Doing the Math on Borrower Benefits

As the financial aid legislation in both the House and Senate have moved forward over the past couple of weeks, lobbyists for loan companies have been going full throttle trying to derail efforts to cut subsidies to lenders. They are even using the new legislation to intimidate borrowers into consolidating their loans—my mailbox has been inundated with letters from loan companies threatening rising student loan costs because of the proposed legislation (there have been plenty more since this).*

A recent advertisement in The Politico by the “Campaign to Reform Student Loans” highlights one of their most popular arguments, that the proposed subsidy cuts will “wipe out the interest rate discounts currently available to borrowers.” And then they give some scary calculations: a student with a $20,000 loan will pay an additional $5,000 over 20 years as a result of this legislation, and a student with a $60,000 loan will pay an additional $38,000 over 30 years.

And this is true. A very, very small percent of students would end up paying more on their loan over the course of repayment without these borrower benefits. But, according to FinAid.org—a great source of independent information on financial aid—less than 1 in 29 borrowers will see the full discount from these borrower benefits.

The most common benefits are a .25 percent discount on the interest rate for automatic debit payments and a 2 percent interest rate discount for 48 on-time payments. But less than 15 percent of students sign up for the direct debit, and less than 10 percent qualify for the on-time payment discount for the entirety of their loan. It is not easy to make 48 consecutive on-time payments, and if a borrower misses just one, he or she loses the benefit for the life of the loan.

FinAid writes:

A review of lender SEC filings reveals that the combined cost of all the discounts, including the direct debit and prompt payment discounts, averaged less than 10 basis points (0.10%) over the past decade. That's less than 5% of the nominal "full" 2.25% discount and less than $50 per borrower on average.

Using FinAid’s handy loan discount analyzer, a student with a $20,000 loan that gets the direct debit discount and has a 1 in 36 chance of being late with a payment (a much more realistic expectation) could expect to save $592. For the student with $60,000 in loans, it would be around $1,700. A much lower benefit than loan company lobbyists advertise.

Beyond the mathematics of loan discounts, it’s worthwhile to think about the lenders’ argument: that they should receive more in subsidies so that they can then pass some of the money along to some students as discounts. In essence, lenders are asking for a smaller cut to their subsidies because they want to act as middlemen for this money.

But wouldn’t it make more sense for Congress to just give this money directly to students, either in the form of interest rate cuts or increased grant aid?

* Lenders are interested in getting students to consolidate before the legislation takes effect because, if this legislation works like past changes to subsidy rates, lenders will be able to collect the old, higher subsidy rate for the life of the loan on any loans consolidated before the new subsidy rate takes effect.