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Student Loan Discounts

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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.)

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Lenders offer loan discounts for competitive reasons. Originally the competition was with the Direct Loan program. However, with the repeal of the single holder rule, lenders are increasingly competing with each other for the highly profitable student loan market.

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:

  • Direct Debit (ACH/EFT) Discounts: Interest rate reductions of 0.25% or 0.50% (Less common are 0.30%, 0.33%, 1.0%, 1.25%, 1.5%, 1.75%, 2.0% and 2.5% rate reductions, some of which also depend on on-time payment behavior.)
  • On-time Payment Discounts:
    • Interest rate reductions of 1% after 0 months, 1% after 36 months, 2% after 48 months. (Less common are split discounts, such as successive 0.5% rate reductions after 24, 36 and 48 months or successive 1% rate reductions after 24 and 48 months.)
    • Principal reductions of 3.3% (based on original loan balance) after 33 months, 7% (based on current loan balance) after 48 months. (Less common are split discounts, such as successive principal reductions of 1% at 24 months, 2% at 36 months and 3% at 48 months.) Some principal reductions may have a dollar cap (e.g., 1% principal reduction capped at $500).
    • Principal reductions of $295 or $595 after 12 months.
    • Credit for first 12 months interest applied after 12 months
    • Rebate origination fee of 3% minus $250 after 24 months.
  • Graduation credits of $250, $300, $500 or $750 (effectively a principal reduction upon entering repayment).
  • Forgive last 5 or 6 payments.
  • Forgive loan balance when drops below $600.

Discounts on Direct Loans

The US Department of Education offers two main types of discounts on Direct Loans:

  • 0.25% interest rate reduction for auto-debit
  • 1.5% rebate at the time of disbursement, retained by making the first 12 payments on time

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:

  • On-time payment is a difficult hurdle. Requirements that all of your payments must be paid on time (usually defined as within 10 to 15 days of the due date) are difficult to maintain. Even if you sign up for automatic direct debit of the monthly loan payments from your bank account, you can still lose these benefits by having insufficient funds in your account. If you are late with a single monthly payment, you lose the benefit permanently. Most borrowers find it difficult to make 12 payments on time, let alone 36 or 48. Obtaining a forbearance or deferment can also cause you to lose the discounts. Note also that consolidation resets the clock on these discounts, assuming that the consolidation loan offers a similar prompt payment discount.

  • Rebates that must be repaid. Many fee rebates and principal reduction discounts include fine print that requires you to repay the discount if you consolidate your loan with another lender within a given time frame.

  • Minimum balances required for discounts. Many of the discounts require you to have a minimum loan balance to qualify, and the best discounts are reserved for borrowers who borrow the most.

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.

Equivalent Discount at Repayment
All Monthly Payments On-Time
Delayed Onset 1% Discount 2% Discount
12 months 0.79% 1.56%
24 months 0.60% 1.19%
36 months 0.45% 0.88%
48 months 0.32% 0.63%

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.)

Probability of Missing a Payment Percentage of Borrowers Who Get a Partial Discount Percentage of Borrowers Who Get the Full Discount Effective Average Value of Discounts
0.83% (1 in 120) 66.92% 36.63% 0.60%
1.00% (1 in 100) 61.73% 29.94% 0.52%
1.25% (1 in 80) 54.67% 22.10% 0.43%
1.50% (1 in 67) 48.41% 16.31% 0.35%
1.75% (1 in 57) 42.85% 12.02% 0.29%
2.00% (1 in 50) 37.92% 8.85% 0.24%
2.25% (1 in 44) 33.54% 6.52% 0.20%
2.50% (1 in 40) 29.66% 4.79% 0.16%
2.75% (1 in 36) 26.22% 3.52% 0.13%
3.00% (1 in 33) 23.18% 2.59% 0.11%

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.

Equivalent Discount at Repayment
1 in 36 Chance (2.75%) of Missing a Payment
Delayed Onset 1% Discount 2% Discount
12 months 0.27% 0.53%
24 months 0.16% 0.31%
36 months 0.09% 0.18%
48 months 0.05% 0.10%

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.

Discount
(All Monthly Payments On-Time)
Rate Reduction
at Repayment
Savings on
$10,000 loan
6.8% interest
10 year term
7.0% principal reduction after 48 months (based on current balance) 0.86% $703.44
Forgive last 6 payments on loan 0.84% $690.48
3.3% principal reduction after 33 months (based on original balance) 0.64% $533.92
2% interest rate reduction after 48 months 0.63% $527.79
Forgive balance when it drops below $500 0.55% $460.32
1% interest rate reduction after 36 months 0.45% $380.17

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.

Expected Discount
(1 in 36 Chance of Missing a Payment)
Rate Reduction
at Repayment
Savings on
$10,000 loan
6.8% interest
10 year term
Forgive last 6 payments on loan 0.84% $690.48
Forgive balance when it drops below $500 0.55% $460.32
3.3% principal reduction after 33 months (based on original balance) 0.24% $208.53
7.0% principal reduction after 48 months (based on current balance) 0.21% $181.65
2% interest rate reduction after 48 months 0.10% $85.08
1% interest rate reduction after 36 months 0.09% $77.26

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:

  • A shorter delayed onset enables more borrowers to initially qualify for prompt payment discounts. Average qualification rates ranged from 10% to 25% for a 24 month delayed onset, 10% to 20% for 36 months and 5% to 10% for 48 months. These qualification rates are consistent with a probability of missing a payment of 5.61% to 9.15% (24 months), 4.37% to 6.20% (36 months), and 4.68% to 6.05% (48 months). That the probability of missing a payment is appreciably higher with a shorter delayed onset is an indication that more of the borrowers who lose prompt payment benefits do so earlier in the repayment term.
  • When lenders institute a shorter delayed onset, they often implement a stricter definition of on-time payment than the typical 15 day grace period.
  • Utilization rates for 0.25% auto-debit discounts range from 10% to 30%, but increase with a higher interest rate reduction.
  • 79% of lenders offer auto-debit discounts. 11% offer origination and default fee reductions, and 32% offer principal rebates.

Tips for Evaluating Loan Discounts

Here are a few tips for evaluating Loan Discounts:

  • Be realistic about your ability to make all of the payments on time.
  • Focus on discounts that are immediate in nature (front-end discounts) and loan discounts which you can't lose. These include discounts for direct debit of the monthly payments from your bank account, fee rebates you receive soon after signing up, and interest rate and principal reductions that do not require on-time payment.
  • When a repayment incentive requires on-time payments, prefer those that involve a shorter time period before you can qualify for the discount. A discount that is suspended for a short time period after you are late with a payment is better than one that terminates after a single late payment.
  • Be sure to ask the lender whether there is a minimum balance to obtain the discounts. Often the discounts require a loan balance that is higher than the minimum balance required to consolidate.
  • Sign up for the direct debit of the monthly payments from your bank account. It is more reliable and secure than sending the payments through the mail. You will be less likely to miss a payment.
  • Be sure to notify the servicer of your loan of your new address any time you move. USPS mail forwarding expires after six months, just as the grace period runs out. Having your mail forwarded can also add delays that cause your payments to be late. This may explain why many borrowers who lose prompt payment discounts do so on the very first payment.
  • Read the fine print on any discounts. In particular, ask whether you will have to repay the discount if you consolidate your loans.
  • Ask what is considered an "on-time" payment; usually this is within 10-15 days of the due date, but for some lenders it can be within 30 days of the due date.
  • Some colleges have negotiated additional discounts with particular lenders, so be sure to ask if there are any additional discounts for students from your school.
  • Ask whether a principal reduction is based on the original principal balance or the current principal balance at the time the rebate is applied. The latter is worth less, since you will have a lower principal balance after making the required number of on-time monthly payments. When the lender fails to specify that the principal reduction is based on the original principal balance, it usually means that the reduction is based on the principal balance at the time you qualify for the reduction.
  • Some lenders require you to request the discounts in writing within a specific time period. Be sure to read all the fine print.
  • Ask whether the 0% fees are an actual waiver (upon disbursement) or a delayed credit (at repayment or later). The former is more valuable than the latter. Some lenders are failing to disclose that "0% origination fees" are actually implemented as a delayed credit.

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.

 

 
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