Website design By BotEap.comIf you are a follower of the student loan and financial aid industry, you will have seen that there has been recent turmoil regarding how federal student loans are distributed and increased downward pressure on interest rates. In addition, a planned interest rate reduction for federally subsidized Stafford loans goes into effect in July 2010, from 5.6% to 4.5%. In July 2011, there will be another rate cut planned to 3.4%.

Website design By BotEap.comThanks to the Student Aid and Fiscal Responsibility Act (SAFRA) passed in March, private banks will no longer be able to originate federal student loans for students attending schools affiliated with the Federal Family Education Loan (FFEL) Program. The effect of this new bill is that, beginning in July, banks participating in FFEL will lose a substantial revenue stream and will begin looking elsewhere to recoup lost revenue. Due in part to these changes, banks are lowering their interest rates and fees to attract borrowers who might not normally be as willing to apply for a credit-based loan. You may be wondering, “What does that mean to me?” Two main things:

1. Lower interest rates = less money paid over the life of the loan
2. Historically low index rate = chance to pay more over the life of the loan

Website design By BotEap.comSounds counter-intuitive, right? Let’s break down the terms and uncover the hidden meanings.

Website design By BotEap.comInterest rate: the percentage of a sum of money that is charged for its use; this number is usually derived from a variable index rate plus a “margin”.

Website design By BotEap.com For example, if you loaned me $100 for a year at 5% interest, when I pay you back… the total will be $105. That $5 is what you charge me for borrowing the money.

Website design By BotEap.comIndex: A statistical indicator that measures changes in the economy in general or in particular areas. For student loans, the fed funds rate and the London Interbank Offered Rate (LIBOR*) are typically the most commonly used rates (The free online financial dictionary).

Website design By BotEap.com*If you would like more information about LIBOR and the fed funds rate, they are published daily in the Wall Street Journal and are available online from a wide variety of financial websites.

Website design By BotEap.comThese indices change over time based on the performance of the economy. If the economy is excellent, they tend to be higher; if it is doing poorly, or in our case, recovering from an intense global recession, they tend to be lower. These changes are all methods of financial controls to help expand or slow down the economy. If you’re new to economics, the important thing to remember is that the Federal Reserve doesn’t want our economy to grow or shrink too quickly; Steady, gradual growth is always preferred over rapid growth because it is less financially risky and easier to forecast. Now that you know what these terms mean, I invite you to think about how a historically low index rate could affect your student loan. To get a firm understanding, there are a few key points to keep in mind:

1. All private student loans have variable interest rates (meaning they change); rates are generally readjusted every 3-6 months
2. Low index rates = economy in recession or an economy poised for high growth
3. Interest rates are based, at least in part, on index rates

Website design By BotEap.comWhen you connect the dots, you see that there is a distinct possibility that as the economy improves, so will the indices. The result? Their variable the interest rate will rise along with the index and cost more money in the long run. Sounds a bit negative, right? Not necessarily. Because of these historically low index rates, you can actually get a private student loan (assuming you have a good or excellent credit score, or a creditworthy co-signer) at lower interest rates than a federal PLUS loan for parents. The game here is really finding a loan that has the best of all worlds. In this case, you want to find one that has a low “margin” number. You know when you see a loan offer and it says something like LIBOR + 3% or Prime + 2.5%? That “+X%” is a margin.

Website design By BotEap.comSo your goal, the savvy loan seeker, is to find a private loan that has a low spread and a low to medium index rate. The more stable the index, the more stable your interest rate will be. Keep in mind that you are not required to accept the first loan offer you receive, and you have a 30-day window to apply for loans without receiving a credit penalty. As a responsible borrower, you are encouraged to shop around for loans and find a product that matches both your needs and your financial capacity.