Borrower Benefits....what's up with that?

This can be a confusing topic, or it's really clear. We see "borrower benefits" as a feature of FFELP consolidation loans mostly. It's basically a way to differentiate a commodotized loan. They're a good thing.

First, the basics. The attributes of a FFELP consolidation loan are dictated by the Deptartment of Education guidelines. The term is a function of aggregate balance of outstanding student loans. The greater your loan balance, the longer the term. The term ranges from 10 years to 30 years. The interest rate is the dollar weighted average of all loans being consolidated rounded up to the nearest eighth of a percentage point. Your amortization schedule ranges from income sensitive, interest only, and a straight amortization - again the Dept dictates the amortization schedule specifics and choices.

So, with all these attributes pre-determined, how can lenders offer "borrower benefits"? Well, it's an after funding treatment to the cashflows dictated by the Department of Ed. The lender is willing to give up a potential portion of the interest income stream in return for the loan to be booked with them. The most common benefit is "1 at 36". This means that you can receive an effective 1% interest rate reduction after 36 on time payments. If you're late that first 36 months, you are not eligible for the benefit. Read the small print, becuase some lenders will grant you the benefit, but if you're late subsequently, they'll take the benefit away! Anyway, how does the interest rate reduction effect you if the interest rate on the loan is predetermined by the Dept of Ed and the promissory note you already signed? Your monthly payment does not change, this is often a misconception. Once the benefit is achieved, you continue to make the same monthly payment, except more of your payment is allocated to principal than before. You effectively pay the loan off faster. It is indeed a good deal.

The dirty secret of "borrower benefits" is that very few people actually achieve the benefit. We hear that probably about 15% of a lenders customers would ever achieve the "1 at 36" benefit. It's a good deal....if you can indeed make 36 on time payments.

There's a bunch of borrower benefits too: "1 at 24", "1% of loan balance cash back after 9 on time payments", "2% of loan balance cash back up to $2,500 after 9 on time payments". They all work under the same principal: it's and after funding manipulation of the agreed upon cash flow designed to reward good repayment behavior. We expect competition to increase the creativity of the borrower benefits beyond what we presently see.