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Why Don’t They…Change Student Loan Interest Rates As Fast As Online Savings Account Rates?

There goes another rate cut I won’t get for a few months.

Just recently, I learned that Wednesday’s one-quarter percentage point reduction in the Federal Funds Target Rate doesn’t affect the variable interest rate I pay on my private student loan until January. How can that be, given that online savings account rates are sure to fall within days?

It took a while to figure out the answer.

The latest Fed rate cut just adds salt to the wound opened 6 weeks ago, when I first started looking into this. Following the one-half percentage point cut in the Fed Funds Rate to 4.75% on September 18, I expected to see my variable rate private loan drop a similar amount.

See, my loan – through Citigroup’s Student Loan Corporation (SLC) – is tied to what’s known as the Prime Rate. That’s the rate banks charge to their best customers. In recent years, the Prime Rate has simply become the Fed Funds Rate plus 300 basis points, or three percentage points. After Wednesday’s cut, that’s 7.5%. To set an individual student loan rate, lenders add or subtract a few points based on several factors, including credit score, any co-signers and the borrower’s school.

But come my October loan statement, the student loan interest rate I was paying hadn’t dropped. Searching the SLC website, I found that the company resets rates quarterly, based on the Prime Rate published in The Wall Street Journal. The exact rules for when the rate resets were not apparent anywhere on the site.

SLC’s press office pointed me to my original promissory note that I signed when I took out the loan, which said that my student loan’s interest rate for each quarter was set a month before. So, on September 1, the Prime Rate was 8.25%. No rate cut for me until January!

Such obscurity and the search for information put me on the hunt. How the heck do other lenders price their private loans?

My cursory search shows the method to be far from standard. For example, Bank of America prices private loans on LIBOR, the London Interbank Offered Rate, which is the average interest rate on U.S. dollar deposits in the London banking market. LIBOR is quoted for terms from one week to a year. Bank of America takes the one-month LIBOR average for three months, and then applies it to the next quarter for its student loan interest rates.

For example, one-month LIBOR is 5.0% on January 1, 5.2% on February 1 and 5.5% on March 1. The three month average is 5.23%. That is the base rate for your loan from April to June. But, if the rate goes down to 4.8% in April – and stays there – you are still paying the higher rate until July.

Other schemes are just as confusing. Keybank and Student Loan Express, part of CIT, use 3-month LIBOR and reset rates quarterly. Sallie Mae references the Prime Rate and resets monthly. To top it all off, Nelnet, which offers loans by Comerica, makes both Prime-based and LIBOR-based loans. The Prime loans reset monthly and LIBOR loans quarterly.

Sure, I’m on the wrong-end of the rate cut this time and the damage is minimal. And, as rates rose, I was paying less. So it goes both ways. It boggles the mind, however, that student borrowers have to be versed in the nuances of money rates – Prime Rate, 1-month LIBOR and 3-month LIBOR – to truly evaluate their private loans.

The student lending bill enacted in September is expected, among other things, to rein in certain marketing tactics banks use to hook borrowers into their Federal loan programs. It goes further to assist lower-income students with better interest rates and even provides loan forgiveness for public service jobs. The bill, however, had no effect on how banks price and market private loans.

So next time you enter any sort of rate-based financial transaction with your bank or lender. Be sure you’re clear on what rate you’re earning or paying, how it’s set and what it’s based on. You may not get a better rate, but at least you won’t be surprised when you don’t.
–Ari Weinberg