Some lenders reward student loan borrowers with discounts to encourage particular types of repayment behavior.
The most common type of student loan discount is an auto-debit discount, sometimes called a direct-debit discount, which reduces the interest rate for borrowers who make automatic payments on their federal education student loans. The U.S. Department of Education offers a 0.25% interest rate reduction to federal education loan borrowers who sign up for auto-debit. Some private student loan programs offer similar discounts for automatic payments, typically either a 0.25% interest rate reduction or a 0.50% interest rate reduction.
Some lenders use the interest rate reduction to reduce the monthly payment. Others do not reduce the monthly payment. Instead, the lower interest rate allows more of the monthly payment to be applied to the principal balance of the loan, leading to quicker repayment of the loan. It can eliminate the last few payments on the loan and save the borrower hundreds of dollars in interest over the life of the loan. For example, a 0.25% interest rate reduction will eliminate the last two payments on a 10-year term and the last ten payments on a 20-year term.
Some borrowers may feel uneasy about a lender reaching into their bank account to take the monthly loan payment. But, it doesn’t actually work that way. The borrower always remains in control and can stop the automatic payments at any time. It is the borrower’s own bank, not the lender, which is transferring money to the lender, as authorized and instructed by the borrower.
Signing up for auto-debit has other benefits. Borrowers who sign up for auto-debit are less likely to be late with a payment. A late payment can still occur, if the borrower has insufficient funds in the bank account. But automatic payment eliminates the possibility that the bill got lost in the mail or was shredded by the borrower’s puppy. Borrowers who make the loan payments automatically save time and money, since they no longer have to write a check and pay for postage.
Lenders previously offered a variety of discounts to borrowers who made all of their payments on time. But since very few borrowers were able to make every payment on time, these discounts were more apparent than real. Most such discounts disappeared with the subprime mortgage credit crisis in 2008.
Some lenders offer a one-time discount to borrowers upon graduation. Borrowers who graduate from college are much less likely to default on their education loans than borrowers who drop out of college.
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