VIEWS: 6 PAGES: 27 POSTED ON: 3/25/2011
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! Alternative Loans & Credit Scores | Page 2 | January, 2007 2 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 Alternative Loans & Credit Scores | Page 3 | 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 Alternative Loans & Credit Scores | Page 4 | January, 2007 4 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? Alternative Loans & Credit Scores | Page 5 | January, 2007 5 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?” Alternative Loans & Credit Scores | Page 6 | 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 Alternative Loans & Credit Scores | Page 7 | January, 2007 7 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 Alternative Loans & Credit Scores | Page 8 | January, 2007 8 FICO: How a score breaks down 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.com Alternative Loans & Credit Scores | Page 9 | January, 2007 9 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 Alternative Loans & Credit Scores | Page 10 | January, 2007 10 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 Alternative Loans & Credit Scores | Page 11 | January, 2007 11 FICO: How do people score? up to 499 500-549 550-599 600-649 650-699 700-749 750-799 800+ Source: www.MyFICO.com Alternative Loans & Credit Scores | Page 12 | January, 2007 12 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. Alternative Loans & Credit Scores | Page 13 | January, 2007 13 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 Alternative Loans & Credit Scores | Page 14 | 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 Alternative Loans & Credit Scores | Page 16 | January, 2007 16 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? Alternative Loans & Credit Scores | Page 17 | January, 2007 17 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 19 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 Tier 2 Libor + 3.3% 1%-immed repay their pricing tier for the 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 20 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 Tier 2 Prime + 2% 1%-immed repay their pricing tier for the 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 21 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 23 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 24 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 25 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 26 Thank you!!! Alternative Loans & Credit Scores | Page 27 | January, 2007 27
"Alternative Loans and Credit Scores"