Consolidation Discounts – Too GOOD TO BE TRUE?

--An Educational Primer Developed by the American Medical Student Association (5/24/05) – Update 10/01/06

If you don’t read and understand the fine print the benefits may never be realized!

Don’t be fooled by consolidation benefits that appear to be “TOO GOOD TO BE TRUE” – they generally are. It is critically important that you read and understand the fine print of borrower discounts. Assuming, not knowing and not understanding exactly how and what is necessary to achieve and maintain borrower rate discounts, rebates and/or bonuses can cost you thousands, ten of thousands and even hundred of thousands of dollars in lost or added payments.

Earn and Protect Your On-Time Borrower Benefits

The loan market is filled with lenders that range from very good companies to those inexperienced with student loans to those that are downright unethical. Find out and understand all terms, conditions, requirements and aspects of your consolidation loan. Your signature on the consolidation application/promissory note obligates you to the terms of the consolidation loan and that lender -- be certain that you know whom you are dealing with, what is being offered and what you must do to obtain and maintain the benefits.

Federal student loan rates on a relative basis are unmatched financial values. The Prime Rate, the interest rate charged by banks to their most creditworthy customers, usually the most prominent and stable business customers, is 8.25% as of October 1, 2006. Stafford loans disbursed before July 1, 2006 carry a variable interest rates during in-school, grace and repayment periods of 6.54% and 7.14% during repayment. These rates are effective through June 30, 2007 and are annually reset on July 1st.

At no cost and with lower monthly payments, Federal student loan consolidation locks in and protects these low student loan interest rates for the life of the loan with fixed simple interest rates with no prepayment penalties. As such, graduates who are still within their grace period can lock in and protect rates as low as 6.625% and even lower at 5.375% with borrower discount benefits. With borrower discounts, graduates with $125,000 in consolidation loans may save (pay less in interest) nearly $32,000.

Graduates whose grace period has expired and are in their repayment period will have a consolidation rate of 7.25% and as low as 6.0% with discount benefits. By using borrower discounts, graduates with $125,000 in consolidation loans may save (pay less in interest) over $32,000.

Stafford loans disbursed on or after July 1, 2006 carry a fixed rate of 6.80% and due to the Federal formula for calculating consolidation interest rates (weighted average* of the loans rounded up to the nearest one-eight of one percent not to exceed 8.25%) the consolidation rate for a portfolio of all post June 1, 2006 Stafford loans would be 6.875% and as low as 5.625% with borrower discounts. A graduate with $125,000 in consolidation loans can save (pay less in interest) nearly $32,000 via borrower discounts.

Borrower benefits are most often earned and kept for on-time payments. Benefits for on-time payments can reduce the loan principal amount, generate a cash rebate or discount the interest rate. Virtually all borrower benefits are contingent upon meeting certain criteria, which generally includes on-time payments of up to 48 months. These on-time payments may be contingent on being consecutive and/or starting payment immediately.

Some lenders may require that you consolidate a minimum balance or have a minimum amount of loans with a particular lender. In some cases the borrower may be required to sign up for proprietary account services that may expose them to affiliate marketing solicitations and require that the borrower only communicate with the servicer via the internet. Prepaying the loan or a single late payment may revoke the benefits forever and in some cases earned benefit savings may be added back into the loan balance. It is important that you, the borrower understand exactly what the benefits are, the details for qualification and maintenance. Achieving and protecting your borrower benefits should and can be easy if you know the facts and appropriate strategies to follow.

Here are some facts you will need to know about student loan consolidation and some tips you should understand in evaluating the “Interest Rate Discounts & Benefits” being offered by consolidation programs.

*Understanding Weighted Average – Example: a student has Stafford Loans originated on or after July 1, 2006. These loans have a fixed interest rate of 6.8%. If they are consolidated by themselves, the consolidation loan will have an interest rate of 6.875%. The interest rate increases slightly because the consolidation calculation requires that the weighted average is rounded up to the nearest one-eight of one percent.

With a mix of loans with different interest rates, the weighted average will be somewhere in between. For example with a $5,000 of Perkins Loans (at 5.0%) and $10,000 of Stafford Loans (at 6.8%), the weighted average is calculated as follows:

$5,000 * 5.0% + $10,000 * 6.8%

------------------------------ = 6.2%

$5,000 + $10,000

This weighted average, 6.2%, is then rounded up to the nearest 1/8th of a percent, yielding a consolidation loan interest rate of 6.25%.

The weighted average does not fundamentally alter the underlying cost of the loan. It preserves the cost structure by including each interest rate to the extent that it applies to part of the overall loan balance. For example, the consolidation loan in the previous paragraph says that of the $15,000 consolidation loan balance, $5,000 will be at 5.0% and $10,000 at 6.8%, yielding an equivalent interest rate of 6.2%.