Understanding
Private Loans
Default Prevention
Agenda
 Essential loan language
 Variable rate language
♦
Types of indexes
 Language for all types of loans
 Dissect an interest rate
♦
Variable rate history
 Finding the best deal
What’s In It For You?
 Improve discussion with borrowers
 Better understanding of loans and terms
 Less stress
Loan Language
APR
Capitalization
Guarantee
Fees
Margin
LIBOR
T-Bill
Origination
Cap
Points
Negative Amortization
Adjustment
Period
Prime
Variable
Know Another Language?
 Review the FAFSA, determine EFC, then
send the AL through your FAM system.
 Is your school Direct or FFEL?
 Do you process EFT through ELM?
 Do you award FWS, Pell and FSEOG?
Loan Language Essentials
Interest Rate
 A charge for a loan
♦
Shown as a percent of borrowed amount
 One of many ways to charge for a loan
♦
Up-front fees
♦ Capitalization frequency
Interest Rate
 Interest
Student loans — monthly
♦ Credit cards — daily or monthly
♦ Earlier payments = less interest
♦
 How payment is applied
♦
Fees
♦ Interest
• Lowest interest rate balance
• Higher interest rate balance
♦
Principal
Interest Rates and Debt
 Secured
♦
Car
♦ Home
 Unsecured
♦
Credit card
♦ Personal loan
♦ Education loan
What’s in an Interest Rate
Cost of funds
+ Operations
+ Inflation
+ Risk
+ Profit
Borrower rate
Index
Margin
Dissecting an Interest Rate
Cost of Funds1
Inflation Rate2
Operations3
Loan Losses4
Total Lender Cost
Profit
Loan Rate5
1,4,5
Credit Card
2.38%
2.50%
0.50%
4.85%
10.23%
2.94%
13.17%
Bank sample June 2006 2Federal Reserve 3Federal Reserve Bank Functional Cost and Profit
Analysis.
APR
 Annual Percentage Rate (APR)
♦
Annual basis
♦ Up-front charges
• Guarantee fees
• Origination fees
♦
Compounding frequency
 Can make shopping easier
♦
Price tag
Index Types




Index and borrower rate
T-Bill
LIBOR
Prime rate
Index
 Index
♦
Wholesale price
• Rate = price lender pays for money
• Name = where lender obtains money
 Borrower rate
♦
Retail price
• Price borrower pays for money
T-Bill
 Treasury bill
 Government borrowing
♦
U.S. deficit
♦
Rate set by the government
♦
Price it will pay to borrow money
 Terms: 13 and 26 weeks
LIBOR
 London Interbank Offered Rate
♦
Rate international banks in London charge
each other for loans
♦
Can take place anywhere
♦
Recorded in London
♦
Similar to NYSE
 Index has been used for 18 years
Prime Rate
 Retail
♦
Credit-worthy customers
• Secured
 Private loans
♦
Wholesale price
♦
Mark-up/margin added
• Borrowers lack credit history
• Unsecured
Margin
 Allowance to cover expenses
♦
Rate the borrower pays
10%
♦
Index (cost of funds)
-4%
♦
Margin (covers expenses)
6%
Index + Margin
What the
Lender pays
+
Lender
Revenue
=
What the
customer pays
Loan Type
Index
Borrower
Margin
Rate
LIBOR Index
5.36%
7.89%
13.25%
Prime Index
8.25%
5.00%
13.25%
T-Bill Index
4.61%
8.64%
13.25%
Floor and Cap
 Floor
♦
Lowest rate
♦
Rarely used
 Cap
♦
Highest rate
♦
Limits consumer risk
♦
Also called ceiling
Cap Example
 Prime + 3% with a cap of 12%
♦
If prime rate is 14% + 3% margin
♦
Rate is ____%
Adjustment Period
 How often rate changes
♦
Annually, quarterly, monthly
 Purpose
♦
Easier budgeting
♦
Keeps lender’s margin/markup level
Adjustment Period Cap
 Maximum rate change each period
 Purpose
♦
Limits borrower risk
♦
Easier to budget
♦
Benefit when rates are going up
♦
Not a benefit when rates decline
Variable Rate Payment Risk
Loan Amount
Loan Rate
Cap
Payment Range
Possible Increase
Based on a 10-year loan term.
$20,000
5.00%
25.00%
$212 - $455
115%
Loan Origination Fees
 Paid up-front
 Usually a percentage of the loan
amount
 Origination
♦
Fee to start a loan
♦ Adds to the total cost of the loan
♦ Included in APR
Points
 Point = % of loan amount
 One point = 1%
♦
Origination fee of 2%
♦
Two points
♦
$25,000 x 2 points = $500
 Mortgage, home equity
♦
student loans
Amortization
 Amortize = Pay off
 Reduction of debt
♦
Regular payments of
• Interest (cost of the loan)
• Principal (actual amount borrowed)
 Result = Loan balance decreases
Negative Amortization
 Increasing debt
 Payments do not cover principal and
interest
 Result = Loan balance grows
 Read the fine print
Monthly payments remain fixed throughout
the life of the loan. Any fluctuation in the
interest rate will be reflected in the length of
repayment, not in the monthly amount.
Capitalization




Adding interest to loan balance
Capital = Money borrowed
Interest is paid on capital
“Capitalized” = when interest becomes
part of the capital
What’s a Better Deal?
 Low fee or a low rate
 $10,000 loan with 10-year term
♦
1% fee = $100
♦
1% rate discount = $626
 A lower rate saves more than a low fee
 Similar to car loan
$626 savings based on an interest rate comparison of 7% and 8% on a 10-year loan term.
The Right Choice
 LIBOR
 Prime rate
 T-Bill
Indexes Mirror Each Other
25%
Prime
90 Day Tbill
3 MO LIBOR
Interest Rate
20%
15%
10%
5%
0%
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
Years
Source: St. Louis Federal Reserve Bank and Federal National Mortgage Association
Rates Mirror Each Other
 Margin compensates for index variety
Any index
+ Margin
= Similar loan rates
Private Loan Choices
Lender
#1
#1
#2
#2
#3
#3
#4
#4
#4
#4
#5
#5
#5
#5
#5
#5
#6
#6
#6
#6
#7
#7
#7
#7
#8
#9
#9
# 10
# 10
Index
LIBOR
LIBOR
PRIME
PRIME
PRIME
PRIME
LIBOR
LIBOR
LIBOR
LIBOR
LIBOR
LIBOR
LIBOR
LIBOR
PRIME
PRIME
PRIME
PRIME
PRIME
PRIME
LIBOR
LIBOR
LIBOR
LIBOR
LIBOR
PRIME
PRIME
PRIME
PRIME
Margin
5.00%
5.00%
0.50%
4.75%
1.00%
1.00%
4.50%
4.50%
5.50%
5.50%
1.60%
1.60%
2.80%
2.80%
0.00%
0.00%
0.00%
0.00%
5.00%
5.00%
2.25%
2.25%
8.00%
8.00%
4.00%
6.50%
6.50%
4.50%
7.75%
Cap
None
None
None
None
None
None
None
None
None
None
12.00%
12.00%
12.00%
12.00%
12.00%
12.00%
None
None
None
None
None
None
None
None
18.00%
None
None
None
None
Current
Rate
10.36%
10.36%
8.75%
13.00%
9.25%
9.25%
9.86%
9.86%
10.86%
10.86%
6.96%
6.96%
8.16%
8.16%
8.25%
8.25%
8.25%
8.25%
13.25%
13.25%
7.61%
7.61%
13.36%
13.36%
9.36%
14.75%
14.75%
12.75%
16.00%
Fees
4.00%
6.25%
0%
0%
0%
3%
2%
9.90%
2%
9.90%
3.75%
7.00%
3.75%
7.00%
3.75%
7.00%
0%
9%
0%
9%
0%
8%
0%
8%
0%
0%
3%
0%
0%
Term
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
Index
Margin
Lender
A
LIBOR
1.00%
A
LIBOR
1.00%
A
LIBOR
2.75%
A
LIBOR
2.75%
B
PRIME
-0.50%
B
PRIME
-0.50%
C
LIBOR
3.75%
C
LIBOR
3.75%
D
PRIME
0.00%
D
PRIME
4.50%
E
LIBOR
0.00%
E
LIBOR
0.00%
E
LIBOR
3.50%
E
LIBOR
3.50%
F
LIBOR
3.85%
G
3 Mo T-Bill 3.40%
G
3 Mo T-Bill 3.40%
H
PRIME
1.25%
H
PRIME
1.25%
H
PRIME
2.25%
H
PRIME
2.25%
I
LIBOR
1.80%
I
LIBOR
1.80%
J
LIBOR
7.50%
J
LIBOR
7.50%
K
LIBOR
4.25%
K
LIBOR
4.25%
K
LIBOR
9.95%
K
LIBOR
9.95%
L
LIBOR
3.25%
Cap
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
Current
Rate
6.36%
6.36%
8.11%
8.11%
7.75%
7.75%
9.11%
9.11%
8.25%
12.75%
5.36%
5.36%
8.86%
8.86%
9.21%
8.01%
8.01%
9.50%
9.50%
10.50%
10.50%
7.16%
7.16%
12.86%
12.86%
9.61%
9.61%
15.31%
15.31%
8.61%
Fees Term
0%
20
8%
20
0%
20
8%
20
0%
20
9%
20
0%
20
7%
20
0%
20
0%
20
6.50%
20
10.50%
20
6.50%
20
10.50%
20
2%
20
6.50%
20
8.00%
20
0%
20
8%
20
0%
20
8%
20
0%
20
9%
20
0%
20
9%
20
2%
20
9%
20
2%
20
9%
20
6.50%
20
Comparison Shopping




Determine amount to borrow
Identify loan choices
Interest rate index
Up front costs
♦
Points, fees, etc.
 Term
 Total cost of loan
♦
Principal, interest, fees
Comparison Chart
Index Name
Index Rate
Margin
Current Rate
Floor
Cap
Adjustment Period
Rate Information
91 Day Tbill
Prime
1.76%
4.75%
3.25%
1.00%
5.01%
5.75%
3.00%
None
None
25.00%
Quarterly
Annually
3 mo LIBOR
1.88%
3.20%
5.08%
1.00%
18.00%
6 months
Fees
Origination Fee %
Loan Amount
Origination Fee
Guarantee Fee %
Guarantee Fee
Other Fees
Total Fees
Term
Payment Range
4.00%
$15,000
$600
1.00%
$150
$75
$825
20 years
$99 to ???
None
$15,000
$0.00
5.50%
$75
$0.00
$75
20 years
$105 to $315
8.00%
$15,000
$1,200
$1,200
20 years
$100 to $232
Considerations
 Variable Rate
♦
♦
♦
♦
♦
♦
♦
Index (base)
Starting rate
Margin
Floor
Cap
Adjustment frequency
Payment range
Private Loan Choices
Lender Cosigner
Index
Margin Adjustment Cap Current Rate Term Fees
Loan # 1
Yes
LIBOR
+ 3.85%
Quarterly
Loan # 2
Yes
LIBOR
+ 3.85%
Quarterly
Alternative Loan Cost Comparison
Lender
#2
Loan
#3
Yes #1 3 mo LIBOR
+ 3.2%#3
Quarterly
Rate Information
Loan
4
Yes91 Day Tbill
3 mo LIBOR
+ 3.2%
Index#Name
Prime
3 mo LIBOR Quarterly
Index Rate
1.76%
4.75%
1.88%
Loan
#5
Optional3.25%
91 Day T-Bill
+ 3.15%
Annually
Margin
1.00%
3.20%
Current
5.08%
Loan
# 6Rate Optional5.01% Prime5.75% + 0.0%
6 Months
Floor
3.00%
None
1.00%
Loan
#7
Yes None LIBOR
+ 2.90%
Quarterly
Cap
25.00%
18.00%
Adjustment
Annually + 2.90%
6 months Quarterly
Loan
# 8 Period
Yes Quarterly LIBOR
Fees
Loan
# 9 Fee Yes 4.00%
52 Week T-Bill
+ 3.10%
Annually
Origination
None
8.00%
Loan Amount
$15,000
$15,000
Loan
A
Yes $15,000 LIBOR
+ 5.25%
Quarterly
$ Origination Fee
$600
$0.00
$1,200
Loan
B Fee Yes 1.00% Prime5.50% + 2.00% - Monthly
Guarantee
$ Guarantee Fee
$75
Loan
C
Yes $150
Prime$0.00
+ 1.00% -- Monthly
Other Fees
$75
Total
$1,200
Loan
DFees Yes $825 Prime$75 + 1.00%
Monthly
Loan E
Yes
Prime
+ 0.5%
Quarterly
Loan F
Yes
91 Day T-Bill + 3.25%
Quarterly
Loan G
Optional
Prime
+ 0.50%
Monthly
Loan H
Yes
91 Day T-Bill + 3.50%
6 Months
Loan I
Yes
91 Day T-Bill + 3.50%
6 Months
None
None
None
None
None
18%
None
None
None
None
None
None
None
25%
None
None
None
None
5.75%
5.75%
5.10%
5.10%
4.88%
4.75%
4.65%
4.65%
4.60%
7.15%
6.75%
5.75%
5.75%
5.25%
4.98%
4.83%
4.23%
4.23%
20
20
20
20
20
20
20
20
20
15
15
15
15
15
15
15
15
15
4.0%
2.0%
12.9%
7.5%
4.0%
7.5%
9.0%
4.0%
5.0%
5.0%
None
9.0%
None
None
4.0%
3.0%
8.0%
4.0%
What is a Good Deal?
 Affordable payment
♦
Fits in your budget
 Competitive rate
 Reasonable fees
 Feeling like you got a fair deal
Finding the Best Deal
 General loan criteria
♦
Homes, cars, credit cards, etc.
♦
Most creditworthy = lower loan rate
♦
Least creditworthy = higher loan rate
♦
Private student loans
Private Loan Choices
Lender
#1
#1
#2
#2
#3
#3
#4
#4
#4
#4
#5
#5
#5
#5
#5
#5
#6
#6
#6
#6
#7
#7
#7
#7
#8
#9
#9
# 10
# 10
Index
LIBOR
LIBOR
PRIME
PRIME
PRIME
PRIME
LIBOR
LIBOR
LIBOR
LIBOR
LIBOR
LIBOR
LIBOR
LIBOR
PRIME
PRIME
PRIME
PRIME
PRIME
PRIME
LIBOR
LIBOR
LIBOR
LIBOR
LIBOR
PRIME
PRIME
PRIME
PRIME
Margin
5.00%
5.00%
0.50%
4.75%
1.00%
1.00%
4.50%
4.50%
5.50%
5.50%
1.60%
1.60%
2.80%
2.80%
0.00%
0.00%
0.00%
0.00%
5.00%
5.00%
2.25%
2.25%
8.00%
8.00%
4.00%
6.50%
6.50%
4.50%
7.75%
Cap
None
None
None
None
None
None
None
None
None
None
12.00%
12.00%
12.00%
12.00%
12.00%
12.00%
None
None
None
None
None
None
None
None
18.00%
None
None
None
None
Current
Rate
10.36%
10.36%
8.75%
13.00%
9.25%
9.25%
9.86%
9.86%
10.86%
10.86%
6.96%
6.96%
8.16%
8.16%
8.25%
8.25%
8.25%
8.25%
13.25%
13.25%
7.61%
7.61%
13.36%
13.36%
9.36%
14.75%
14.75%
12.75%
16.00%
Fees
4.00%
6.25%
0%
0%
0%
3%
2%
9.90%
2%
9.90%
3.75%
7.00%
3.75%
7.00%
3.75%
7.00%
0%
9%
0%
9%
0%
8%
0%
8%
0%
0%
3%
0%
0%
Term
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
15
Index
Margin
Lender
A
LIBOR
1.00%
A
LIBOR
1.00%
A
LIBOR
2.75%
A
LIBOR
2.75%
B
PRIME
-0.50%
B
PRIME
-0.50%
C
LIBOR
3.75%
C
LIBOR
3.75%
D
PRIME
0.00%
D
PRIME
4.50%
E
LIBOR
0.00%
E
LIBOR
0.00%
E
LIBOR
3.50%
E
LIBOR
3.50%
F
LIBOR
3.85%
G
3 Mo T-Bill 3.40%
G
3 Mo T-Bill 3.40%
H
PRIME
1.25%
H
PRIME
1.25%
H
PRIME
2.25%
H
PRIME
2.25%
I
LIBOR
1.80%
I
LIBOR
1.80%
J
LIBOR
7.50%
J
LIBOR
7.50%
K
LIBOR
4.25%
K
LIBOR
4.25%
K
LIBOR
9.95%
K
LIBOR
9.95%
L
LIBOR
3.25%
Cap
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
None
Current
Rate
6.36%
6.36%
8.11%
8.11%
7.75%
7.75%
9.11%
9.11%
8.25%
12.75%
5.36%
5.36%
8.86%
8.86%
9.21%
8.01%
8.01%
9.50%
9.50%
10.50%
10.50%
7.16%
7.16%
12.86%
12.86%
9.61%
9.61%
15.31%
15.31%
8.61%
Fees Term
0%
20
8%
20
0%
20
8%
20
0%
20
9%
20
0%
20
7%
20
0%
20
0%
20
6.50%
20
10.50%
20
6.50%
20
10.50%
20
2%
20
6.50%
20
8.00%
20
0%
20
8%
20
0%
20
8%
20
0%
20
9%
20
0%
20
9%
20
2%
20
9%
20
2%
20
9%
20
6.50%
20
How to Find the Best Deal
 Separate private loans by term
 Sort by rate
 Divide into three sections
♦
Best credit
♦ Average credit
♦ Poor credit
Private Loan Choices
Guiding Students
Before
 Term
 Credit rating
 Index
 Fees
 Apply
 Confusion
Now
 Term
 Credit rating
 Apply
Guiding Students




1% rate discount vs. 1% fee discount
Rates typically mirror each other
Prepare for payment to change
Pay off higher interest rate debt
♦
Credit cards
♦
Private loans (if rate goes up)
♦
Deferment/forbearance options
Conclusion
1.
2.
3.
4.
5.
Variable rate language
Types of indexes
Language for all types of loans
What is a good deal?
Guiding students
Thank you for attending
Mike Stein
301-231-7557
mstein@edfund.org