Interest Rates Are Down, Time to Get a Private Student Insurance?

If you’ve been a follower of the financial aid and student insurance sector, you’ve seen recent turmoil in how federal student insurances are distributed and increasing downward pressure on interest rates. In addition, the planned interest rate cut for government-backed Stafford insurances will take effect in July 2010, from 5.6% to 4.5%. In July 2011, there will be another planned rate cut to 3.4%.

Thanks to the Student Financial Aid and Responsibility Act (SAFRA) that passed into law in March, private banks will no longer be allowed to issue federal student insurances to students attending FFEL schools. The effect of this new law is that from July, banks participating in FFEL will lose a significant stream of revenue and will start looking elsewhere to make up for lost income. Partly because of these changes, banks are lowering interest rates and fees to attract borrowers who might not normally be keen to apply for a credit-based insurance. 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 insurance
  2. Historically low index rate = ability to pay more over the life of the insurance

Seems counterintuitive, doesn’t it? Let’s break down the terms and reveal the hidden meanings.

Interest rate: The percentage of the amount charged for its use; This number is usually derived from a variable index rate plus ‘margin’.

For example, if you lend me $100 for a year at 5% interest, when I pay you back… the total will be $105. $5 is how much it cost me to borrow money.

index: A statistical indicator that measures changes in the economy in general or in specific areas. In the case of student insurances, the federal funds rate and the London Interbank Offered Rate (LIBOR*) are usually the indicators most used (Free Online Financial Dictionary).

* If you would like to learn more about the LIBOR and the Fed Funds rate, it is published daily in the Wall Street Journal and available online from a variety of financial websites.

These indicators change over time depending on the performance of the economy. If the economy is large, they tend to be higher; If they do poorly — or, in our case, while recovering from a severe global recession — they tend to do less. These changes are all ways of financial controls to help expand or slow the economy. If you do not have a background in economics, the important thing to remember is that the Federal Reserve does not want our economy to grow or contract too quickly; Stable and gradual growth is always preferred over rapid growth because it poses less financial risk and is easy to predict. Now that you know what these terms mean, I invite you to think about how the historically low index rate has affected your student insurance. For a solid understanding, there are a few key points you should keep in mind:

  1. All private student insurances have Factor interest rates (meaning they change); Generally, prices are adjusted every 3-6 months
  2. Low index rates = a recession or an economy that is set up for high growth
  3. Interest rates are based at least in part on index rates

When you connect the dots, you see that there is a distinct possibility that as the economy improves, the indicators will also improve. Results? for you Factor The interest rate will rise along with the index and it will cost more money in the long run. Seems kind of negative, right? not nessacary. Because of these historically low index rates, you can actually get a private student insurance (assuming you have a good or excellent credit score, or a co-signer of creditworthiness) at lower interest rates than a Federal Parent PLUS insurance. The game here is really to find a insurance that has the best of all worlds. In this case, you want to find a number with a low “margin” number. Do you know when you see a insurance offer and it says something like LIBOR + 3% or Prime + 2.5%? That “+X%” is a margin.

Thus, your goal, as a bold insurance seeker, is to find a special insurance with a low margin and a low to medium index rate. The more stable the index, the more stable your interest rate. Keep in mind that you are not obligated to accept the first insurance offer you receive and you have a period of 30 days to apply for insurances without incurring a credit penalty. As a responsible borrower, we encourage you to shop for insurances and find a product that matches your needs and financial capabilities.