All 5 Hidden Costs I Experienced When Refinancing My Student Loans
And What You Can Learn From It
The student loan refinancing market is flooded with companies that claim to help student loan borrowers get a hold of their finances and become debt free. Just to name a few: SoFi, CommonBond, Earnest, Laurel Road, LendKey, First Republic, Citizens Bank. As a student loan borrower, I’m not naïve enough to think they have my best interest at heart. But the critical problem is that these poorly regulated for-profit businesses with inefficient processes likely are benefiting handsomely while costing student borrowers money.
In the investment space, non-accredited investors are held to a higher standard of care because there is an implicit expectation that such investors are less knowledgeable and therefore should be protected.
Why doesn’t such a standard of care exist in the lending space?
Student loan borrowers, many of whom first sign on the dotted line when they are 17 or 18 years old, should be held to a higher standard of care.
Until our policymakers deliver on that, I want to share the knowledge I gained from refinancing so fellow borrowers can gain clarity and know how to determine if they are eligible for a refund. Additionally, I hope future borrowers can avoid the issue, and lawmakers can implement policy that will require student loan providers improve their practices.
APPLICATION PROCESS — THE DUPLICATE LOAN AND HIGHER INTEREST RATE
Earlier this year, I noticed that my credit score improved substantially and wondered if I could refinance to a better interest rate on my student loans. I went to the website of one of the available lenders, input my information, and was ecstatic to see 4.65% as an option for 15 years. This was 2% better than the rate I had at the time, so I took a photo of the computer screen so that I could show my mom! I then entered the information needed to authorize a hard credit pull. I had some difficulty entering my loan details and noticed that my loan balance appeared twice but was unable to delete the duplicate line item. I just made a mental note of this and carried on.
The next day I received an email from the lender, but they were now quoting an interest rate of 5.12%, instead of the 4.65% that I saw the day prior!
I wondered, “could this have been because my loan was double counted?”
When I called the loan provider and explained the problem to the nice-sounded customer service representative, one of the first things I said was, “I noticed that my loan balance appeared twice while I was going through the application. Could that be contributing to the higher interest rate?”
He responded, “no, I don’t see that showing up in my system so I don’t think that’s the problem. Also, please remember that the rates provided during the soft-pull stages are only estimates and are subject to change. But let me look into it and get back to you.”
Later that day I received an email from him. “I got the information you were looking for! I spoke to our underwriters, and it looks like the difference in the rates is from the amount of free cash available. It seems that the main factor in this is your rent.”
This response made my head spin. First off, when I had spoken with the representative earlier, he told me that I had underrepresented my income my $10K in the application. Shouldn’t this higher income have more than made up for any concerns about my rent payment? Second, my rent is very low for my income. How could one reasonably believe rent can drive a 0.5% interest rate increase?
I asked for the underwriter to call me directly, but instead got a call back from the same representative who tried to convince me that my rent is the problem.
Despite his confidence, I persisted and told him, “this is a bait and switch and would represent a flagrant error with your algorithms, and lack of transparency. If a better explanation isn’t provided about why I originally was quoted a 4.65% interest rate, and now am being quoted a 5.12% interest rate, then I will report your company to the Consumer Financial Protection Bureau.” The representative promised to look into it further.
Two days later, I received a call from an underwriter. It turns out that I was correct when I communicated the duplicate loan as the possible cause of the discrepancy. The customer service representative did not have access to the information necessary to see the inconsistency, and the underwriter reverted my rate back to 4.65%.
The issues here are:
- There was no system in place to catch the duplicate loan entry, and I wonder what other issues can arise when completing a loan application.
- I suggested the possible cause — duplicate loan — but was dismissed. Instead, the issue was falsely identified as my rent. An average borrower might have accepted that response, and in the worst case, would have accepted a incorrectly higher interest rate!
- If I did not take a picture of the preliminary interest rates just to show my mom, then I would not have had proof that the original interest rate was 4.65%, nor the confidence to fight back as much as I had to.
What borrowers can do about it:
- When applying for a new loan, always take a screenshot of the rates that you receive during the soft-pull stage.
- If you authorize a hard pull, compare the final interest rate with the rate you saw during the soft-pull stage.
- If there is a discrepancy, then have the confidence to disagree with them until you receive a satisfactory answer.
APPLICATION PROCESS — THE MISLEADING INTEREST RATE
Student loan lenders are currently allowed to represent interest rates and minimum monthly loan payments however they like.
Some show the interest rate without any deductions, but do offer a 0.25% autopay discount. Others, like CommonBond and Earnest, represent their interest rates with a 0.25% autopay deduction already calculated in. Citizens Bank gives borrowers an option to toggle on or off the loyalty and autopay discounts. FirstRepublic does not even offer an autopay discount because, to take advantage of the lower interest rate, the loan payment must be withdrawn from a FirstRepublic checking account.
Even though I am a detail-oriented person, I had not realized that my interest rate was not actually 4.65%, but rather 4.90%, until I received the Final Loan Disclosure from my new lender. The monthly loan payment was calculated using 4.90%, but so long as I am enrolled in autopay, my interest will accrue at the discounted rate of 4.65%. When I asked what would have to happen if I wanted my monthly loan payments calculated off the 4.65% — a difference of $20 per month — I received conflicting answers. Ultimately, I stuck with the higher minimum monthly payment since it means more of my payment goes towards principal.
The issues here are:
- As I said earlier, student loan borrowers should be held to a higher standard of care.
- All this discrepancy in the way that a loan interest rate is represented does nothing more than confuse borrowers and make it harder to adequately compare loan terms.
- The minimum monthly payment that is represented on the website should align with the minimum monthly payment that appears on the Final Loan Disclosure document.
What borrowers can do about it:
- Pay very close attention to the interest rate and any disclaimers that may be on the lender’s website.
- Contact the lender’s customer service, either by phone or by chat, and ask if the listed interest rate includes any discounts.
LOAN DISBURSEMENT — OVERPAYMENT
On May 30th, I received an email notifying me that my new lender had disbursed the funds and issued payment to my prior loan provider. Out of random curiosity, I checked my loan balance and noticed that my new lender overpaid.
I waited one week before writing to customer service, “I’ve been checking on my student loan and I expected a message notifying me that you overpaid but have not received anything. What is the usual process in these cases?”
The response was, “We almost always make overpayments when refinancing. What will happen is that your old lender will send the excess funds back to us and we will apply them to your loan. We’ll also backdate the payment, so you don’t end having to pay interest on money you never owed on us in the first place!”
It sounded so simple. But it turned out to represent yet another hidden cost.
I received further reassuring responses like, “it will take 45–60 business days to receive the check from your prior lender” or “don’t worry at all, we will process everything when we receive the refund — you don’t need to do anything.”
But by mid-August, three months after my loan was disbursed, I grew impatient because the refund was still not credited to my account. At that point my current loan servicer told me to contact my prior lender and find out if they sent a check, and if it was deposited.
When I did, I discovered that my prior lender had mailed the check on June 4th, only six days after my loan was disbursed, and my current lender cashed the check on June 20th. Therefore, my new lender had received the check more than two months prior but had never applied the credit to my account.
If I followed their original advice and trusted that everything would go smoothly, then that money would never have been applied to my account.
Unfortunately, it took yet another three weeks of getting bounced around to find the right group that could help me get the credit applied. But even then, the comedy of errors continued because the lender did not backdate my refund correctly — applying it to June 20th, rather than May 29th.
This entire debacle made me reflect on the email I received in May, when a customer service representative said, “we almost always make overpayments when refinancing.” If this happens all the time, then why did my check get lost in the mix?
I contacted the lender’s customer service again and asked, “what information do you provide prior lenders to facilitate the refund?”
The response was disconcerting. “We don’t send any information to the previous lender… They have the address to return the refund to, as it is on the check they received from us initially, and we’ve been working with them for many years.”
On the one hand, no information is provided because they work together all the time, but on the other hand, my refund was not applied because the necessary information was not sent along with my check. Clearly the system is broken, and I could have paid the price if I was not so careful.
The issues here are:
- My question was aimed at understanding what information is provided to ensure uniform processing of refunds. If no strict practices are issued, then it is reasonable to assume that many other borrowers also have refunds that were never applied to their account.
- Lenders could be getting unjustly enriched by the common process of overpaying, especially if they are depositing these funds into accounts that benefit them financially.
What borrowers can do about it:
- Call or log-in to your prior loan provider’s portal to check what your loan balance was on the day that your new loan was disbursed.
- If an overpayment was made, then contact your new lender to find out what their process is for managing the overpayment.
- Keep a close eye on your account balance over the course of the next month. If your credit has not been applied, then contact your old loan provider and ask them if they issued a check and if the check was deposited. If it was deposited, then contact your current loan provider (not the loan servicer) and have them apply the credit to your account.
LOAN DISBURSEMENT — DOUBLE INTEREST
This is the most important hidden cost of refinancing. It represents potentially illegal behavior because it appears that borrowers may end up paying interest to two lenders for the same loan, at the same time.
When my new loan was disbursed, I calculated that the over-payment was approximately $750. When I received the refund check from my old loan provider, I was shocked to see that it was only in the amount of $619. What caused the difference?
It took a bit of digging but I discovered that my new loan provider started charging me interest on May 29th, but my old loan provider stopped charging me interest on June 3rd. Therefore, for 6 calendar days I was paying interest to both lenders for the same exact loan.
This felt wrong: my new lender started charging me interest on the day they wrote the check, not the day the funds were withdrawn from their account, meaning they charged interest before the funds even left their account.
I once again called the lender’s customer service department, explained the double interest payment, and asked, “why do loans start accruing interest once they’re sent out [rather than when the prior lender withdraws the funds]?”
It took 9 business days, but the response I received was: “This was difficult to find an answer for since it is the common practice and as far as I know most lenders operate in the same way. The answer I was able to find is because it’s the simplest way to do it. Beginning accrual once the funds have been applied to your old account balances is unreliable because we have no way of knowing for sure when a lender applies those funds to your account. When interest starts accruing at disbursement, it also ensures that every borrower starts accruing interest at the same time.”
Let’s unpack this response.
First, the rep said, “…it’s the simplest way to do it.” Truth is a defense, “simplicity” is not — especially when borrowers are paying the price.
Second, the rep said, “…we have no way of knowing for sure when a lender applied those funds to your account.” In the current technology era where we can get notifications every time a credit card is used, I have confidence that if lenders want to have a way to know, then they certainly could. But it benefits them to avoid building such an alerting system since borrowers are the ones who pay the price.
Third, if it is such a common practice then why aren’t borrowers clearly informed in writing that there is a chance they will pay interest to both lenders until the original lender received payment?
After sending a very dissatisfied email, I received a phone call from the same underwriter who adjusted my interest rate in May. I explained the issue and why I believe this is an illegal practice to charge interest on a loan before the funds have left the lender’s account.
The underwriter acknowledged the issue and proceeded to offer me a $125 refund — the amount of interest I paid to them while also paying interest to my prior loan provider.
The issues here are:
- Borrowers like me are paying interest to two lenders for the same loan at the same time, when refinancing.
- This is a common practice, as the customer service representative stated, but there is no common approach. Some lenders acknowledge the date of the check as the day to stop charging interest, while others acknowledge the date of receipt of the check (which was 6 days later, in my case). These non-standard practices introduce a level of opaqueness into the process and borrowers ultimately pay the price.
- I received a refund for my double interest payments because I persisted and refused to accept insufficient answer. But how many other borrowers out there have refinanced their loans and have unknowingly paid interest to two lenders for the same loan at the same time?
What borrowers can do about it:
- Call or log-in to your prior loan provider’s portal to find out what day they stopped charging you interest.
- Check with your current loan provider to find out what day they started charging you interest.
- If there is any overlap between the two, then ask your current loan provider to calculate how much interest you paid over the course of the overlapped days.
- Have them issue you a refund in the amount of the calculated interest for those overlapped days.
FIRST PAYMENT — EXTRA INTEREST
Earlier this year I wrote about the cumbersome process I went through to figure out why I was paying $3 more per month, and $621 more interest in total, than what was listed on my loan disclosure document. After at least 10 hours of phone calls and significant amount of research over the course of a year, I uncovered the cause.
My lenders informed me that they have 30 to 60 days to schedule the first payment after a loan is disbursed. This means there will almost always be more than 30 days between when a new loan provider funds the loan and when the first payment is due. For me, interest accrued for 15 extra days and, when the first month’s payment came due, my payment had to cover $378 more of interest.
This led to a ripple effect because, when less of my first month’s payment went towards principal than scheduled, the principal balance was $378 higher the next month, and ultimately was scheduled to lead me to pay $641 more interest over the life of my loan.
When I refinanced my loans the first time in 2016, I was not aware of this behavior, and neither are most borrowers. Even though lenders say, “you are welcome to make a payment any time you want,” the issue is that most borrowers have no way of knowing that they should consider paying more than the minimum. If the repayment schedule is misrepresented to borrowers, then they have a right to know. Unfortunately, even when I was well informed about the issue, and knew what to ask for during my second refinance in 2019, I was met with inaccurate reassurances.
I emailed customer service and asked how they account for the extra days of interest between the day my loan was disbursed and the first payment, and what the impact will be to my overall estimated interest payable.
The customer service representative emailed me, “your first payment will cut out any interest accrued up to that point, including those extra days you mentioned.” But after I responded with disagreement, he elaborated, “I can assure you that your first payment will cut out all of the interest that has accrued. All of our monthly payments are calculated to take care of all interest that has accrued up to that point, along with a portion of principal. Because there’s more than 30 days of interest accrual to pay off on this first payment, that just means that a little more of this specific monthly payment will be applied to interest than to principal.”
Despite the rep’s assurances, the problem was hidden in his response: the lender was aware that more of my first payment will go towards interest, which means that less will go towards principal, and the original repayment schedule will clearly not be followed.
Rather than notifying borrowers that they should pay more than the minimum for the first month, lenders make the change on their own because “it’s simpler this way.”
The issues here are:
- When lenders are given 30–60 days to schedule the first payment, there is no way of knowing if they will take longer simply because it will earn them more money.
- On a per borrower basis, it might not make that big of a difference. But when we consider that 44M students hold federal or private debt and more than 50% of borrowers have more than $40K in loans (which accounts for less than 4% of defaults, meaning they do fulfill their obligations), then we may assume that at least 20M borrowers will seek to refinance to “better” terms at some point in their loan life.
- If 20M borrowers pay a few extra dollars of interest every month due to withheld information, then lenders are poised to capture tens of millions of dollars of additional interest income per month. This can then be turned into brand new loans, and thus repeat the cycle which fuels the beast.
What borrowers can do about it:
- If you have already refinanced, then you can calculate how much interest you could be overpaying my clicking into this article and scrolling down to point #3 where I included a GoogleSheet that will help you easily calculate
- If you have not yet refinanced then, when you do, make a note of the day your loan was disbursed (e.g., June 1st) and the date of your first payment (e.g., July 14th). You will want to ask you loan provider how much interest is scheduled to accrue on your loan between (e.g.,) June 1st and June 14th, and make a payment in that amount on your loan on June 14th.
If you have any questions about the information covered in this article, please email FiscalHappiness@gmail.com.
Editorial Note: This content is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article do not represent financial advice.
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