1. Understanding Private Loans Default Prevention

2. 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

3. What’s In It For You?  Improve discussion with borrowers  Better understanding of loans and terms  Less stress

4. Loan Language APR Guarantee Fees Origination Capitalization Margin LIBORCap Adjustment Period T-Bill Points Prime Negative AmortizationVariable

5. 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?

6. Loan Language Essentials

7. 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

8. 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

9. Interest Rates and Debt  Secured ♦ Car ♦ Home  Unsecured ♦ Credit card ♦ Personal loan ♦ Education loan

10. What’s in an Interest Rate Cost of funds + Operations + Inflation + Risk + Profit Borrower rate Index Margin

11. Dissecting an Interest Rate Credit Card Cost of Funds 1 2.38% Inflation Rate 2 2.50% Operations 3 0.50% Loan Losses 4 4.85% Total Lender Cost10.23% Profit2.94% Loan Rate 5 13.17% 1,4,5 Bank sample June 2006 2 Federal Reserve 3 Federal Reserve Bank Functional Cost and Profit Analysis.

12. APR  Annual Percentage Rate (APR) ♦ Annual basis ♦ Up-front charges Guarantee fees Origination fees ♦ Compounding frequency  Can make shopping easier ♦ Price tag

13. Variable Rate Language Floor CapLIBOR Margin Adjustment Period Index T-Bill Prime

14. Index Types  Index and borrower rate  T-Bill  LIBOR  Prime rate

15. Index  Index ♦ Wholesale price Rate = price lender pays for money Name = where lender obtains money  Borrower rate ♦ Retail price Price borrower pays for money

16. 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

17. 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

18. Prime Rate  Retail ♦ Credit-worthy customers Secured  Private loans ♦ Wholesale price ♦ Mark-up/margin added Borrowers lack credit history Unsecured

19. Margin  Allowance to cover expenses ♦ Rate the borrower pays 10% ♦ Index (cost of funds) -4% ♦ Margin (covers expenses) 6%

20. Index + Margin Loan TypeIndexMargin Borrower Rate LIBOR Index5.36%7.89%13.25% Prime Index8.25%5.00%13.25% T-Bill Index4.61%8.64%13.25% What the Lender pays Lender Revenue What the customer pays +=

21. Floor and Cap  Floor ♦ Lowest rate ♦ Rarely used  Cap ♦ Highest rate ♦ Limits consumer risk ♦ Also called ceiling

22. Cap Example  Prime + 3% with a cap of 12% ♦ If prime rate is 14% + 3% margin ♦ Rate is ____%

23. Adjustment Period  How often rate changes ♦ Annually, quarterly, monthly  Purpose ♦ Easier budgeting ♦ Keeps lender’s margin/markup level

24. 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

25. Variable Rate Payment Risk Loan Amount$20,000 Loan Rate5.00% Cap25.00% Payment Range$212 - $455 Possible Increase115% Based on a 10-year loan term.

26. Language For All Loans Capitalization Negative Amortization Amortize Points Origination Fees Capitalize

27. 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

28. 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

29. Amortization  Amortize = Pay off  Reduction of debt ♦ Regular payments of Interest (cost of the loan) Principal (actual amount borrowed)  Result = Loan balance decreases

30. 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.

31. Capitalization  Adding interest to loan balance  Capital = Money borrowed  Interest is paid on capital  “Capitalized” = when interest becomes part of the capital

32. 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.

33. The Right Choice  LIBOR  Prime rate  T-Bill ?

34. Indexes Mirror Each Other Source: St. Louis Federal Reserve Bank and Federal National Mortgage Association

35. Rates Mirror Each Other  Margin compensates for index variety Any index + Margin = Similar loan rates

36. Private Loan Choices

37. 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

38. Comparison Chart

39. Considerations  Variable Rate ♦ Index (base) ♦ Starting rate ♦ Margin ♦ Floor ♦ Cap ♦ Adjustment frequency ♦ Payment range

40. Private Loan Choices ?

41. What is a Good Deal?  Affordable payment ♦ Fits in your budget  Competitive rate  Reasonable fees  Feeling like you got a fair deal

42. 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

43. Private Loan Choices

44. How to Find the Best Deal  Separate private loans by term  Sort by rate  Divide into three sections ♦ Best credit ♦ Average credit ♦ Poor credit

45. Private Loan Choices

47. Guiding Students Before  Term  Credit rating  Index  Fees  Apply  Confusion Now  Term  Credit rating  Apply

48. 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

49. Conclusion 1. Variable rate language 2. Types of indexes 3. Language for all types of loans 4. What is a good deal? 5. Guiding students

50. Thank you for attending Mike Stein 301-231-7557 mstein@edfund.org