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October 4, 2006

Comparing Student Loan Discounts
Project on Student Debt

The best way to compare prices on a student loan is to match up the interest rates with all other factors held equal. But when lenders offer different types of discounts at different points in the repayment process, comparisons aren’t easy.

How do you compare a fee reduction with a lower interest rate? What about an interest rate reduction that doesn’t kick in until the fifth year of the loan?

The table below shows how to compare some typical types of discounts offered by companies that provide federal student loans. The most common federal student loans (Stafford loans) have a fixed 6.8% interest rate before any discount.

Discount Offered
Equivalent Value

1% reduction of interest rate at start of loan
1.00%

1% lower interest rate at start of repayment (after 4 years of interest accrues without discount while student is in school)
0.78%

1% lower interest rate after 48 payments (see warning)
0.33%

1% reduction in fees charged to the borrower
0.23%

1% reduction of principal after 48 payments (see warning)
0.12%

All assume a standard 10-year repayment period (120 payments) and a fixed interest rate of 6.80% (before any discount). Equivalent values are interest rate reductions.

The table shows that a four-percent reduction in fees is roughly worth a one-percent reduction in the overall interest rate. A reduced interest rate that takes effect after the first four years of a ten-year repayment term is one-third as valuable as a lower interest rate for the entire term of the loan. Reductions in principal that occur after four years are even less valuable: a lender would have to offer an eight-percent reduction for it to be worth a one-percent reduction in the overall interest rate on a loan.

Warning about “on-time payment” discounts: Only a minority of borrowers actually qualify for lender discounts that take effect after a particular number of “on-time payments.” Generally, these offers require borrowers to stick to the original payment schedule without even one late or adjusted payment, a feat few achieve. And even when borrowers manage to get the discount, they can lose it if they ever miss or change a payment later on. Also, these discounts are usually not included in the promissory note, (the contract between the borrower and lender), which means that the discount rules can change or disappear at any time.

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