Alternative Loans and Credit Scores

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					                   Education Finance Division




Alternative Loans
and Credit Scores
What every financial aid officer
        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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January, 2007
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Alternative 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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January, 2007
                                                                                                         3
                                                                                                Over $16 billion
                                                                                                2005-06 (1052%
                                                                                               increase in 10-yrs)




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

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January, 2007
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                           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 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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January, 2007
                                                          6
                                               FICO 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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January, 2007
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                                     FICO 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 down
                                           New
                                          Credit
                Types of                  10%                 These percentages are
                Credit in                                     based on the importance
                  Use                              Payment
                                                    history   of the five categories for
                  10%                                         the general population.
                                                     35%
               Length
              of Credit                                       For particular groups –
               History                                        for example, those who
                15%                    Amounts
                                        owed                  have not been using
                                        30%                   credit for long – the
                                                              importance of these
                                                              categories may vary.
                              Source: www.MyFICO.com




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January, 2007
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                              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
               applicants to provide info such as income, length of
               present employment and types of credit the
               applicant has pursued. Generally, a high enough
               FICO will serve as a “pre-approval” until these other
               financial documents are provided
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January, 2007
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                     FICO: How do people score?

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



                            20%                 20%         20%           20%     20%

                                                       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.
                                                                                   Source: www.MyFICO.com


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January, 2007
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                     FICO: How do people score?

                                     National distribution of FICO scores

             30%                                                                              27%

             25%

             20%                                                                       18%
                                                                             15%
             15%                                               12%                                    13%

             10%                                    8%
                                         5%
               5%          2%
               0%
                    up to 499 500-549      550-599 600-649 650-699 700-749   750-799   800+



                                                                                                Source: www.MyFICO.com


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January, 2007
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                                    FICO: 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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January, 2007
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                           FICO: Top Reason Codes
              Serious delinquency               Level of delinquency
              Serious delinquency,             on accounts
             and public record or                Number of accounts
             collection filed                   with delinquency
              Derogatory public                 Amount owed on
             record or collection               accounts
             filed                               Proportion of balances
              Time since                       to credit limits on
             delinquency is too                 revolving accounts is
             recent or unknown                  too high
              Length of time                    Too many accounts
             accounts have been                 with balances
             established

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January, 2007
                                                                           14
  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

Alternative Loans & Credit Scores | Page 15 |
January, 2007
                                                   15
          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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January, 2007
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                 Are there alternative loans that
                   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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January, 2007
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                             Prime & 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

 Alternative Loans & Credit Scores | Page 18 |
 January, 2007
                                                                     18
                               Prime & 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)

Alternative Loans & Credit Scores | Page 19 |
January, 2007
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          What tiered pricing might look like
                       (LIBOR)
    FICO                   % rate               fees
                                                                    Lender establishes FICO
                                                                   range per tier (generally
    Tier 1                 Libor + 2.8%         0%-immed repay
                                                                   confidential)
                                                0%-defer repay
                                                                    Borrower(s) remain in
                                                                   their pricing tier for the
    Tier 2                 Libor + 3.3%         1%-immed repay
                                                1.5%-defer repay   life of the loan
                                                                    Interest rates and/or
    Tier 3                 Libor + 3.8%         2%-immed repay     fees may vary depending
                                                2.5%-defer repay   on the repayment option
                                                                   the borrower chooses
    Tier 4                 Libor + 4.3%         4%-immed repay      Most, if not all,
                                                5.5%-defer repay   alternative education
                                                                   loans are variable rate
    Tier 5                 Libor + 4.8%         6%-immed repay     loans based on either the
                                                7.5%-defer repay   Prime or LIBOR index


Alternative Loans & Credit Scores | Page 20 |
January, 2007
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          What tiered pricing might look like
                       (PRIME)
    FICO                   % rate               fees
                                                                    Lender establishes FICO
                                                                   range per tier (generally
    Tier 1                 Prime + .5%          0%-immed repay
                                                                   confidential)
                                                0%-defer repay
                                                                    Borrower(s) remain in
                                                                   their pricing tier for the
    Tier 2                 Prime + 2%           1%-immed repay
                                                1.5%-defer repay   life of the loan
                                                                    Interest rates and/or
    Tier 3                 Prime + 4%           2%-immed repay     fees may vary depending
                                                2.5%-defer repay   on the repayment option
                                                                   the borrower chooses
    Tier 4                 Prime + 5%           4%-immed repay      Most, if not all,
                                                5.5%-defer repay   alternative education
                                                                   loans are variable rate
    Tier 5                 Prime + 6%           6%-immed repay     loans based on either the
                                                7.5%-defer repay   Prime or LIBOR index


Alternative Loans & Credit Scores | Page 21 |
January, 2007
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                                                Apples & Oranges:
                       A 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

Alternative Loans & Credit Scores | Page 22 |
January, 2007
                                                                                                       22
                           Apples & Oranges, cont.


         School requirements                    Stafford   Alternative

      Entrance counseling                       Required   Not required

      Exit counseling                           Required   Not required

      Return of Title IV funds                  Required   Not required

      NLSDS updates                             Required   Not required

      Default management                        Required   Not permitted


Alternative Loans & Credit Scores | Page 23 |
January, 2007
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                          Good 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)

Alternative Loans & Credit Scores | Page 24 |
January, 2007
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                               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.

Alternative Loans & Credit Scores | Page 25 |
January, 2007
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                               Useful 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



Alternative Loans & Credit Scores | Page 26 |
January, 2007
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                              Thank you!!!


Alternative Loans & Credit Scores | Page 27 |
January, 2007
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