Dear Mr. Ethics,
My school’s alumni association recommends a private lender who will refinance our graduates’ education loans, including federal student loans, at a lower interest rate. Is this a problem?
Yes—from both a regulatory and an ethical standpoint.
Under “Regulation Z” as interpreted by the Consumer Financial Protection Bureau (CFPB):
Further, a school or affiliated organization that provides information regarding a private education loan from a lender to a prospective borrower must provide certain disclosures, even if it does not participate in a preferred lender arrangement. This information, as well as requirements surrounding preferred lender arrangements, may be found in the FSA Handbook, starting on page 2-179 in the 2020-21 edition.
IRS law also defines education loans for the purpose of qualifying for the student loan interest deduction on tax returns. Their definition includes loans taken to refinance education loans; there is no distinction made between federal student loans and private education loans. Although this definition is applicable to specific IRS purposes, it provides another argument that loans taken after the borrower is no longer a student that are used to refinance federal and/or private education loans should be viewed in a similar light to the original education loan.
Ethically, we generally assume that students, especially early in their academic careers, have little knowledge or experience concerning financial literacy. Therefore, we go to some lengths to protect them. We ensure that student borrowers are counseled—at least twice—about their federal student loans. Special provisions extend to lenders of private education loans, which can include schools and affiliated organizations. Preferred lender arrangements between creditors and schools are regulated to ensure that schools are true advocates for their students.
What protections associated with private loans used to refinance education loans does a borrower who is not currently a student have, other than those applicable to any ordinary loan under the Truth-in-Lending Act? Who is their advocate?
By the time they graduate, have those borrowers we protected as students become financial wizards? Even after a couple of years in the “real” world after leaving school, should we assume that they cannot be misled, that they will be aware of lost benefits if they refinance their federal loans, or that they have the skills necessary to make the best finance or career decisions? In most cases the answers to those questions are probably no.
Does the school still have any obligation to its former students related to the disposition of educational debt when it comes to products the school or its affiliated organizations recommend? Even leaving regulation aside, from an ethics standpoint we would say yes.
Under preferred lender arrangement rules, an institution must “exercise a duty of care and a duty of loyalty to compile the preferred lender list… without prejudice and for the sole benefit of the students….” Regulations further require that schools and their affiliated organizations, which includes an alumni organization, have a code of conduct that precludes, among other things, conflicts of interest and revenue sharing under the arrangement.
It does not seem unreasonable to extend the same duties of care and loyalty, and code of conduct, to any loans that the school or its affiliated organizations recommend or promote to their former students, even in situations where the preferred lender arrangement rules don’t apply. And after all the care we put into counseling students about their federal loans, shouldn’t schools ensure that former students considering private refinancing of their federal loans be reminded of the benefits they would give up?
The CFPB addresses the question of “Should I refinance my federal student loan into a private student loan with a lower rate?” by saying “It depends,” and giving a concise summary of the considerations. At a minimum, ethics dictate that any information about refinancing federal student loans provided by a school or its affiliated organizations be accompanied by that summary.
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Publication Date: 6/20/2017