Student Loan Discounts

By Mark Kantrowitz

Lenders offer student loan discounts as incentives for prospective student loan borrowers. The two main types of student loan discounts are interest rate reductions and principal balance reductions. Some discounts are offered to encourage beneficial behavior, such as signing up to auto-debit programs and making all payments on time. Other discounts are offered to attract prospective student loan borrowers, since such discounts are often expected by borrowers.

Auto-Debit Discounts

The auto-debit discount is the most popular and most common type of student loan discount.

Auto-debit involves an automatic transfer of the monthly student loan payment from the borrower's bank account to the lender. Auto-debit may also be called automatic payment or direct-debit.

To encourage borrowers to sign up for auto-debit, lenders offer a small interest rate reduction, typically by 0.25% or 0.50% percentage points.

Auto-debit discounts may also require the borrower to agree to electronic billing. This saves the lender money on the printing and mailing of monthly loan statements and the lender passes the savings on to the borrowers.

Auto-debit discounts provide other benefits to the borrower in addition to the savings. Borrowers who sign up for auto-debit are less likely to be late with a payment. This helps the borrower build a good credit history.

Lenders can apply the auto-debit discounts in one of two ways. One method keeps the monthly payment unchanged, basing it on the original interest rate. The reduction in the interest rate means that more of each payment is going to the principal balance, instead of interest. This causes the loan to be paid off more quickly, reducing the term of the loan. The shorter repayment term saves some interest costs, above and beyond the reduction in the interest rate. The other method bases the monthly loan payment on the new, reduced interest rate, yielding a lower monthly loan payment.

Some borrowers are reluctant to sign up for auto-debit, because they are uncomfortable with the idea of the lender reaching into their bank account to take the money to pay the monthly student loan bill. But it doesn't really work that way. Instead, the borrower is authorizing the borrower's bank to make a monthly transfer of up to a specified amount to the student loan lender. The borrower always remains in control and can cancel the automatic monthly payments at any time.

Graduation Discounts

Graduation discounts, sometimes called graduation rewards, reduce the principal balance of the borrower's loans when the borrower graduates within 150% of the normal time-frame. The principal reduction is typically 1% or 2% of the loan balance or a specific dollar amount, such as $250, $500 or $750, depending on the student's academic degree level.

It is worthwhile for lenders to offer graduation rewards because borrowers who drop out of college are four times more likely to default 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% for existing banking customers. These discounts help the lender cross-sell the lender's other banking products and services.

No-Fee Loans

Federal student loans charge fees that range from about 1% to about 4%. Some private student loan programs compete with the federal student loans by eliminating the fees. Although the lenders could have rolled the fees into the interest rate, many keep the interest rates unchanged, treating the elimination of the fees as a discount on the loan. Assuming a 10-year repayment term, 4% in fees is roughly the equivalent of a 1% point increase in the interest rate.