Alternative Loans and Credit Scores by jennyyingdi

VIEWS: 3 PAGES: 27

									                   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)
                 Alternativeloan 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
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                                                                                                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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| January, 2007
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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
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                                             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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                  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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                  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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                                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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                        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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  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???



  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
                 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 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 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 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


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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


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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

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                        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



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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)

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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.

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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



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                          Thank you!!!


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