Refinancing Can Cost Borrowers Student Loan Forgiveness, Warns Federal Watchdog

A federal financial watchdog agency warned borrowers this month that some private student loan companies may be misleading borrowers to convince them to refinance their federal student loans. 

“Companies break the law when they mislead student borrowers about their protections or deny borrowers their rightful benefits,” said Consumer Financial Protection Bureau (CFPB) Director Rohit Chopra in a statement last week. “Student loan companies should not profit by violating the law.” The CFPB is a federal agency that regulates the financial services sector, including student loan lenders and servicers.

According to a new CFPB report, the agency has fielded complaints from borrowers alleging that some private student loan companies are engaging in deceptive tactics to lure borrowers with federal student loans into refinancing via a private loan product. Doing so can mean the permanent loss of federal protections and access to key federal student loan forgiveness, repayment, and discharge programs. Here’s what borrowers need to know.

Federal student loan forgiveness and repayment programs are limited to federal student loans

Federal student loan borrowers enjoy a wide range of benefits. For those struggling with their monthly payments, borrowers can access generous deferment and forbearance opportunities, as well as income-driven repayment (IDR) plans that can provide manageable monthly payments even for large federal student loan balances. If borrowers get into trouble on their federal student loans, there are default resolution options that can restore the loans to good standing again. 

There are a variety of pathways to eventual student loan forgiveness based on a borrower’s repayment plan (i.e., IDR plans), occupation (i.e., Public Service Loan Forgiveness and Teacher Loan Forgiveness), disability status (the Total and Permanent Disability discharge program), or issues with a school (i.e., Borrower Defense to Repayment and Closed School Discharges). 

But these benefits are limited to federal student loans only. Private student loans are ineligible for these opportunities. And while the federal student loan system is far from perfect, borrowers who choose to refinance their federal student loans via a private company risk completely and permanently losing out on these benefits. That’s because once a borrower refinances a federal student loan into a private loan, they cannot re-convert it back into a federal student loan again.

“Refinancing student loans poses risks for borrowers, including loss of benefits tied to federal student loans,” says the CFPB in its December report. “In addition to other benefits, federal student loans offer access to various forgiveness programs… When borrowers refinance or consolidate these loans through a private lender, they lose these benefits and protections.”

CFPB warns of deceptive student loan refinancing tactics

In its December report, the CFPB warned borrowers that some student loan companies are engaging in deceptive tactics to try to convince federal student loan borrowers to refinance their loans via a private product.

“Examiners found that private lenders offering to refinance federal student loans engaged in deceptive acts or practices where their marketing and disclosure materials give a misleading net impression that refinancing federal loans might not result in forfeiting access to federal forgiveness programs, when, in fact, it was a certainty,” said the CFPB. 

Even where lenders warned borrowers of some of the benefits that could be lost by refinancing federal student loans, the CFPB found that some lenders omitted any reference to the loss of student loan forgiveness eligibility, or used ambiguous language that could have left borrowers with the impression that they could maintain access to federal student loan forgiveness and discharge programs.

“Examiners found that the lenders engaged in abusive acts or practices by taking unreasonable advantage of a lack of understanding on the part of borrowers regarding the material risks, costs, or conditions of refinancing federal loans into private loans,” continued the CFPB. 

“The lenders took unreasonable advantage of borrowers where their representations misled borrowers about the federal benefits at risk when borrowers refinance their student loans. Here, the lenders created the impression that refinancing federal loans may not result in forfeiting access to federal forgiveness programs. The lenders profited from borrowers paying the full amount of their loans, when the borrowers otherwise potentially could have had some or all of those loans forgiven.”

The CFPB uncovered other potentially deceptive or misleading refinancing tactics by certain private student loan refinancing companies, as well. These include failing to re-amortize a loan balance after certain balance adjustments during the refinancing process, and failing to cancel a refinancing during a three-day cancellation period available to borrowers.

When student loan refinancing makes sense

The CFPB report does not necessarily mean that all student loan borrowers should steer clear of refinancing. It just means borrowers should make well-informed decisions and be wary of possibly misleading or deceptive tactics when talking to private student loan refinancing companies.

Refinancing existing private student loans via a different private lender to get better repayment terms can sometimes make good financial sense. If borrowers can convert high-interest or variable-interest private loans into a more stable, lower-interest fixed-rate loan, they can potentially save quite a bit of money in the long run, depending on the specific terms and conditions of the loan product compared to their existing debt obligation.

But borrowers considering refinancing federal student loans into a private loan should be more wary. 

While refinancing may be tempting, particularly for higher-interest federal Graduate PLUS and Parent PLUS loans, borrowers should be absolutely clear-eyed about the benefits they would be losing. This includes any access to federal student loan forgiveness and discharge programs, generous deferment and forbearance opportunities, default resolution options, and income-driven repayment plans. If you walk away from these options by refinancing your federal student loans via a private lender, you won’t be able to get back into the federal student loan system later if you change your mind or experience a shift in circumstances.