Educat i on Fi nance Di vi si on
Alternative Loans and Credit Scores What we all should understand
Things you should know…. Brief history of alternative education loans Quick comparison of Stafford & alternative What is a credit check? What happens? FICO scores: what are they and how they impact an alternative loan application Pricing scales and tiers for alternative loans Interest rate indexes Good counseling practices Useful resources for the financial aid office and the borrower Al t er nat i ve Loans & Cr edi t Scor es | Page 2 | Fal l 2008 2
Alternative loans….how far they’ve come • Nonfederal loans increased from 4% of external funds used to finance postsecondary education in 1997-98 to 12% 2007-08. • Tax credits and deductions, which did not exist in 1997-98, constituted 4% of funds by 07-08. • Campus-based aid—Federal Supplemental Educational Opportunity Grants (FSEOG), Perkins Loans, and Federal WorkStudy—declined from 4% to 2%. • Subsidized Stafford Loans declined from 26% to 18% of the total. See graphic next slide Source: The College Board; Trends in Student Aid 2008
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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 Al t er nat i ve Loans & Cr edi t Scor es | Page 5 | Fal l 2008 5
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
NSLDS updates
Required
Not required
Default management
Required
Not permitted
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Does this sound familiar?
A student needs more money. You direct him/her an alternative loan application. You tell the student, “check with the lender to see if you’re approved.” But what actually happens? Al t er nat i ve Loans & Cr edi t Scor es | Page 7 | Fal l 2008 7
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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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 Al t er nat i ve Loans & Cr edi t Scor es | Page 9 | Fal l 2008 9
FICO 101, continued The FICO score is an equation that evaluates the following five factors – and only these five: 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 Al t er nat i ve Loans & Cr edi t Scor es | Page 10 | Fal l 2008 10
FICO: How a score breaks down Types of Credit in Use 10% Length of Credit History 15%
New Credit 10% Payment history 35%
Amounts owed 30%
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
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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? Bel ow 620
20%
620- 690
690- 740
740- 780
Above 780
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 Al t er nat i ve Loans & Cr edi t Scor es | Page 13 | Fal l 2008 13
FICO: How do people score? National distribution of FICO scores 30%
27%
25% 18%
20% 15%
15% 8%
10% 5%
13%
12% 5% 2%
0% up t o 499
500- 549
550- 599
600- 649
650- 699
700- 749
750- 799
800+
Source: www.MyFICO.com Al t er nat i ve Loans & Cr edi t Scor es | Page 14 | Fal l 2008 14
On the average…. Each person with established credit has 13 obligations (9 revolving, 4 installment) Less than half of all consumers have ever been reported as 30 days or more late on a monthly payment; only 30% have ever been 60 days late; less than 20% have ever defaulted on a credit agreement 48% of consumers carry less than $5,000 of non-mortgage debt; 37% carry over $10,000 of non-mortgage debt The typical consumer has approximately $19,000 of available credit The average person has a credit history of 14 years Most people apply for new credit once per year; fewer than 6% of the population applies for new credit four times in a year
Source: www.MyFICO.com Al t er nat i ve Loans & Cr edi t Scor es | Page 15 | Fal l 2008 15
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 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? Many have little to no credit history Many cannot meet additional application factors such as income history and debtto-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 or sliding scale” pricing models. Generally speaking, the higher the FICO, the better rates & fees Recently, lenders began using more “sophisticated” pricing models to include FICO, applicant income and school profile to determine a borrowers rate and/or fees. Al t er nat i ve Loans & Cr edi t Scor es | Page 19 | Fal l 2008 19
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 4.00%. Prime is always 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 durations, such as the 1-month and 3-month rates, give lenders & borrowers a more predictive index Lenders typically set rates based on the averages of the 1 month LIBOR 3 month LIBOR Currently, the 1-month LIBOR is 3.375%
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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 & coborrower 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, but do not count towards COA. Consider an alternative loan that offers combined billing with Stafford, if applicable w/school process. Al t er nat i ve Loans & Cr edi t Scor es | Page 22 | Fal l 2008 22
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. Federal/state benefits, such as teacher cancellation, nursing cancellation and armed forces deferments are gone, as are deathdisability discharges. Al t er nat i ve Loans & Cr edi t Scor es | Page 23 | Fal l 2008 23
Good counseling: credit reports EVERYONE should review his/her credit report at least once per year. How? www.AnnualCreditReport.com Free of charge, once every 12 months – not for profit FICO score available for a nominal fee
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Good counseling: reviewing reports Items that appear on a credit report‌review them for accuracy Identifying information (name, SSN, date of birth, address, employer) Trade lines (individual credit accounts; check for balances, account status, date opened, credit limit, etc.) Credit inquiries (a list of everyone who has accessed your credit report during the past two years, both voluntary and involuntary. Public record and collection items (public record data from collection agencies and courts; info includes liens, judgments, bankruptcies and wage garnishments)
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Good counseling: resolving disputes Contact both the credit bureau and the organization reporting the erroneous information. Each are responsible for correcting inaccurate or incomplete info under the Fair Credit Reporting Act. Provide (in writing) an identification of: The item on the report in question Clearly stated facts as to why you believe its an error Copies (not originals) of any documents to support your claim)
Immediately close any revolving credit accounts, or deactivate credit cards, should you suspect fraud Credit bureaus must investigate your claim, usually within 30 days of receipt
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Good counseling: improving scores Payment History: Pay everything on time Get current, stay current Negotiate a better rate
Amounts Owed: Installment better than revolving Pay debt down, don’t shift it Keep the accounts you need, close those you don’t Too much available credit can hurt
Length of credit history: Keep oldest account open Don’t open new credit rapidly
New credit Do “focused” rate shopping Re-establish credit if you’ve had problems It’s OK to check your credit
Types of credit: Apply for only what you need Revolving credit lines can help your score, but only up to a certain amount.
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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.CollegeBoard.com – follow links to the “Trends in Student Aid 2008” report.
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Thank you!!! Ben Brudnock Citizens Bank Education Finance 724-499-5822 office ph. ben.brudnock@citizensbank.com
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