Rare Opportunity – Interest Rate Cuts and Private Student Loans
MilkYourMoney.com has received an increasing amount of traffic directed to an earlier post titled, “How Do the Federal Interest Rate Cuts Affect My Student Loans,” in recent days and with good reason. The Federal Funds Rate has been dramatically reduced in the last couple of months, which has adjusted borrower’s monthly payments for nearly every loan borrowed at a variable rate, including credit card rates. However, depending on the benchmark for which your loan rate is based, your loan could actually be moving in the opposite direction of the rate cuts – which is the case for my private student loans.
This weekend, my wife and I received a letter from Iowa Student Loan’s (my borrower) offering, what I consider, a rare opportunity. Because my private loan interest rates are based off the Cost of Funds Index (COFI), my interest rates have actually spiked from 8% three months ago to around 13% as of April 1, 2008. Because of this unaffordable rise in interest rates for many private loan borrowers, Iowa Student Loans has offered us the opportunity to amend our original loan contract and adjust the benchmark our loans follow in order to determine our rates to the London Interbank Offered Rate (LIBOR) benchmark. If I choose to amend my original loan contract to use the COFI benchmark, my rates would drop from the current 13% to around 6.5%.
I can’t help but to think the current strains our economy is facing due to the mortgage crisis is the primary reason for our lenders recent offer. Most lenders are finding themselves in a position where higher interest rates, which ultimately give them higher profits, are not benefiting them because the higher rates are actually pushing some borrowers into default. Job losses, the declining dollar, rise in commodities are all, in my opinion, forcing banks to become more consumer friendly. (An interesting fact, student loan debt is the only debt that dies with you, no survivors have to make payments on your behalf.)
I have until April 30th to decide if my wife and I should make the move to the new benchmark. At the surface, the decision sounds like an obvious one, which is exactly what makes me hesitant. I need to do some research to determine over a 20-year period which benchmark, the COFI or the LIBOR would offer me the most consistent lower rate, thus, saving me the most money in interest payments. It’s also important for me to consider how these benchmarks are set and if they move independently of the Federal Funds Rate.
Below I have included more information on the two benchmarks – what should I do?
Cost of Funds Index (COFI)
Currently, my private variable student loan rates are based off the COFI. The COFI is a regional average of interest expenses incurred by financial institutions that is used to calculate variable rate loans. To our knowledge, the COFI rate is a private calculation between banks and is not available to the public. Most lenders readjust your rate quarterly (every three months) based off this average. Most importantly, the COFI is not directly linked to the federal funds rate, which means the index does not move in the same direction as the recent rate cuts. In fact, since January 1, my student loan rates have actually increased. You can easily find out how your student loan rates are set by calling your lender and asking, it worked for me.
London Interbank Offered Rate (LIBOR)
Many lenders will use this rate if you decide to consolidate your private student loans with a variable rate product. The LIBOR rate is the interest rate the most credit-worthy banks around the world charge each other for loans. The rate fluctuates throughout the day based on the market, similar to stocks. Most Student loan lenders that set their rates using LIBOR will readjust their rates quarterly, based on the LIBOR rate + an additional percentage depending on factors like if you have a co-signer, how big of a origination fee you choose etc. For example, if I were to consolidate my student loans now my rate would be based of the LIBOR Rate from the start of the new quarter (January 1) which was at 5.12% + 3.14%(call your lender to ask what this additional amount will be) for an interest rate of 8.26%. It is important to remember that the LIBOR rate moves independently of the federal funds rate. $
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Comments
I also have my loans through ISL, and I’m very hesitant. It seems too obvious to choose the lower one. Am I missing something here? Still researching..
I’m interested to know your final decision!
I will switch, see below for details
http://milkyourmoney.com/2008/04/16/my-student-loan-decision/
dandu!!!