Howard University College of Dentistry, EAS Loan Consolidation Program for HUCD Interest Rate

Tips you should understand in evaluating the “Interest Rate Discounts & Benefits” being offered by consolidation programs

TIPS:

1. “Principal Reduction” vs. “Interest Rate Reductions.”

Few venture to question and virtually all borrowers are surprised to learn that an offer for an “Immediate 5.0% Up front Principal Reduction” may be thousands of dollars more expensive to the borrower than a “1.0% Interest Reduction after 36 On-time Payments.” When considering consolidation programs be sure you understand the differences between discount benefits based upon “principal reduction” and “interest rate reductions.”

Principal reduction is based upon the amount of the total loans being consolidated. This is generally a one-time calculation often requiring fulfillment of a number of on-time (initial, immediate, consecutive or regular – see below for definitions) payments to maintain the benefit. This benefit also is generally capped at a maximum amount. For example a lender may advertise a 5% principal reduction with the fine print noting a $4,000 maximum cap that becomes effective after 36 consecutive on-time payments.

An interest rate reduction is applied to the interest rate. After meeting the criteria of a certain number of on-time (initial, immediate, consecutive or regular) payments the lender will reduce the interest rate being applied to the consolidation loan. The fine print should be read or explained and put into writing to determine if the interest rate discount is “back end loaded” (where the calculated benefits are applied to the last schedule payment thus reducing the total number of payments) or permanent where the consolidation is redisclosed (loan re-written), thus reflecting immediate and permanent lower monthly payments based upon the permanent lower interest rate once the criteria is meet.

2. “Cash Back and Rebates”

Cash Back and Rebates are similar to principal reduction because the rebate is based upon a percentage of the amount of the total loans being consolidated. This is generally a one-time payment often requiring fulfillment of a specific number of on-time (initial, immediate, consecutive or regular) payments to maintain the benefit. This benefit also is generally capped at a maximum amount. For example a lender may advertise a 5% rebate with the fine print noting a maximum cap that becomes effective after 36 consecutive on-time payments. The fine print should be investigated to determine if the rebate is permanent or may be added back to the principal for some reason such as a late payment or prepayments.

Some lenders may offer what appears to be large cash back payments or principal reductions of 2% to 5%. Lenders who are offering a cash-back, principal reduction or rebate may be diluting the benefit by applying the reduction to the end payments with the knowledge that the borrower most likely will not fulfill the criteria for on-time payments for the full-term which may be up to 30 years.

For example: Assuming a $100,000 consolidation loan at 3.375% with a 3% principal reduction discount the borrower assumes their consolidation loan is for $97,000. In actuality, the consolidation loan is amortized (calculations which includes interest to determine the monthly payments) for a $100,000. Should the borrower meet all criteria, payments will conclude approximately 4 years and 6 months earlier than scheduled, saving approximately $1,777.00 in interest. Should a 1.0% interest rate reduction after 36 consecutive on-time payments been applied, the borrower would save nearly $16,000 in interest payments over a 30-year term.

An important note of caution: Some “Cash Back”, “Rebate” and/or “Bonus” incentive programs may create potential tax liability for the borrower if the program is based upon principal credit. It has been estimated that based upon the IRS regulations, if the borrower receives a $2,000 credit on their loan account, they may you owe taxes on $1,400 of income. Even worse, the cash back rebate and/or bonus is likely to be applied as a credit on your loan but you will have to pay “cash” out of your pocket for taxes.

As per the IRS Web site: A school loan is not taxable at the time you get the money and should not be included as income on your return. A loan is not income because you are expected to repay the amount borrowed (plus interest). If, at a later date, any part of the loan were forgiven, the amount forgiven would be income in that year. Under certain circumstances, student loans forgiven are not income. For more information, refer to Exceptions under Canceled Debts in Publication 525, Taxable and Nontaxable Income.

When considering a “Cash Back”, “Rebate” and or “Bonus” incentive program seek the professional advice of a professional tax expert to determine if the incentive program is structured to steer clear of tax liabilities.

3. “Bonus”

A bonus is similar to a rebate in that it is a derived payment, which depends on the performance of financial investments/portfolio, which is awarded to the borrower as a reduction in interest cost. Bonuses are generally scheduled to be paid on a monthly, quarterly or yearly basis as a credit equal to an annualized return on investment and are paid to all borrowers in repayment who are less than a certain number of days (30 – 90) delinquent. Bonuses are generally paid only during times where the borrower is making active repayment. Bonuses are based on a financial portfolio’s performance that is the result of financial market conditions and values and are therefore subject to unpredictable market change and fluctuation.

There are no guarantees of future market performance and the borrower should not assume that the current bonus rate should continue or increase throughout a full repayment term. “Past performance is no guarantee or indicator of future returns.” is a tried and true investor credo. Bonuses under these circumstances should be considered as involving higher degrees of risk, “speculative” or generating low returns (low bonuses) due to the need to preserve principal with more conservative less speculative investments.

Borrowers who have the financial where-with-all or working with finance professional most likely may find relevant information in the financial statements of the underlying lender company. Where applicable, “financial performance” and “risk factors” information may be found in the “offering memoranda” for securitizations. (See below for an explanation of securitization.)Borrowers have no control or input over the achievement of a bonus and most likely are not told how the bonus will actually be calculated and determined. With a consolidation loan’s traditional interest rate discounts based on a certain fixed number of payments, the borrower has a great deal of control in achieving the goal (making the required payments on time) and can easily inform themselves on the basis for determining on-time payments.

When considering a “Cash Back”, “Rebate” and or “Bonus” incentive program seek the professional advice of professional tax and financial planning experts to determine if the incentive program is structured to steer clear of tax liabilities.

What is Securitization? Securitization is a financial maneuver, which creates a more or less standard investment to raise funds and/or manage cash flow. Securitization is a financial maneuver, which creates a more or less standard investment to raise funds and/or manage cash flow. In securitization, the receivables (future loan payments) are moved off the balance sheet of the originator/lender and replaced by a cash equivalent (less expenses of the securitization), thus improving the Originator's/lender’s balance sheet and resulting in gain or loss, which itself is usually an intended, beneficial consequence. In this case, the Originator does not have to wait until it receives payment of the receivables to obtain funds to continue its business and generate new receivables. The securities issued in the securitization are more highly rated by participating rating agencies (because of the isolation of the receivables in a "bankruptcy-remote" entity), thus reducing the cost of funds to the originator/lender when compare to traditional forms of financing. In instances where the receivables bear interest, there is usually a significant spread between the interest paid on the securities and the interest earned on the receivables. Ultimately, the originator/lender receives the benefit of the spread. In addition, the originator/lender usually acts as servicer and receives a fee for its services. Because the originator usually acts as servicer and there is normally no need to give notice to the obligors (borrowers) under the receivables, the transaction is transparent to the originator's/lender’s customers and other persons with whom it does business. These advantages are tempered by the fact that the securitization structure results in higher costs than traditional forms of financing, but this is more than offset by the advantages.

4. “Payment”

A full payment is the entire amortized value of the monthly payment (principal + interest). Full monthly payments may be defined as those to be received 15 days prior through 15 days after the payment due day. Payments received outside this window or where the use of Economic/Temporary Hardship Forbearance or payment in full within the first 36 months may result in the reduced interest being added back to the loan balance.

5. “On-Time, Initial, Immediate, Consecutive and Regular Payments”

Unfortunately, on-time payments are not as easy as they sound. Sometimes just having the money is the problem. It has been reported that those who graduate from college struggle to handle their student loans. Starting careers in metropolitan areas with higher housing cost may drive living cost onto credit cards, which compounds existing debt. Surprisingly the burden of travel to visit family and friends and attend friends’ weddings, which is generally financed, via credit cards has created a precarious financial situation for what Tamara Draut, in her analysis of the plight of young Americans has deemed “Generation Broke.”

According to Demos USA, an independent think-tank reports that, “One of five among the youngest adult households reported being late or missing payments within the last year on a loan, a 27% increase since 1992.” Furthermore, a recent survey found most grads are struggling to repay their student loans with about one-third of recent graduates unprepared to make there first student loan payment. As reported in U.S. News & World Report, “An internal study by PHEAA showed that only about 7% of borrowers managed two years of perfect on-time payments.” Remember with most borrower benefit programs, miss a payment and you lose the deal on the rate.

On-time may include a 15-day grace period or defined as being received a certain number of days before or after or on the due day and possibly by a certain time of day; for example 2:00 pm. Many borrower benefits are based on fulfilling and continuing “on-time” payments. When evaluating borrower benefits, it is important to know and confirm the definition and criteria for “on-time”.

For example, look for a lender with a reasonable to generous 10 to 15-day grace period for on-time payments. Given post-graduate training requirements it would be smart to look for lenders who may allow borrowers to fulfill the borrower benefit requirement by making the total number of payments on time, but not necessarily consecutive payments. For example, 36 on-time payments may be met by making the first 10 payments followed by several months of forbearance followed by 26 payments on time. For some lenders this non-sequential payment pattern may not meet their criteria for on-time “consecutive” payments, which means there cannot be a break in payments (not even for deferment, forbearance or disability) otherwise the opportunity for the borrower discounts, rebates and/or bonuses are lost, most often forever.

Some lenders may allow a single late payment and not penalize the borrower. Other lenders may allow the borrower to re-qualify for the benefits through another series of on-time payments. Some lenders require on-time payments to be “full monthly payments that are to be received a specific number of days prior through a specific number of days after the payment due day; payment outside this criteria are deemed not to be on-time. For some lenders, on-time payments may only be made via electronic direct debit. To maximize the advantages and value of consolidation borrowers must understand and know exactly how to fulfill the requirements to obtain and maintain borrower discount benefits.

Initial generally means that payments are to begin in approximately 30 -45 days after the consolidation loan has been completed (fully disbursed – all underlying loans paid in full) and continue on a monthly basis as scheduled. Initial generally does not allow for deferment, forbearance or any other type of interruptions in payments. For example we have looked into the details of lenders that have offered very appealing cash back benefits after making "initial payments on-time each month for 48 consecutive months". The details of the benefit meant that the borrower had to begin payment immediately. A deferment or forbearance would void the offer and the borrower would be faced with the original terms of the offer and no further discounts. In addition, such language as consecutive months most often means that once repayment begins there can be no breaks and if there is a break the benefit is lost thus adding the amount of the benefit back into the loan.

Immediate is another term generally interchangeable with initial where payment begins approximately 30 - 45 days after the consolidation has been fully disbursed. Immediate means the borrower must begin making payments right away and cannot use any type of deferments, forbearance, National or Community service or Income Sensitive Forbearance within the first 12 - 36 months as specified in the offer. In other words, upon completing consolidation the borrower must begin and continue to make the specified number of payments to keep the benefit. So if you consolidate upon graduation from dental school you must begin making payments immediately or forfeit the benefit.

For example: borrowers casually hear and read promotions for a 5.0% immediate upfront principal reduction and assume it is superior to a 1.0% interest rate reduction after 36 on-time payments benefit. These percentages are based on two entirely different principles: reducing principal balance (good for short, five to seven years repayment periods) and reducing interest rate (best for longer repayment periods and exceptional when interest rates are low). A lender may publicize an immediate “5% up front principal reduction”. The reality of the offer may be that the benefit is not immediate. The reduction may appear to be immediate in that it is “conditionally credited” throughout the repayment period. If and “after the first 36 on-time payments are made” without the use of deferments or forbearances the principal reduction will become permanent.

Consecutive generally means that the payments must be in order and without postponements or interruptions once payment begins. For example 36 consecutive payments may means once the loan enters repayment the 1st through the 36th monthly payments are made in order for exactly three years. Lenders may deem that the use of Economic/Temporary Hardship Forbearance or payment in full within an initial specific number of months (12 – 48) will result in the reduced principal or discounted interest rate being added back to the loan balance. For some lenders, not meeting the initial, immediate or consecutive requirement will permanently void the opportunity to achieve the discount benefit. For other lenders, if the qualification criteria were met, the benefit would remain in place.

Regular payments are unique in that they generally require that payment be made on or before the due date. Regular payments need not be consecutive. Regular payments allows for eligible and permitted breaks and postponements such as deferment and forbearance. In most cases you should confirm the definition of “regular”. Regular payments are borrower friendly and practical.

6. The “Back- End Loaded” Benefit

A back- end loaded benefit is where the benefit is not immediately realized when achieved. With back-end loaded benefits the loan is not immediately redisclosed (re-written) reflecting the reduced interest rate and lower monthly payments. With back end loaded benefits the amount of the benefit is calculated and added as a credit to the last scheduled payment thus reducing the loan amount and shortening the number of monthly payments necessary to pay off the loan. For example, on a 30 year loan the discount benefit is calculated and first credited to payment 360. Once the benefit has earned enough to complete the 360th payment the earned benefit value is then applied to the 359th payment and so on until the scheduled monthly payments meet your declining balance.

The principal reduction benefit is significantly lessened when applied to the last payments because the interest rate has not been reduced thus over time more interest is being paid. In addition, in real economic terms (the value of a dollar when adjusted for inflation), the benefit is less valuable because the borrower is being rewarded with “cheaper” deflated dollars.

With some lenders, if a payment is late or the borrower pays off the loan early, the benefits earned to date will be voided with the credits being reversed and added back to the loan balance forfeiting any and all accrued discounts.

7. Asterisks, Notes, Footnotes and Other Language and Fine Print

Be on the look out for asterisks, notes, footnotes and other language and fine print that states or suggests that there are other criteria regarding borrower benefit eligibility. Some lenders will require that all communications are done on-line and that the borrower signs up with a proprietary system that will expose them to other marketing solicitations. To have the interest paid on unsubsidized Stafford loans during the grace period, one lender requires that the benefit was available only to graduate and professional students with at least $7,500 in eligible outstanding loans. In addition, the consolidation application had to be received before a certain date at which point the borrower had to be in his or her grace period. Furthermore, when the borrower's grace period is completed, repayment had to begin on the new consolidation loan. After entering repayment, the borrower had to make at least his or her first payment to retain the benefit.

8. It’s Math Not Magic – Choose Benefits That You Understand and Control

Borrowers should be cautioned not to suspend reality and assume that because a benefit is called a “Bonus” that an "immediate 3/4 of one percentage point discount" which depends on the performance of an unidentified financial portfolio is unquestionably superior to other discounts such as a 1.25% (0.25% for auto debit plus 1.0% for 36 on-time regular payments) interest rate discount. Borrowers are urged to inform themselves of the facts and do the math. Ask to see audited statements of the financial portfolios in question with comparisons of the portfolio’s performance (income earned) to the bonuses paid over the past 5 – 10 years. Borrowers should be mindful of the fact that past performance is no guarantee of future returns and that any assumptions that the borrower makes to a continuous future bonuses is speculative and out of the control of the borrower. By comparison, auto debit and on-time payments are criteria that are definable and within the borrower’s control.

Do the math; determine the number of years you will plan to take to pay-off your consolidation loan and determine which discount scenario is best for you. Don’t forget that financial planners recommend that you always consider the value and alternative use of your money and you pay off your most expensive debt first. For example, you should pay off credit card debt at 11.0% before paying off a student loan with a fixed interest rate of 2.875%. You should consider investing your money in equities that have historically returned 6.0% - 10.0% before paying off a 2.875% fixed interest rate student consolidation loan. Look to maximize the value of your money and take advantage of the benefits of compounding and accruing interest that come from early saving and investing. Allow more of your money to work longer and harder for the goals you have established.

9. Putting It Together: How to Earn/Protect Your On-Time Borrower Benefits

To begin, create an income and spending plan (budget) and cash flow chart (items, times and amounts you receive money and pay out money on a monthly basis). As soon as you discover that you will have a shortfall or a problem with a loan payment, contact your lender/servicer and discuss the situation. In most cases the lender will allow you to apply for forbearance. With forbearance you will be allowed to make no payment, partial payment or interest only payments. The benefit is that you will not be reported as missing a payment or making a late payment, both extremely bad for good credit maintenance. Here is also where having discounts based on making “regular” on-time payments benefits your ability to continue to earn, achieve and maintain discounts because a break in the payment stream will not forfeit your discounts.

There are several things a borrower can do to help assure that they will be able to achieve the reduced rates offered through on-time payments and protect the benefits once earned. You should set up an account that is not based upon your physical location/current home address or work location such as a local bank or credit union checking or savings account. A money market account that is independent of your residence such as one with a National Bank, Online Bank, or financial services companies like Schwab, Merrill Lynch, Vanguard, Morgan Stanley or any of the other national financial services firms. A money market account is suggested because it is highly liquid and will generate some interest while funds are waiting to be disbursed.

The reason to use such an account and not your local bank’s checking of savings account is because when moving or relocating to a new neighborhood, city or state many individuals find it necessary to change their banking relationship and thus interrupting the automatic debit process, which increases the likelihood of missing a payment. With a financial account that is not primarily based upon your physical address you are moving or relocation does not require that you change accounts. Given the increasing number of national banks and large regional banks coupled with the increased use of online banking you may not be tied to your local branch and thus be able to use your current bank because the banking relationship and processes remains in place. The point is that you want to be sure that the source of your automatic debit payments remains stable throughout the qualification and full repayment periods. If for some reason you find yourself having to chance the account you use for automatic debit payment, confer with the servicer of your loan and identify exactly what should be done to make a change in accounts and not lose your payment eligibility or status.

If and when possible you should pre-pay, make one or two monthly loan payments in advance. You should check with your consolidation loan servicer to be sure of how this is best done. You want to make sure that your pre-payment is going to the immediate next month and not toward principal, interest, or the last month payment. The rational for this move is that in prepaying a month or two in advance it will take a month or two plus any grace period before your payment can be deemed late. This cushion should accommodate any system lapses. However, do remember to review and reconcile your account statements on a monthly basis to be sure deposits and payments are being made, as they should. Most lenders will only allow you to pre-pay a few months in advance in meeting their on-time payment criteria. Confirm with your loan servicer the proper protocol for a pre-payment that will not adversely affect your on-time payment criteria. Consolidation lenders will not allow you to prepay the benefit qualification period. Be sure you maintain a sufficient balance (with some extra) in the account from which the automatic debit for your loan payment is being withdrawn. Set up a direct deposit account from your employer or from your primary checking or saving account to be sure that your consolidation loan payment account is funded. When setting up your direct deposit to your consolidation loan paying account, have the payment made a week before it is due and set up overdraft protection on your accounts.

10. Can I change my mind after my Consolidation loan is complete?

As the borrower, you have the right to cancel the application and the consolidation process before the loan is disbursed and only if the application process has not been completed. Processing times vary. Consolidation loans can be processed within 24 hours to eight weeks. Contact your lender if considering cancellation, for confirmation. After your funds are disbursed, the loans are paid in full, and no longer exist. At any time during the processing of your application, you may request that the lender notify you of the scheduled disbursement date and the exact terms of the loan. The Federal Loan Consolidation Application and Promissory Note is a legal document. By signing this document, you are requesting a Consolidation loan and agreeing to the terms of the loan disclosed to you.

11. Deferments, National & Community Service or Income Sensitive Forbearance

Borrowers, particularly graduates of medical, dentistry and law school, should be conscientious of the fact that some lenders may void the borrower benefits it the borrower uses any type of Deferment, National & Community service or Income Sensitive Forbearance within the first 12 – 48 months of consolidation. Know what your lender requires. One lender has stated, “Medical and dental students participating in an internship or residency program who are considering a consolidation loan may wish to consolidate after they complete their program in order to benefit from the 5% principal reduction.” To wait for unknown and most likely higher variable interest rates and not lock in the lowest rates in history is not sound financial planning advice for borrowers currently considering consolidation. Some other lenders will just reset the counter to “0” at the end of the deferment to begin counting the required on-time payments again.

12. It is Important to Know How Long You Plan to Take to Pay off Your Loans

For those who plan on paying off their consolidation loan within 5 – 7 years, an immediate 3.0% - 5.0% principal balance reduction may be a superior choice over a 1.0% interest rate reduction after making 36 or more consecutive on-time monthly payments. A borrower needs to carefully assess and determine if the benefit will remains in tact if the loan is paid off early. In money management terms it is generally better to take the maximum term available when the rates are very low, assuming low inflation and the ability and discipline to save and invest for better returns. However, some graduates may have personal of professional reasons to not carry or quickly reduce debt. This is another case where consultation with financial professionals such financial planners, tax advisors, attorneys and your consolidation counselor would be beneficial and is highly recommended.

In Conclusion

Although all lender borrower benefits are subject to change without notice, be sure that you understand the nuances and details of these benefits and obtain them in writing. Look for a consolidation program with competitive discounts, with forthright and honest health professions student-oriented personnel experienced and trained to assist you in a non-pressured environment to decipher the maze of borrower benefits and make an informed decision. If you need help or have questions email the EAS Loan Consolidation Program for HUCD at info@HUCDloanconsolidation.com.