By Mark Kantrowitz
Lenders offer student loan discounts as incentives for prospectivestudent loan borrowers. The two main types of student loan discountsare interest rate reductions and principal balance reductions. Somediscounts are offered to encourage beneficial behavior, such assigning up to auto-debit programs and making all payments ontime. Other discounts are offered to attract prospective student loanborrowers, since such discounts are often expected by borrowers.
Auto-Debit Discounts
The auto-debit discount is the most popular and most common type ofstudent loan discount.
Auto-debit involves an automatic transfer of the monthly student loanpayment from the borrower's bank account to the lender. Auto-debit mayalso be called automatic payment or direct-debit.
To encourage borrowers to sign up for auto-debit, lenders offer asmall interest rate reduction, typically by 0.25% or 0.50% percentagepoints.
Auto-debit discounts may also require the borrower to agree toelectronic billing. This saves the lender money on the printing andmailing of monthly loan statements and the lender passes the savingson to the borrowers.
Auto-debit discounts provide other benefits to the borrower inaddition to the savings. Borrowers who sign up for auto-debit areless likely to be late with a payment. This helps the borrower build agood credit history.
Lenders can apply the auto-debit discounts in one of two ways. Onemethod keeps the monthly payment unchanged, basing it on the originalinterest rate. The reduction in the interest rate means that more ofeach payment is going to the principal balance, instead ofinterest. This causes the loan to be paid off more quickly, reducing theterm of the loan. The shorter repayment term saves some interestcosts, above and beyond the reduction in the interest rate. The othermethod bases the monthly loan payment on the new, reduced interestrate, yielding a lower monthly loan payment.
Some borrowers are reluctant to sign up for auto-debit, because theyare uncomfortable with the idea of the lender reaching into their bankaccount to take the money to pay the monthly student loan bill. But itdoesn't really work that way. Instead, the borrower is authorizing theborrower's bank to make a monthly transfer of up to a specified amountto the student loan lender. The borrower always remains in control andcan cancel the automatic monthly payments at any time.
Graduation Discounts
Graduation discounts, sometimes called graduation rewards, reduce theprincipal balance of the borrower's loans when the borrower graduateswithin 150% of the normal time-frame. The principal reduction istypically 1% or 2% of the loan balance or a specific dollar amount,such as $250, $500 or $750, depending on the student's academicdegree level.
It is worthwhile for lenders to offer graduation rewards becauseborrowers who drop out of college are four times more likely todefault on their student loans than borrowers who graduate.
Customer Appreciation Discounts
Some banks offer discounts, called customer appreciation discounts,for borrowers who have other accounts with the bank. For example,one lender will reduce the interest rate by 0.25% or 0.50% forexisting banking customers. These discounts help the lender cross-sellthe lender's other banking products and services.
No-Fee Loans
Federal student loans charge fees that range from about 1% to about4%. Some private student loan programs compete with the federalstudent loans by eliminating the fees. Although the lenders could haverolled the fees into the interest rate, many keep the interest ratesunchanged, treating the elimination of the fees as a discount on theloan. Assuming a 10-year repayment term, 4% in fees is roughly theequivalent of a 1% point increase in the interest rate.
