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Education Finance DivisionEducation Finance Division

What we all should understandWhat we all should understand

Alternative Loans Alternative Loans and Credit Scoresand Credit Scores

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Alternative Loans & Credit Scores | | Fall 2008

Things you should know….Things you should know….

Brief history of alternative education loans Quick comparison of Stafford & alternative What is a credit check? What happens? FICO scores: what are they and how they impact an

alternative loan application Pricing scales and tiers for alternative loans Interest rate indexes Good counseling practices Useful resources for the financial aid office and the

borrower

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Alternative loans….how far they’ve comeAlternative loans….how far they’ve come

• Nonfederal loans increased from 4% of external funds used to finance postsecondary education in 1997-98 to 12% 2007-08.

• Tax credits and deductions, which did not exist in 1997-98, constituted 4% of funds by 07-08.

• Campus-based aid—Federal Supplemental Educational Opportunity Grants (FSEOG), Perkins Loans, and Federal Work-Study—declined from 4% to 2%.

• Subsidized Stafford Loans declined from 26% to 18% of the total. See graphic next slide

Source: The College Board; Trends in Student Aid 2008Source: The College Board; Trends in Student Aid 2008

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Apples & Oranges:Apples & Oranges: A Quick comparison of Federal & Alternative LoansA Quick comparison of Federal & Alternative Loans

Federal loans Federal guarantee to lenders Same interest for all borrowers No credit check or collateral Grade level & aggregate limits 10-year standard repay Citizenship requirements Discharged for death/disability and forgiveness programs

Private/alternative loans Lender assumes all risk; no federal involvement Interest rates & fees vary Yearly limits not set by grade level higher limits Longer repayment period, based on amount Loans available to non-citizens Co-borrower is responsible upon death/disability of primary

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Apples & Oranges, cont.Apples & Oranges, cont.

School requirements

Entrance counseling RequiredRequired Not requiredNot required

Exit counseling RequiredRequired Not requiredNot required

Return of Title IV funds RequiredRequired Not requiredNot required

NSLDS updates RequiredRequired Not requiredNot required

Default management RequiredRequired Not permittedNot permitted

Stafford Alternative

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Does this sound familiar?Does this sound familiar?

A student needs more money.You direct him/her an alternative loan

application.You tell the student, “check with the lender to

see if you’re approved.”

But what actually happens?

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The credit check processThe credit check process

Any pursuit of credit – home loan, auto loan, private education loan, etc – authorizes a

lender to obtain a credit score. A lender uses this score to help answer the question,

“What is the likelihood that this borrower will pay us back on time?”

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FICO 101FICO 101

A FICO score is the most commonly used credit rating

FICO is the acronym of Fair Isaac & Company, developers of the software used by lenders when performing a credit check

Scores based solely on information in consumer credit reports maintained at the credit reporting agencies (Experian, TransUnion & Equifax)

Credit scoring is a quick, objective & consistent method for lenders to measure the “risk” of an applicant

The higher the score, the lower the risk

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FICO 101, continuedFICO 101, continued

The FICO score is an equation that evaluates the following five factors – and only these five:

payment history amount you owe length of your credit history pursuit of new credit (inquiries) types of credit you use

A FICO score is a constant work in progress

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FICO: How a score breaks downFICO: How a score breaks down

Payment history35%

Amounts owed30%

Length of Credit History15%

Types of Credit in

Use10%

New Credit10% These percentages are

based on the importance of the five categories for the general population.

For particular groups – for example, those who have not been using credit for long – the importance of these categories may vary.

Source: www.MyFICO.comSource: www.MyFICO.com

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What are the scores???What are the scores??? 300 to 850 Scores may vary slightly between the credit bureaus

(due to variations in the way creditors report information)

Lenders decide from which credit bureau to pull scores FICO scores only reflect the info that appears on a

credit report Important to remember that lenders may also ask Important to remember that lenders may also ask

applicants to provide info such as income, length of applicants to provide info such as income, length of present employment and types of credit the applicant present employment and types of credit the applicant has pursued. Generally, a high enough FICO will serve has pursued. Generally, a high enough FICO will serve as a “pre-approval” until these other financial as a “pre-approval” until these other financial documents are provideddocuments are provided

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Below 620 620-690 690-740 740-780 Above 780

20% 20% 20% 20% 20%

FICO: How do people score?FICO: How do people score?

Based on the general U.S. population’s FICO scores

What’s good, what’s bad? It depends on the lender and/or loan

product. There are no universal standards.


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National distribution of FICO scores

2%5%

8%

12%15%

18%

27%

13%

0%

5%

10%

15%

20%

25%

30%


FICO: How do people score?FICO: How do people score?

up to 499 500-549 550-599 600-649 650-699 700-749 750-799 800+

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On the average….On the average….

Each person with established credit has 13 obligations (9 revolving, 4 installment)

Less than half of all consumers have ever been reported as 30 days or more late on a monthly payment; only 30% have ever been 60 days late; less than 20% have ever defaulted on a credit agreement

48% of consumers carry less than $5,000 of non-mortgage debt; 37% carry over $10,000 of non-mortgage debt

The typical consumer has approximately $19,000 of available credit The average person has a credit history of 14 years Most people apply for new credit once per year; fewer than 6% of the

population applies for new credit four times in a year


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FICO: Reason CodesFICO: Reason Codes

Up to four “score codes” are provided to a lender when a FICO score is pulled. These codes are the top reasons why the score was not higher. Codes help a lender explain to a borrower why credit was denied.

Additionally, these codes may be more useful for the applicant than the FICO score itself. Codes may illustrate potential errors in a credit report as well as providing tips on how to improve one’s credit health.

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FICO: Top Reason CodesFICO: Top Reason Codes Serious delinquency Serious delinquency, and public record or collection filed Derogatory public record or collection filed Time since delinquency is too recent or unknown Length of time accounts have been established

Level of delinquency on accounts Number of accounts with delinquency Amount owed on accounts Proportion of balances to credit limits on revolving accounts is too high Too many accounts with balances

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Why do so many students need a co-borrower?Why do so many students need a co-borrower?

Many have little to no credit history Many cannot meet additional application

factors such as income history and debt-to-income ratio

Most will benefit from the FICO score of an established borrower with good credit

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Credit is approved…..what happens next???Credit is approved…..what happens next???

For many alternative loan products, interest rates and/or fees are determined by “tiered or sliding scale” pricing models.

Generally speaking, the higher the FICO, the better rates & fees

Recently, lenders began using more “sophisticated” pricing models to include FICO, applicant income and school profile to determine a borrowers rate and/or fees.

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Prime & LIBOR indexesPrime & LIBOR indexes

Prime rate (also known as Wall Street Journal Prime)

Basically a consensus rate that large lenders charge their best corporate customers

Published daily by the WSJ and can change at any time Banks tend to change their prime rate whenever the Federal

Reserve Board raises or lowers its target federal funds rate, usually in the exact amount of the fed change

Currently, Prime is 4.00%. Prime is always 3% above the current Federal Funds rate

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Prime & LIBOR indexesPrime & LIBOR indexes

LIBOR index Stands for London Interbank Offered Rate It is the rate which banks borrow money from each other in the London

interbank market Gaining momentum within alternative education loan market because

there are several LIBORS (i.e. daily, weekly, monthly, quarterly & yearly) Longer durations, such as the 1-month and 3-month rates, give lenders

& borrowers a more predictive index Lenders typically set rates based on the averages of the

1 month LIBOR 3 month LIBOR

Currently, the 1-month LIBOR is 3.375%

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Good counseling practicesGood counseling practices

Students – even those with approved credit – should seek a co-borrower

Application process goes smoother when financial documents are in hand and both student & co-borrower are present

Don’t wait until the semester is closing in! (Wishful thinking, ehh?)

Use alternative loans that require school certification. “Direct to consumer” loans often are more expensive, but do not count towards COA.

Consider an alternative loan that offers combined billing with Stafford, if applicable w/school process.

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Good counseling, cont.Good counseling, cont.

Stafford and Alternative loans cannot be consolidated into a federal loan

Some loans exist that will consolidate the two, but the resulting loan is a private loan that is subject to a credit check and possibly fees and/or variable interest rates.

Federal/state benefits, such as teacher cancellation, nursing cancellation and armed forces deferments are gone, as are death-disability discharges.

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Good counseling: credit reportsGood counseling: credit reports

EVERYONE should review his/her credit report at least once per year.

How?

www.AnnualCreditReport.com

Free of charge, once every 12 months – not for profit

FICO score available for a nominal fee

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Good counseling: reviewing reportsGood counseling: reviewing reports

Items that appear on a credit report…review them for accuracy

Identifying information (name, SSN, date of birth, address, employer)

Trade lines (individual credit accounts; check for balances, account status, date opened, credit limit, etc.)

Credit inquiries (a list of everyone who has accessed your credit report during the past two years, both voluntary and involuntary.

Public record and collection items (public record data from collection agencies and courts; info includes liens, judgments, bankruptcies and wage garnishments)

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Good counseling: resolving disputesGood counseling: resolving disputes

Contact both the credit bureau and the organization reporting the erroneous information. Each are responsible for correcting inaccurate or incomplete info under the Fair Credit Reporting Act.

Provide (in writing) an identification of: The item on the report in question Clearly stated facts as to why you believe its an error Copies (not originals) of any documents to support your claim)

Immediately close any revolving credit accounts, or deactivate credit cards, should you suspect fraud

Credit bureaus must investigate your claim, usually within 30 days of receipt

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Good counseling: improving scoresGood counseling: improving scores

Payment History: Pay everything on time Get current, stay current Negotiate a better rate

Amounts Owed: Installment better than

revolving Pay debt down, don’t

shift it Keep the accounts you

need, close those you don’t

Too much available credit can hurt

Length of credit history: Keep oldest account open Don’t open new credit rapidly

New credit Do “focused” rate shopping Re-establish credit if you’ve

had problems It’s OK to check your credit

Types of credit: Apply for only what you need Revolving credit lines can help

your score, but only up to a certain amount.

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Useful resources for allUseful resources for all

www.MyFico.com – provides credit awareness, credit health tips and instructions on reading credit reports & fixing errors

www.AnnualCreditReport.com – government recognized free credit report service. Available once in a 12-month period to all consumers

www.BankRate.com – daily updates on all interest rate indexes

www.CollegeBoard.com – follow links to the “Trends in Student Aid 2008” report.

http://www.myfico.com/

http://www.annualcreditreport.com/

http://www.bankrate.com/

http://www.pelalenders.org/

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ThankThank you!!! you!!!

Ben BrudnockCitizens BankEducation Finance724-499-5822 office [email protected]

mailto:[email protected]

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