Most loan fees are deducted proportionately from each disbursement. The remaining money is then deposited to the student’s account at the school to be applied to tuition and fees and other institutional charges. For example, if a $10,000 loan has 4% fees and is paid in two disbursements of $5,000 each, $200 will be deducted from each disbursement, yielding two net disbursements of $4,800 each or $9,600 total. Yet, the borrower is still responsible for repaying the full amount of the loan borrowed; in this example, $10,000.
If the student needs to net $10,000 after the loan fees are deducted, most schools will allow an adjustment to the school's cost of attendance to include the fees in the cost of attendance. To net $10,000 after subtracting 4% in fees, the loan amount would need to be increased to $10,000 / (1 – 4%) = $10,416.67. Four percent of this figure is $416.67, leaving the student with $10,000 in net loan proceeds to pay for college costs. Note, however, that while the school can increase the cost of attendance to accommodate adding the fees to the loan balance, the loan balance before deducting the fees must be less than or equal to the appropriate loan limits.
Students sometimes get confused about the difference between fees and interest. Generally, a one percentage point increase in the fees is less expensive than a one point increase in the interest rate. For example, a loan with 4% fees and a 10-year level repayment term is the equivalent of a loan with a 1% higher interest rate and no fees. The total payments (including principal, interest and fees) on a 10-year loan with a 6% interest rate and 4% in loan fees is the same as the total payments on a 10-year loan with a 6.91% interest rate and no fees. A 10-year loan with a 4% interest rate and 9% in loan fees is the equivalent of a 10-year loan with a 6.05% interest rate and no fees.
Since loan fees are paid or deducted when a loan is disbursed, they are effectively a form of up-front interest. As such, borrowers who plan on paying off a loan early should try to avoid fees, if possible, since a loan with no fees or lower fees will cost them less. The table below provides an example of how an equivalent loan with no fees will cost less if the borrower pays off the loan early.
|Loan with Fees||Loan with No Fees|
|Repayment Term||10 Years||10 Years|
|Total Payments (10 Years)||$13,351||$13,352|
|Total Payments (Payoff at 2 Years)||$11,798||$11,122|
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