has signaled his support for lowering student loan interest rates.

The idea is not just popular among political elites, but also has widespread appeal among voters: in a 2016 poll, New America found that 94 percent of likely Democratic voters and 85 percent of likely Republican voters favored such a policy. But despite its popularity, there is very little in the way of empirical analysis of who gains from student loan refinancing or by how much. 

In a paper out today, we use the 2013 Survey of Consumer Finances, a triennial survey sponsored by the Federal Reserve Board, to examine borrower’s interest rates, monthly payments, and total owed over the course of the remaining repayment period. We add to these projections of how refinancing would impact each of these measures, generating insights on how these policies might change borrower’s interest rates, monthly payments, and the total amount paid in accumulated interest and principal.

Overall, we find that just over half of all households (52.8 percent) would be able to lower their interest rates on at least one education loan. The average interest rate would drop by less than two percentage points: falling from 5.8 percent today to 4.2 percent after refinancing. What’s more, the monthly savings are minor: on average, households with student loans would save just $8.17 per month. Over time, these monthly savings add up to $941 saved on average, in nominal dollars over the remaining life of their loan. 

Moreover, not all borrowers would benefit equally. Well documented links between student loan debt, education, and future earnings mean that those who borrow the most have often done so because they've stayed in school longer and obtained their degree or have even obtained a postgraduate degree. This additional educational attainment confers an economic benefit in the labor market, corresponding to higher earnings.This, plus the inextricable link between interest rates and loan balances, means that the savings from refinancing will be greatest for those with large loan balances - who also tend to have the highest educational attainment and household earnings.

Obviously, some borrowers prove to be exceptions to the rule. But on average, our findings confirm these theoretical links: those with household earnings above $105,000 annually would save an average of $10 per month and $1,161 in total, while those with master’s degrees or higher save $9 per month and $994 in total, and those who owe at least $44,000 save $15 per month and $1,929 in total.* As a result, these borrowers take in a disproportionate share of the benefits associated with student loan refinancing. 

Generous, targeted programs like income-based repayment already exist to help support borrowers who are struggling to make their monthly payments. In this light, an excessive focus on interest rates risks poorly targeting crucial federal dollars by concentrating savings among borrowers who don’t need the help.

Refinancing is likely so popular because people think they will receive a large benefit when it comes to their monthly payments. But we find that among low-income households with student debt, nearly all (95.9 percent) would lower their monthly payment more by enrolling in existing income-based repayment programs than they would under refinancing. On average, the monthly payments for these borrowers would drop from $122 today to $33 under income-based repayment,** saving them nearly $100 per month on average. In contrast, under refinancing, these borrowers would still pay $115 per month, saving only about $7 per month.

Given the high projected costs of allowing borrowers to refinance their loans—the Congressional Budget Office estimates that Senator Warren’s bill would cost $60 billion over the next three years—a better understanding of the size and distribution of the benefits should cause policymakers to reconsider how to better target loan policies to help low- and moderate-income borrowers.

*The correlation across these three groups is not perfect, and are not the focus of this paper. However, on average those with higher debt levels also had higher levels of education and higher household earnings.

**We model IBR payments using the terms of Revised Pay as You Earn (REPAYE), because it is the most generous and widely available income-driven plan.