Many lenders offer loan discounts to encourage borrowers to obtain their education loans from them. The following information will help you understand how loan discounts work, and the best way to pick a school consolidation loan based on the best available discounts.

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.)

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:
o 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.)
o 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).
o Principal reductions of $295 or $595 after 12 months.
o Credit for first 12 months interest applied after 12 months
o 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.

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.