Student Loan Discounts
Many lenders offer loan discounts to encourage borrowers to obtain their education loans from them. This section of FinAid discusses these discounts, their history, their benefits, and several caveats. It also includes comparison charts that list the loan discounts offered by the most popular education lenders.
Why Lenders Offer Loan Discounts
The Higher Education Act of 1965 sets the maximum interest rates and fees on student loans. Nothing, however, prevents a lender from charging lower interest rates and fees. (The illegal inducements regulations prevent lenders from providing immediate rebates, which would be akin to paying borrowers for their loans. However, most lenders work around these restrictions by instituting a one month delay in rebate-style discounts, or by providing the discounts when the loan enters repayment or at other milestones.)
Since the repeal of the single holder rule on June 15, 2006 allows borrowers to consolidate their loans with any lender, the originating lenders face a risk of losing their borrowers to other lenders. They are responding by offering better discounts on unconsolidated Stafford and PLUS loans, by instituting discounts that depend on longevity with the lender (e.g., rate reductions and principal reductions after so many months into repayment and waivers of the last six monthly loan payments), and by requiring certain discounts to be repaid if you consolidate with another lender. The originating lenders can offer better discounts on unconsolidated Stafford and PLUS loans because lender margins are tighter on consolidation loans.
The Most Common Discounts
The most common loan discounts include a 0.25% interest rate reduction for having your monthly loan payments direct debited from your bank account (and also often requiring online electronic statement delivery). Many lenders also waive the origination fees on Stafford Loans. Depending on the guarantor, they may also waive the 1% default fee (previously "guarantee fee").
Many lenders also offer additional discounts for making all of your monthly payments on time. For consolidation and PLUS loans many lenders offer a 1% interest rate reduction after 36 months of on-time monthly payments for as long as you continue making on-time payments. The on-time payments must be consecutive (no skips) and start when the loan enters repayment. (A few lenders offer a "repair option" which resets the on-time payment clock, but most lenders require all the initial monthly payments to be on-time.) For Stafford loans the most common discount involves a 2% interest rate reduction after 48 months of on-time monthly payments for as long as you continue making on-time payments. A recent trend is to replace these interest rate discounts with principal reductions after reaching a milestone, such as 3.33% principal reduction after 33 months.
The most common loan discounts include:
Discounts on Direct Loans
The US Department of Education offers two main types of discounts on Direct Loans:
Tim Ranzetta of Student Lending Analytics obtained data from the US Department of Education concerning the utilization of these rebates. He reports in his blog that 18.6% of Stafford loan borrowers, 40.4% of PLUS loan borrowers and 47.0% of consolidation loan borrowers qualified for the rebate from August 2001 to October 2008. It is curious that successful utilization rates were lower for consolidation loan borrowers seeking both a rebate and an interest rate reduction than for consolidation loan borrowers seeking just a rebate. More recent YTD utilization rates are more successful than the long-term utilization rates. FinAid has transcribed the data from his FOIA request into a spreadsheet that analyzes the loan discount utilization rates.
Loan Discount Caveats
There are a few important caveats about loan discounts:
The loan discounts often sound more impressive than they are in reality. Less than 15% of borrowers sign up for direct debit of the monthly payments because they want to maintain control over their accounts. Less than 10% of borrowers qualify for the full term of their prompt payment discounts. A prompt payment discount that requires 48 months of on-time payments for a reduced interest rate is effectively reducing the value of the discount by about 69%. This is partly because the discount is in effect for a reduced time period, partly because the interest portion of the monthly loan payment is lower the further you are into repayment due to a smaller remaining loan balance, and partly because of the impact of a discount on accelerating loan repayment. So a 2% interest rate reduction after 48 months may sound like a lot, but it's really the equivalent of a 0.63% interest rate reduction from the start of repayment. (A 2% rate reduction after 36 months is the equivalent of a 0.88% rate reduction from the start of repayment.)
The following table illustrates the equivalent discount at repayment for various discounts with delayed onset.
Moreover, these figures assume that you are able to make all your monthly loan payments on time. Most borrowers do not, further reducing the value of the discounts to borrowers. A review of lender SEC filings reveals that the combined cost of all the discounts, including the direct debit and prompt payment discounts, averaged less than 10 basis points (0.10%) over the past decade. That's less than 5% of the nominal "full" 2.25% discount and less than $50 per borrower on average.
The following table illustrates the relationship between the probability that a borrower will miss a payment and the value of the discounts, assuming a 2% interest rate reduction on a 10-year loan after 48 months of on-time payments for as long as the borrower continues making the payments on time. As this table shows, if you are likely to be late with just one of the 120 payments on the loan, your chances of getting the full benefit is about a third (1 in 2.7) and the expected value of the discount is only 0.60%. More realistic is a 1 in 36 chance of being late with a payment, which translates into about 1 in 4 borrowers getting some discount, less than 1 in 29 getting the full discount and an expected value of the discount of only 0.13%. (Note: These figures do not consider the reduced value of the discounts due to the lower loan balance at the time the discount is applied, along the lines outlined in the previous table. One can estimate the combined impact by multiplying the values in the following table by 0.63%/2.00% or 0.32. This is a simplification which will tend to slightly overestimate the actual discount; more accurate figures could be obtained by running Monte Carlo simulations.)
The following table illustrates the equivalent discount at repayment for various discounts with delayed onset, but with a 1 in 36 chance of missing a payment.
In an open letter to borrowers, Tim Fitzpatrick, then CEO of Sallie Mae, said that "approximately 70 percent of borrowers" lose prompt payment discounts by consolidating their loans within the first year of repayment, and that "only about 20 percent of borrowers who do not consolidate make their first 36 monthly payments on time." He added that "the bottom line is that less than 10% of borrowers will earn all the advertised Repayment Benefits as they will either consolidate their loans or miss a scheduled payment sometime during the first several years of repayment." If only 20 percent of borrowers make their first 36 monthly payments on time, that means that the probability of missing a payment is approximately 4.37% (1 in 23). Assuming a ten year repayment term and that the probability of missing a payment remains constant throughout the repayment term, this suggests that less than 0.47% of borrowers who don't consolidate get the full prompt payment discount (and less than 0.14% of borrowers overall). It is reasonable to assume that the probability of missing a payment decreases the further a borrower gets into the repayment term, so the percentage of borrowers getting the full prompt payment discount is probably higher than this figure. In fact, anecdotal evidence suggests that most students who lose a discount lose it by being late on the very first loan payment. The figures in the Sallie Mae letter are consistent with less than 6 percent of borrowers getting any prompt payment discount (i.e., of the 30 percent who don't consolidate in the first year, 20 percent make the first 36 payments on time, and 20% of 30% is 6%). So the percentage of borrowers who qualify for the full prompt payment discount is somewhere between 0.14% and 6.0%, much less than the 10% figure mentioned in the Sallie Mae letter.
The following table shows the equivalent interest rate reduction starting at repayment and the savings on a $10,000 ten-year loan at 6.8% interest for a variety of popular loan discounts. The results reported in this table do not consider the impact of delayed onset on the likelihood of qualifying for prompt payment discounts. All else being equal, discounts which require a shorter delay until the borrower qualifies are better than those which require a longer delay. Principal reductions are better than interest rate reductions since they don't require ongoing prompt payment behavior once the milestone is reached.
Here is the same table, but with a 1 in 36 chance of missing a payment. Note that the discounts that forgive the last 6 payments or the balance when it drops below $500 remain unchanged because they do not depend on prompt payment behavior.
The Project on Student Debt has similar findings, showing how a 1% discount varies in value depending on whether it is an interest rate reduction or principal reduction and depending on the degree to which the onset of the discount is delayed.
Fitch Ratings published a report, Borrower Benefits in FFELP: Student Loan ABS Cash Flow Considerations (October 31, 2006) that provided some stastistics concerning loan discounts based on information provided by lenders. While the focus of the report was on the theoretical impact of borrower benefits on lender cash flows, relevant findings included:
Tips for Evaluating Loan Discounts
Here are a few tips for evaluating Loan Discounts:
The Loan Discount Analyzer can help you evaluate the various loan discounts and decide which discounts will save you the most money.
Loan Discount Comparison Charts
The following pages offer basic comparison charts that highlight the loan
discounts each lender offers for each type of loan. The discounts each
lender offers usually depend on the type of the loan, since lender
profits vary by loan type. Only lenders that offer loan discounts are
included in these charts.
The following pages offer basic comparison charts that highlight the loan discounts each lender offers for each type of loan. The discounts each lender offers usually depend on the type of the loan, since lender profits vary by loan type. Only lenders that offer loan discounts are included in these charts.
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