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Choosing a Lender


Some of the major considerations involved in choosing a lender include cost, flexibility and customer service. Some borrowers also focus on the most popular lenders.

Additional discussion appears in Loan Tradeoffs - Federal vs. Private and Preferred Lender Lists.

Loan Cost (Borrower Benefits & Discounts)

Since July 1, 2010, all new federal education loans have been made through the Direct Loan program. Private lenders no longer have a role in making new federal loans. However, private lenders may still offer discounts on non-federal private student loans.

Although all Federal education loans have the same interest rates and fees, some lenders offer discounts that can reduce the cost of the loan. These repayment incentives, also referred to as borrower benefits, include interest rate reductions, full or partial origination fee rebates, and principal balance reductions. They reward the student for using automatic direct debit of monthly payments and/or for making on-time monthly payments. Some of the cost savings are immediate, while others require the student to make the first 12, 24, 30, 33, 36 or 48 monthly payments on time and to continue making the payments on time.

In many cases the repayment incentives offered by a lender depends on the guarantor that insures the loans against default and the secondary market to which the lender sells its loans. Some student loan guarantee agencies, for example, have waived the 1% default fee (previously "guarantee fee") on the student loans they insure against default.

It is important to realize that if you are late on a single monthly loan payment you will no longer qualify for the prompt payment discounts. Do not overestimate your ability to make all the payments on time. Ask the lender what percentage of their borrowers qualify for each of the borrower benefit programs. Less than 15% of borrowers succeed in obtaining any discount other than the 0.25% interest rate reduction for EFT. (Even students who sign up for EFT occasionally miss a payment by having insufficient funds in their account. Students are, however, more likely to succeed in qualifying for the discounts if they sign up to use electronic funds transfer to automatically debit their bank account for the monthly payments.) The actual success rate is probably closer to 10%.

A 2% interest rate reduction after 48 months of on-time payments may sound like a lot, but it is the equivalent of a less than 0.7% point reduction in the interest rate over the ten-year lifetime of a regular student loan. (Most of the other different interest rate discounts offered by various lenders yield a similar financial benefit, typically yielding an equivalent interest rate reduction that varies by less than 0.05% points from this figure.) Even after adding in the 0.25% point reduction for signing up for EFT, the savings is still less than a 1% point interest rate reduction. Since very few students qualify, the cost to the lender of offering student loan discounts is the equivalent of only about a 0.1% point reduction in the interest rate.

The discounts for consolidation loans are not as good as the discounts for unconsolidated loans, partly because the lender doesn't earn as much profit on consolidation loans. The typical discount is a 1% interest rate reduction after 48 months of on-time payments. This is the equivalent of a 0.36% interest rate reduction.

Since so few students ultimately qualify for the full discount of any borrower benefits that require continual on-time payments, most students should focus on the availability of the 0.25% interest rate discount for signing up for EFT and any immediate discounts (such as a waiver of the 1% default fee).

See Student Loan Discounts for additional information and caveats about borrower benefits, including a directory of loan discounts offered by hundreds of lenders on Stafford, PLUS and Consolidation loans. See also the Loan Discount Analyzer for help evaluating student loan discounts.

Loan Types/Flexibility

In addition, the different types of education loans have different costs. Stafford and Perkins loans are among the least expensive, followed by PLUS loans. Private education loans are among the most expensive, with the highest fees and interest rates, although they are less expensive than credit card debt. Non-education loans, such as home equity loans and lines of credit, may also be worth considering. Generally, home equity debt is slightly more expensive than the PLUS loan, and unsecured personal loans are slightly more expensive than private education loans.

FinAid recommends that families consider other types of loans only when they have reached the Stafford loan limits. Stafford loans are among the least expensive loans and have some of the most flexible repayment terms.

Some families, however, choose a more expensive loan because the repayment terms are more flexible or the loans offer other features that are attractive to families. Private education loans, for example, may have higher loan limits than the Stafford loan. Some parents don't want to borrow through the PLUS loan program because the student is not obligated to repay, unlike a private student loan. However, if the parent cosigns the private student loan, they are held responsible for the loan if the student defaults. Parents may wish to consider borrowing from the PLUS loan program and entering into a private agreement with the student to have the student make payments on the PLUS loan, since the PLUS loan is usually a less expensive loan.

Customer Service

Many lenders sell their student loans to a secondary market when the loans enter repayment. Many lenders also use a third-party servicer to manage the processing of payments and customer service requests. If you consolidate your loans, you are effectively paying off your old loans and replacing it with a combined loan from a single new lender. As a result, the company that services your student loan might not be the same as the bank that originally issued the loan.

Some lenders offer life-of-loan servicing, which means that the same servicer will be used even if the loan is sold. It does not guarantee that the loan won't be sold. In fact, in many cases life-of-loan servicing means that the lender has a forward purchase agreement with a secondary market (i.e., the lender has committed to selling the loan to the secondary market) and the secondary market is already providing the servicing on the loan, as well as other features such as loan discounts.

Other common customer service considerations include the availability of:

  • an online loan application process
  • toll free customer service 24 hours a day, 7 days a week, 365 days a year with minimal time on hold
  • an online interface to the account information
  • combined billing for Federal and private education loans
  • how well does the lender resolve problems
  • does the lender generate a lot of complaints from its borrowers

If you have questions about the quality of the customer service offered by a particular lender, talk to the financial aid administrator at your school. When students and alumni encounter problems with a lender, the school's financial aid office is often the first place they turn to for help. So the financial aid administrator will be able to tell you which lenders have more unresolved problems.

Many schools maintain a preferred lender list of lenders they feel benefit students the most. Although the preferred lender list is generally unbiased, some schools may choose lenders that provide administrative assistance (e.g., online tools to simplify the certification, processing and management of the school's student loans) or which are located in the same state. But generally, most schools focus on recommending lenders that provide the lowest cost loans and the best customer service.

Students and parents are not required to use a lender from the school's preferred lender list, but many do. (In fact, more than 90% pick the first lender on the list.) Picking a lender that isn't on the preferred lender list may add delays to the loan certification and disbursement process, as the school and lender may not be familiar with each other's requirements or have an established online loan certification process. But the college may not introduce artificial delays into the process. Sending a loan certification by mail should add only a few days delay, not weeks.


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