The End of Federal Student Loans?

The Federal subsidized student loan market does not behave like a normal market; it charges the same interest rate no matter how risky the borrower is, no matter which degree they obtain, or the time horizon of the repayment plan.

Recently I have noticed many companies popping up refinancing student loans. Some have rather stringent requirements. For instance, they won’t refinance you unless you have a Master’s degree that is in demand and good credit. In other words, there is actual underwriting.

Here is a picture of the current market for student loans.

As you can see, good borrowers are going to be paying more than they would in a normal private market. Meanwhile, bad borrowers are going to be paying less than under normal market conditions. So what refinance companies are doing is taking advantage of this discrepancy.

Good borrows will be better off given any rate lower than the subsidized student loan rate, so they will flock to refinance. Meanwhile, bad borrowers will be better off sticking with the subsidized loans. So basically, the government will be stuck with the high risk borrowers. They will have two options: (1) adapt to make the process more dynamic or (2) keep increasing the interest rate until all borrowers refinance in the private market.