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04/23/2009

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Tim,

What do you think about total cost as a better comparison tool than APR? Keith on our team did a post on this topic a couple of days back: http://home.overturecorp.com/public/item/230100

Brilliant series on private loan shopping BTW.

- David

David,

Nice to hear from you and thanks for sending me along that post about total cost as an alternative to A.P.R. I enjoy reading about it. My initial reaction is that before a borrower considers either A.P.R. or total cost, they have to make a fundamental judgment about what their ability to repay the loan will be. A loan that requires interest-only payments while in-school (e.g. Sallie Mae Smart Option) may look great from a total cost perspective but may not work given a student's cash flow position.

The danger of focusing strictly on total cost can be found in this repayment example found on the Sallie Mae Smart Option site: http://www.salliemae.com/get_student_loan/apply_student_loan/interest_rates_fees/student_loan_interest_rates_fees.htm#Smart. If you look at A.P.R. example #1 and focused strictly on Total Cost, Smart Option comes out ahead by over $6,000. But this analysis is effectively comparing apples and oranges.

All private lenders offer an interest-only repayment option, and even if they didn't, borrowers could replicate that repayment stream since there are no prepayment penalties. Second, Sallie Mae touts that a shorter payment period reduces costs "Borrower will pay off their loan 9 years earlier." Again, a borrower with another lender can replicate the repayment stream of the Sallie Mae product. Interesting how a product's main weaknesses, its lack of flexibility in repayment options and loan terms is sold as a strength.

Once a student has selected a repayment option, among their three choices, I believe that A.P.R. works for comparison purposes. Frankly, I also worry that students will jump at the chance to get "the low cost" loan option if that is the focus and not fully take into account the implications of making interest payments while in school. I guess the good news is that the Federal Reserve will be providing both A.P.R. and total cost calculations, according to their Regulation Z proposal.

Hi Tim,

Thanks for sharing all your student loan analytics. First Marblehead owns Union Federal Savings Bank which offers student loans with some rates as low as 5% if you qualify:

http://www.monticellostudentloan.com/student_loan/rates_repayments.aspx

Regards,
George

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