What every financial aid officer should know

1. Alternative Loans and Credit Scores What every financial aid officer should know

2. 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!

3. 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

4. Over $16 billion 2005-06 (1052% increase in 10-yrs) Source: 2005 NASFAA conference presentation by Vicky Powers, Tonya Drain & Stephanie Forest

5. 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?

6. 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?”

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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.

14. 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 FICO: Top Reason Codes • 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

15. 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

16. 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

17. 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?

18. 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 is7.25%,this is down from 8.25% a year agoand 7.75% a month ago.As recently asDecember 2001, it was4.25% • Historically, Prime has always been 3% above the current Federal Funds rate

19. 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)

20. What tiered pricing might look like(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

21. What tiered pricing might look like(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

22. 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

23. Apples & Oranges, cont. • School requirements Alternative Stafford Entrance counseling RequiredNot required Exit counseling RequiredNot required Return of Title IV funds RequiredNot required NLSDS updates RequiredNot required Default management RequiredNot permitted

24. 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)

25. 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.

26. 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

27. Thank you!!!