education finance division what every financial aid officer should know alternative loans and credit...

Education Finance DivisionEducation Finance Division

What every financial aid officer What every financial aid officer should knowshould know

Alternative Loans Alternative Loans and Credit Scoresand Credit Scores

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Alternative Loans & Credit Scores | | January, 2007

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

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

alternative loan? Pricing tiers and interest rates. Quick comparison of Stafford & Alternative loans. Good counseling practices!

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

Federal loans are not keeping up with the rising costs of education.The federal student loan limit has changed

for the first time since 1992; from 1992 to 2004 the national average of 4 year public tuition has increased by nearly 70%. (Nellie Mae)

Alternative loan volume has grown by over 1,000% from the 95-96 school year to 05-06 school year. (CollegeBoard)

Source: 2005 NASFAA conference presentation by Vicky Powers, Tonya Drain & Stephanie Forest

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Source: 2005 NASFAA conference presentation by Vicky Powers, Tonya Drain & Stephanie ForestSource: 2005 NASFAA conference presentation by Vicky Powers, Tonya Drain & Stephanie Forest

Over $16 billion 2005-06 (1052%

increase in 10-yrs)

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Does this sound familiar?Does this sound familiar?

A student needs more money.

You give him/her an alternative loan application.

You tell the student, “call 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

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 present employment and types of credit the applicant has pursued. Generally, a high enough applicant has pursued. Generally, a high enough FICO will serve as a “pre-approval” until these other FICO will serve as a “pre-approval” until these other financial documents are providedfinancial documents 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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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 historyMany 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 pricing”

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

Counsel the borrower to look for and know these terms before signing the final loan documents

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Are there alternative loans that Are there alternative loans that do not use tiered pricing?do not use tiered pricing?

Some loans may offer zero fees to all approved borrowers but still use pricing tiers for interest rates

Customized alternative loan agreements between a school & lender are likely the only way in which all approved borrowers receive the same rate & fee structure

Do you consider Home Equity and personal loans to be alternative education loans?

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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 7.25%, this is down from 8.25% a year ago and 7.75% a month ago. As recently as December 2001, it was 4.25%

Historically, Prime has always been 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 indexes, such as the 3-month rate, give lenders & borrowers a

less volatile rate Lenders typically set rates based on the averages of the

1 month LIBOR 3 month LIBOR

Currently the 3-month LIBOR is 4.91%, down from 5.24% a month ago and 5.37% a year ago (both lenders and borrowers can count on four interest rate variations per year; no more, no less)

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What tiered pricing might look likeWhat tiered pricing might look like(LIBOR)(LIBOR)

Lender establishes FICO range per tier (generally confidential) Borrower(s) remain in their pricing tier for the life of the loan Interest rates and/or fees may vary depending on the repayment option the borrower chooses Most, if not all, alternative education loans are variable rate loans based on either the Prime or LIBOR index

FICO % rate fees

Tier 1 Libor + 2.8% 0%-immed repay0%-defer repay

Tier 2 Libor + 3.3% 1%-immed repay1.5%-defer repay




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What tiered pricing might look likeWhat tiered pricing might look like(PRIME)(PRIME)

Lender establishes FICO range per tier (generally confidential) Borrower(s) remain in their pricing tier for the life of the loan Interest rates and/or fees may vary depending on the repayment option the borrower chooses Most, if not all, alternative education loans are variable rate loans based on either the Prime or LIBOR index

FICO % rate fees

Tier 1 Prime + .5% 0%-immed repay0%-defer repay

Tier 2 Prime + 2% 1%-immed repay1.5%-defer repay




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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

NLSDS updates RequiredRequired Not requiredNot required

Default management RequiredRequired Not permittedNot permitted

Stafford Alternative

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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.

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 which may be higher.

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

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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.PelaLenders.org – the PA Education Lenders Assoc website offers an alternative loan comparison search

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Thank you!!!Thank you!!!

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