By Scott Thompson
October 27, 2017

American students today owe over $1.45 trillion in outstanding student loans and interest rates are near historical lows. As a result, a host of new companies have sprung up over the last few years offering student loan refinancing. Private lenders like Earnest, CommonBond, and the market leader, SoFi, all pitch the benefits of refinancing at lower market-based interest rates. Their TV ads show happy millennial professionals saving over $20,000 by refinancing.

It sounds amazing, doesn’t it?

But the truth is less promising. In fact, starting this year the entire business model of private student loan refinancing may prove to be less viable.

There are two primary reasons for this. First, only a tiny percentage of all student loan borrowers can reap significant savings from private loan refinancing. The vast majority of borrowers either don’t qualify or their projected savings are not be worth the loss of protections that come with federal student loans. And second, the private refinance boom was created by a historically large spread between federal and private rates. As today’s federal student loan rates fall and private loan rates rise, that gap is shrinking.

Up until 2013, interest rates on federal student loans were fixed by the government and had no relation to market interest rates. Historically these rates have been between 6% and 8%. Since the Great Recession, market interest rates have fallen and short-term rates today remain close to zero. Since banks and lenders can borrow at almost 0%, the new private student lenders are able to offer loans with much lower rates—in the 3.5–5% range—and still make a profit.

SoFi, for example, claims the average lifetime savings of borrowers who have refinanced with them is $22,359. I tried using SoFi’s own calculator to arrive at such a figure, and found that a borrower paying 8% on $100,000 in loans with 10 years remaining could refinance down to 4.5%, saving up to $177 a month or $21,285 over the life of the loan.

This implies that SoFi’s average customer has a six-figure loan balance and a rate of 8% or higher. Students who have borrowed $100,000 or more often have done so to attain postgraduate or professional degrees. Consumer finance site NerdWallet indicates that the average approved borrower at SoFi has an annual income of $130,000 and an average credit score of 766. From this we can infer what kind of borrowers fit SoFi’s profile: lawyers, doctors, MBAs, and other professionals who are high earners.

It turns out that private lenders are targeting a very small slice of student loan borrowers. To put things in perspective, as of September 2017, only 6.9% of all working professionals make $130,000 or more per year.

But what about the average student loan borrower? Going back to the calculator, an undergraduate degree borrower with $30,000 in loans who refinances from 6% to 4.5% would only save $22 a month.

In 2013, the government changed the way it set interest rates for federal student loans. It started indexing student loan rates to the 10-year U.S. Treasury note. Current year Stafford loans have a rate of only 3.76%.

The decline in federal student loan rates is now accompanied by a rise in short-term market rates. As the difference between federal loan rates and refinancing rates gets smaller and smaller, at some point the savings won’t be big enough to entice borrowers to give up federal loan repayment protections. Even though federal loan rates have recently spiked to 4.45%, this higher rate is still lower than the lowest current rates offered by SoFi.

The new-age private student lenders seem to recognize that their prime value proposition may have an expiration date as a viable business, which is why they are diversifying into other product areas like personal loans, mortgages, and wealth management. In other words, they’re becoming banks. It just goes to show that when something seems a bit to good to be true, it’s because it isn’t.

Scott Thompson is the CEO of Tuition.io.

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