A Random Walk through Financial Peace
Introduction
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Read: Ramsey Chapter 1 (Chapter 2 Optional)
If you don’t have Microsoft Office, download OpenOffice for free:
https://www.openoffice.org/download/
Course Outline
Introduction .................................................................................................................................................. 1
Monthly Budgeting ....................................................................................................................................... 2
Credit Cards and Paying Off Debt ................................................................................................................. 3
The Value of a Long-Term Strategy............................................................................................................... 5
Investing and Asset Classes........................................................................................................................... 7
Short and Mid Term Savings ......................................................................................................................... 9
Long Term Savings ...................................................................................................................................... 10
Taxes ........................................................................................................................................................... 14
Appendix (Identity Theft/Protection, Buying House, Buying Car, Student Loans) ..................................... 15
Glossary ....................................................................................................................................................... 16
Ramsey’s Baby Steps
For the Young Adult age group, we will focus primarily on the first 4 steps – but some of our discussions
may lead into steps 5-7.
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Step 1: Put $1,000 in a beginner emergency fund ($500 if your income is under $20K/yr)
o Begin financial planning and build protection against unexpected expenses
Step 2: Pay off all debt using debt snowball. (Consider excluding mortgage and student loans)
o Eliminate the huge anchor to building wealth and road-bock to financial peace
Step 3: Put 3-6 months of expenses into a savings as a full emergency fund
o Protection against temporary loss of income
Step 4: Invest 15% of your household income into Roth IRAs and pretax retirement plans
o Build long-term wealth for income independence
Step 5: Begin college funding for your kids
Step 6: Pay off your home early
Step 7: Build wealth and give
Monthly Budgeting
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Read: Ramsey Chapter 3 - Ramsey Steps: 1-3
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Dave Ramsey’s online budget tool: https://www.daveramsey.com/everydollar
Web/Smartphone budget: https://www.mint.com/
List of 70+ Budget Categories: http://christianpf.com/basic-personal-budget-categories/
Budget Overview: http://www.thesimpledollar.com/preparing-a-budget-ten-tips-for-making-that-budget-successful/
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Why have a budget
 The budget will give you a spending-and-saving roadmap – as well as a monthly measuring stick.
 If you are working on Step 1 (building a $1,000 emergency fund), knowing where to cut current
spending will be a key to success. An accurate/realistic budget will help reveal areas of spending
that have the greatest impact.
 A budget can have positive effects beyond financial benefits by ensuring money is able to be
used for fitness, charity, gifts, and other things we often want to use our money for but may not
feel we are able to afford.
 For those in a relationship, a shared budget (with input and acceptance from both partners) can
reduce conflicts around money.
Start Your Budget by Looking Back
The best way to predict what you will spend in the future is to see what you have spent in the past.
Gather your bank, credit card, and debit card statements over the last three months and classify each
line-item into a category of your choosing.
The list of budget items (link above) is helpful resource for thinking of categories to add to your budget especially for things you have not purchased in the last few months which would not be on your current
spending statements.
Walk Through Budget Spreadsheet
Review the Monthly Budget Spreadsheet and sample credit/bank statement as an example method to
set up a budget – Use the results to find areas where the person can most effectively cut costs to have
the biggest impact on their monthly savings.
Credit Cards and Paying Off Debt
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Read: Ramsey Chapter 4 (Optional Chapter 5) - Ramsey Step: 2
APR Video: https://www.khanacademy.org/economics-finance-domain/core-finance/interesttutorial/credit-card-interest/v/annual-percentage-rate-apr-and-effective-apr
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http://www.investopedia.com/articles/pf/08/pay-in-cash.asp
Optional Intro to Interest Videos: https://www.khanacademy.org/economics-finance-domain/corefinance/interest-tutorial/interest-basics-tutorial
Finding a card (pretty good, but not comprehensive): http://www.nerdwallet.com/
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Interest Working Against You
//Review the Credit Card Calculator Spreadsheet
According to Experian, 53.8% of used cars and 85.0% of new cars are bought by financing.
What to pay off each month:
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The Minimum Balance is the amount you need to pay to avoid a late payment, but paying only
this amount will result in interest being charged.
The Current Balance is the amount of all the charges that have posted to your account since the
beginning of the billing period and when you pay your bill. Some of the charges included in the
Current Balance may be for purchases made after the previous billing cycle ended.
Cash vs Cards
Studies that show people spend ~20% more when using credit card vs. cash.
Dave Ramsey is big on cash and no cards. However, there are some practical advantages beyond reward
points and FICO scores to credit/debit cards that he neglects that are worth noting.
Security: if cash is lost or stolen – it is gone. Also, you get a level of protection on purchases made with
a credit card. If a product/service is faulty and the dealer refuses to give you a refund, you can file a
fraud claim with your card company (use this VERY sparingly – I have not done this in 15 years).
Visibility: Using only cash makes it difficult to look back and see where your money is going. Cards give
you detailed monthly records that you can easily download and compare to your monthly budget to
track your spending. If you do not have a budget, these statements are the best place to start one!
Also, if you lose a receipt for a major purchase, your credit/debit card statement can give you a leg to
stand on if you need to return an item for warranty (or answer questions like: When was my car
repaired?)
Credit Cards vs Debit Cards
Compromised card: If (when) your number is compromised, you are not liable for any charges made on
a credit card or a debit card. However a compromised debit card removes money directly from your
bank account and is a much bigger hassle to get corrected. In this case, you may not have access to the
stolen money during the time it takes for your bank to investigate and reimburse you for the stolen
funds. When your credit card is used by a thief, typically your credit card company will catch it before
you do and put a hold on the card. Over the phone, you can point out the fraudulent charges to be
reversed and they will issue a new card in about a week. You don’t have a credit card for a week, but
the money in your bank account was never missing.
If you set the limit of your card at or near your monthly budget, it will just cut you off rather than
charging you overdraft fees for going over. Typical bank overdraft charges are $25-$35 per “swipe.”
Historically, banks will order “swipes” in a given day to maximize overdraft charges. (Let’s say you have
$10 in the bank and make charges for: $1, $2, $3, $4 and $10 in a day. The bank will process the $10
dollar charge 1st to clean out the account and then process the next four charges to rack up $100 in
fees.)
Credit cards will typically pay some kind of reward points to entice you to use them. Debit cards will
offer reward points but debit card pay-backs are often much lower.
Credit cards (when and only when used correctly) build up your credit score. But you should not focus
on this by getting more cards than you really need (2) with much higher limits than your monthly
budgets. Debit cards are neutral to your credit score.
Credit Scores
https://www.annualcreditreport.com/index.action - Only Gov’t source to access your free required
reports. Each reporting company owes you a report every 12 months. Check in Jan/June/Just-in-Case.
FICO Score weighting:
 35%: Debt History
 30%: Debt Levels
 15%: Duration of the Debt
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10%: Type of Debt
10%: New Debt
As of Jan 2015, in the US:
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Auto Loans: $0.84 Trillion
Credit Cards: $0.88 Trillion (About 1.1 Billion cards for 150 million card holders)
Student Loans: $1.2 Trillion
The Value of a Long-Term Strategy
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Ramsey Steps: 3-4
Optional Intro to Compound Interest Video: https://www.khanacademy.org/economics-financedomain/core-finance/interest-tutorial/compound-interest-tutorial/v/introduction-to-compound-interest
Interest Working for You
Spreadsheet Calculation Walkthrough
http://www.bankrate.com/calculators/savings/compound-savings-calculator-tool.aspx
Reduce Risk by Holding Assets for Longer Periods of Time
Range of Annual Return Rates on Common Stocks for Various Time Periods 1950-2015:
Dollar-Cost Averaging: “Buy Low and Sell High”
Don’t be alarmed by the complicated-sounding name. Dollar-cost averaging simply means investing the
same fixed amount of money into an investment at regular intervals, over a long period of time.
Periodic investments of equal dollar amounts in stocks can reduce (but not avoid) the risks of equity
investment by ensuring that the entire portfolio of stocks will not be purchased at temporarily inflated
prices. The investor who makes equal dollar investments will buy fewer shares when prices are high and
more shares when prices are low. No matter how pessimistic you are, and no matter how bad the
financial and world news is, you must not interrupt the automatic pilot nature of the plan or you will
lose the important benefit of ensuring that you will buy at least some of your shares after a sharp
market decline.
For most people, the real issue is whether they will be willing to continue the program of common-stock
investing during periods of market decline, when pessimism appears to be ubiquitous. There would
certainly be no benefit to the program if investors failed to stick with it during market decline. It is
usually a good time to buy after the market has fallen out of bed and no one can think of any reason
why it should rise. Just as hope and greed can sometimes feed on themselves to produce speculative
bubbles, so do pessimism and despair react to produce market panics. The greatest market panics are
just as unfounded as the most pathological speculative explosions. No matter how bleak the outlook
was in the past, things usually got better. For the stock market as a whole, Newton’s law has always
worked in reverse: What goes down must come back up. But this does not necessarily hold for
individual stocks, just the overall market in general.
Investing and Asset Classes
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Ramsey Steps: 3-4
Watch Mutual Fund and ETF Overview Videos: https://www.khanacademy.org/economics-financedomain/core-finance/investment-vehicles-tutorial/mutual-funds/v/open-ended-mutual-fund-part-1
Asset Return vs. Length of Time
Type of Asset
Expected
Return before
Taxes
Length of Time Investment Must Be
Held to Get Expected Rate of
Return
No specific investment period
required. Many thrift institutions
calculate interest from day of deposit
to day of withdrawal.
No risk of losing what you put in. Deposits
up to $100,000 guaranteed by an agency
of the federal government. An almost sure
loser with high inflation however.
No risk of losing what you put in. Deposits
guaranteed as above. Rates geared to
expected inflation and will vary over time.
Bank Accounts
0 - 3%
Money-market
deposit
accounts
0.5 - 4%
No specific investment period
required, but check withdrawals
limited to three per month.
0.5 - 5%
No specific investment period
required. Most funds provide check
writing privileges.
3.5 - 5%
Money must be left on deposit for the
entire six months to take advantage of
higher rate.
Money-market
funds
Special sixmonth
certificates
Treasury
inflation
protection
securities (TIPS)
High-quality
corporate bonds
(prime-quality
public utilities)
Diversified
portfolios of
blue-chip US or
developed
foreign country
common stocks
Real Estate
Diversified
portfolios of
relatively risky
stocks of smaller
growth companies
2.5% + inflation
rate
6%
7 - 8%
Similar to
common stocks
8 - 9%
Diversified
portfolios of
emerging
market stocks
8 - 11%
Commodities
Impossible to
predict
Risk Level
These are long-term securities
maturing in five years or longer.
Very little risk because most funds are
invested in government securities and
bank certificates. Not usually guaranteed.
Rates vary with expected inflation.
Early withdrawals subject to penalty.
Rates geared to expected inflation and will
vary.
Prices can vary if sold before maturity.
Investments must be held until
maturity (20-30 years) to be assured
of the stated rate. (The bonds also
need to be protected against
redemption.) The bonds may be sold
at any time, but market prices vary
with interest rates.
No specific investment period
required and stocks may be sold at
any time. The average expected
return assumes a fairly long
investment period and can only be
treated as a rough guide based on
current conditions.
Some as for common stocks in
general if purchase is made through
REITs.
Same as above. The average
expected return assumes a fairly long
investment period and can only be
treated as a rough guide based on
current conditions.
Very little risk if held to maturity. Moderate
to substantial fluctuations can be expected
in realized return if bonds are sold before
maturity. Rate geared to expected longrun inflation rate. "Junk bonds" promise
much higher returns but with much higher
risk.
Plan to hold for at least 10 years.
Projected returns impossible to
quantify precisely.
Fluctuations up or down of 50% to 75% in
a single year are not uncommon but have
diversification benefits.
High returns could be earned in any
new speculative craze as long as
there are greater fools to be found.
Substantial risk. Gold is believed to be a
hedge against doomsday and
hyperinflation. Commodities play a useful
Moderate to substantial risk. In any one
year, the actual return could in fact be
negative. Diversified portfolios have at
times lost 25% or more of their actual
value. Contrary to some opinions, a good
inflation hedge over the long-run.
Same as above but REITs are good
diversifiers and can be a good inflation
hedge.
Substantial risk. In any one year the
actual return could be negative.
Diversified portfolios of very risky stocks
have at times lost 50% or more of their
value. Good inflation hedge.
role in balancing a diversified portfolio,
however.
Single Stock
Currency
Exchange
Impossible to
predict
There are no long-term trends
associated with currency exchanges.
Currency exchange trading is pure
speculation.
Reduce Risk by Diversification (Mutual Funds and ETFs)
ETFs are bought and sold just as any individual stock. They can be purchased in the morning and sold in
the afternoon. Each buy and sell of an ETF will require a transaction cost. Mutual funds on the other
hand are bought at the closing price of the purchase day and cannot be sold until the close of the
following day. Low-cost, no-load funds do not charge the investor for purchasing more shares or
rebalancing. For many small periodic investments (dollar-cost-averaging), index mutual funds are
greatly preferred to ETFs. The simple reason is that it costs nothing for 12 incremental investments
throughout the year with a mutual fund, but it would cost in the neighborhood of $12 per investment
with an ETF – an additional investment expense of $144 per year.
Short and Mid Term Savings
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Ramsey Step: 3
Optional Banking Overview Video: https://www.khanacademy.org/economics-finance-domain/corefinance/money-and-banking/banking-and-money/v/banking-1
Choosing a Fair and Functional Credit Union (or Bank)
Setting up a Money Market Account
Opening an Investment Account
Long Term Savings
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Ramsey Step: 4
Lifecycle Guide to Investing
Asset Class: Cash  Vanguard Prime Money Market Fund: VMMXX
Money-market accounts are offered by most banks. They currently have returns around 1%. Shop
around and look for the best rates or see your current bank out of convenience. Money-market
accounts typically require minimum deposits of about $2,500. The cash portion of a portfolio could
also be held in bank CDs or US treasury bills. Money-market accounts provide lower returns but
offer the benefit of liquidity. Banks offer lower returns with the added security of FDIC protection.
Asset Class: US Stocks - This should consist of US stock index fund(s).
 S&P 500 Index Fund: VFINX, IVV, SPY
 Wilshire 500 Index Fund: VTSMX, VTI, TMW
The Wilshire 5000 is preferred to the S&P 500 because it contains thousands of smaller firms that
are not in the S&P 500. Many of the greatest stock success stories of the past century came from
stocks that were not in the S&P but grew to become leading corporations. The Wilshire 5000 will
include the growth from these stocks. Historically, the Total Stock Market fund has had better
returns than the simple S&P 500 fund. However, many 401(k) plans only offer an S&P 500 index but
not a Wilshire 5000 index fund. In these cases, the S&P 500 index is preferred over other actively
managed large-cap funds because of the lower expense ratios.
Asset Class: Bonds - This should consist of a bond index fund.
 Total Bond Market Index Fund (US): VITBX, AGG
 Vanguard Long-Term Bond Index Fund (US): VBLTX, BLV
 Vanguard Treasury Inflation Protection Securities (US TIPS) Fund: VIPSX, TIP, IPE
 International Bond Market Funds: BNDX, VTIBX– These funds are made up of international,
intermediate bonds. There is some additional currency fluctuation risk with this class; these
Vanguard funds are “hedged” against currency exchange risk to minimize this movement.
 High Yield Bonds (Junk Bonds): HYG, VWEHX - These are bonds issued by risky corporations.
They tend to fluctuate more than typical bonds but may have a higher return. Consider with
caution or safely avoid altogether.
The bond portion of the portfolio should be made up of a broad bond fund. Long term bonds
typically have better returns and are a little more volatile than the total bond index. Because of this,
young investors may prefer long-term bonds to the broad bond index. On the other-hand, older
investors may prefer the stability of the total bond index. TIPS are treasury bond except that
principal and coupon payments are adjusted to eliminate the effects of inflation.
Asset Class: Foreign Stocks - This should consist of an international index fund.
 Total International Stock Index Fund: VGTSX, EFA
 Developed International Markets: BTAEX
 European Stock Index Fund: VEURX, IEV, VGK
 Pacific Stock Index Fund: VPACX, VPL
Broad indexes are preferred over more costly actively managed funds or individual stocks. This
portion of the portfolio should consist of developed markets such as the large countries in Europe
(United Kingdom, Germany, France, etc...) and developed countries in the Pacific area (Japan,
Australia, etc…).
Asset Class: REITs - Real Estate Investment Trust Index fund.
 REIT Index Fund, ETF: VGSIX, RWR, VNQ
 International REIT Index Fund: VGXRX, VNQI
This index fund holds only Real Estate Investment Trusts. In other words, it is like buying in to
companies that buy and sell commercial real estate. It allows you to own land in the same manner
you would own stock.
Asset Class: Aggressive Stocks - Emerging Market and US Small cap index funds.
 Emerging Markets Stock Index Fund, ETF: VEIEX, VWO, EEM
 Small-Cap Index Fund, ETF: NAESX, VB, DSC
The emerging market index and small cap index should play a role in a well-diversified portfolio,
particularly with young investors. The Emerging Market fund contains stocks from countries such as
India, China and Brazil. The Small Cap mutual fund should contain US stocks that are smaller than
those in the Fortune 1000.
It should be noted that small caps are contained in the “Total Stock Market” fund and emerging
markets are held within the “Total International Fund.” Younger investors who want to have an
increased portion of their portfolio to contain these high-risk, high reward funds can purchase these
in addition to the broad index funds that already contain them. Older investors may want to drop
these from the portfolio since they add risk and are already held within VTSMX and VGTSX.
Asset Class: Commodities – energy, precious metals, industrial metals, agriculture, livestock
Commodity Index ETFs: DBC, GSG, GSP, DJP
Energy, Metals, Agriculture ETF: DBE, USO, OIL, DBB, DBP, IAU, DBA
Commodities and raw materials are the elements used to build an economy. Stocks tend to fall as
these base elements rise and vice-versa. Because of this, there may be some diversification value
for holding a small portion in a well-balanced portfolio. The charts below do not include the
commodity asset class but could be included as a sub-section of the Aggressive Stock class –
preferably less than half of the class. Investors with a low tolerance for risk should avoid this class –
and it would be wise for all investors to keep the allocation of commodities below 2.5%.
REITs
10%
Bonds
10% Cash
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Age: Mid-Twenties
Lifestyle: Fast, aggressive. With a steady
stream of earnings, capacity for risk is fairly
high. Need to discipline of payroll savings to
build a nest-egg.
Aggressive Stocks
15%
US Stocks
40%
International
Stocks
25%
Cash
-
Bonds
15%
US Stocks
40%
REITs
10%
Aggressive
Stocks
10%
International
Stocks
25%
Cash
5%
US Stocks
30%
Bonds
25%
REITs
10%
Aggressive
Stocks
8%
International
Stocks
22%
Additional Considerations:
 Increase percentage of REITs and/or
aggressive stocks
 Small amount of commodity -class
assets within the Aggressive Stock
mix
 Long Term Bond Index or TIPS Index
may be preferred to Total Bond Index
Age: Late Thirties to Early Forties
Lifestyle: Midlife crisis. For childless career
couples, capacity for risk is still quite high.
Risk options are vanishing for those with
college tuitions looming.
Additional Considerations:
 Increase percentage of REITs
 Long Term Bond Index or TIPS Index
may be preferred to Total Bond Index
 Increase bonds up to 20%-25%
 Minimal amount of commodity -class
assets within the Aggressive Stock
mix
Age: Mid-Fifties
Lifestyle: Many still reeling from college
tuitions. No matter what the lifestyle, this
age group must start thinking about
retirement and the need for income
protection.
Additional Considerations:
 Increase percentage of REITs
 Increase percentage of cash
 Reduce percentage of aggressive
stocks
 Minimal commodity -class assets
 Total Bond Index with TIPS Index may
be preferred to Long Term Bond
Index
Cash
10%
US Stocks
21%
Bonds
40%
International
Stocks
14%
REITs
10%
Aggressive Stocks
5%
Age: Late Sixties and Beyond
Enjoying leisure activities but also guarding
against major health costs. Little or no
capacity for risk.
Additional Considerations:
 Increase percentage of cash
 Reduce or eliminate percentage of
aggressive stocks
 No commodity -class assets
 Total Bond Index with TIPS may be
preferred to Long Term Bond Index
Automatic for the People
For most investors, a single life-cycle fund made up of diverse index funds would be recommended (if it
is offered in your retirement plan). The expense ratios for life-cycle funds should be around 0.20-0.25%
if comprised of low cost index funds. One of the advantages to life-cycle funds is the low cost of entry.
The Vanguard life-cycle funds described above require a $3,000 minimum deposit to open. To have a
fully diversified portfolio when purchasing each index fund separately, one would need about $15,000
to open five individual index funds – and this allows for only a 20% allocation for each asset class. This is
quite a hurdle for young investors, particularly to achieve an optimal asset class allocation. The life-cycle
fund on the other hand provides a fully diversified portfolio with an appropriate asset class allocation
and only requires $3,000 to open.
The life-cycle fund also eliminates the temptation for an investor to shift money into an index fund that
has become hot in an attempt to time the market. Life-cycle funds also provide a single mutual fund to
manage which helps in setting up future contributions. Plus, it is simple to track a single stock ticker
when checking the performance of the fund. Finally, because life-cycle funds are rebalanced annually
and the asset class allocation is adjusted with age, they are virtually hands-free – like an automatic
transmission. For those starting out, life-cycle funds made up of individual index funds are perfect!
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Vanguard Target Retirement 2060 Fund (VTTSX)
Vanguard Target Retirement 2055 Fund (VFFVX)
Vanguard Target Retirement 2050 Fund (VFIFX)
Vanguard Target Retirement 2045 Fund (VTIVX)
Vanguard Target Retirement 2040 Fund (VFORX)
Vanguard Target Retirement 2035 Fund (VTTHX)
Vanguard Target Retirement 2030 Fund (VTHRX)
Vanguard Target Retirement 2020 Fund (VTWNX)
Vanguard Target Retirement Income Fund (VTINX)
Taxes
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Watch Traditional IRA, Roth IRA, and 401(k) Videos: https://www.khanacademy.org/economics-financedomain/core-finance/investment-vehicles-tutorial/ira-401ks/v/traditional-irasIf
Article: If a caller says he’s with the IRS, he’s not
Taxes on Income
Taxes on Dividends and Capital Gains
Standard Deduction vs. Itemized
 Mortgage Interest, Student Loan Interest (if qualified), Tithe
Retirement Savings
 Traditional IRA
 Roth IRA
 401(k)
Appendix (Identity Theft/Protection, Buying House, Buying Car, Student
Loans)
Insurance
Efficient Market Theory
Actively Managed Funds vs. Index Funds
Expense Ratios
Data Security
Credit Freeze
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http://www.creditcards.com/credit-card-news/credit-report-freeze-1282.php
http://www.consumerreports.org/cro/news/2014/02/should-you-put-a-security-freeze-on-the-credit-file/index.htm
The most secure way to protect your identity is to issue a credit freeze for your SSN. It costs $10 to
freeze reports from each agency ($30 total) and $10 each ($30 total) to temporarily or permanently
unlock your reports to apply for a new card, auto loan, mortgage, etc… If you are the victim of identity
of theft, you can get this service for free. However, it may not be worth waiting. You have to 1) have
your identity stolen, 2) have an account opened in your name, 3) file a police report, 4) fax/mail police
report to 3 different agencies to set up the freeze… all the while your account it exposed to further
fraudulent activity.
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
https://www.transunion.com/freeze
http://www.equifax.com/help/credit-freeze/en_cp
https://www.experian.com/ncaconline/freeze
State
Security Freeze
Placement
ID Theft
Victim
NonVictim
Protected
Consumer
Texas
Fees (Aug 2015)
Date
Specific
Range
Party Lift
Lift
Permanent
Removal
Replacement
PIN
Free
Free
Free
Free
Free
$10
$10
$12
$10
$10
Free
Not
Available
Not
Available
Free
Not Available
If you or a protected consumer are a victim of identity theft and you submit or have previously
submitted a copy of a valid police report, investigative report, or complaint made under
Section 32.51, Penal Code, no fees will be charged to place a security freeze on your Equifax
credit file, temporarily lift the security freeze for a specific party or specific period of time, to
permanently remove the security freeze from your Equifax credit file, or for a replacement 10digit PIN. A "protected consumer" is an individual who is younger than 16 years of age at the
time a request for the placement of a security freeze is made.
Buying a House
http://www.zillow.com/mortgage-calculator/
Student Loans
For students that qualify, there are a number of benefits to getting a federal student loan. Unlike private
student loans, the interest rate charged by the federal government is fixed, with the rate resetting each
July 1 for the following year. For loans disbursed between July 1, 2014, and June 30, 2015, the
subsidized rate is 4.66% for undergraduate loans and 6.21% for graduate student loans.
In addition to a fixed interest rate, federal loans have repayment plan options. The standard 10-year
repayment period has the highest monthly payment, but accumulates the least interest. Other options
include longer repayment periods (which lower the monthly payment, but cost more in interest) and
income-based repayment terms. Flexible repayment terms are beneficial during times of financial
distress. Federal loans also have more lenient terms than private loans in other respects; for example,
federal loans are not considered to be in default until the borrower misses payments for nine months.
Default conditions for private loans depend on the lender’s contract and can be as strict as only one
missed payment.
Private lending has historically been less attractive to students due to higher interest rates, lower
flexibility in repayment terms, floating interest rates and little consumer protection. Floating interest
rates can increase during the life of the loan depending on the fluctuation of prime rates and LIBOR.
Interest charged by private lenders varies according to the credit profile of borrowers. In addition, many
private lenders, such as Discover and Sallie Mae, may require the student to have a co-signer guarantee
the loan. We also note that higher education loans are typically not dischargeable in bankruptcy,
according to Sallie Mae.
Glossary