In an earlier post this week, I indicated the high level results of my recent on-line private loan shopping trip with starting interest rates ranging from 7.0% to 12.125% (remember that private loans are variable rate and change monthly or quarterly based on an underlying index). Remember that private loans should only be taken out as a last resort and borrowers should exhaust all federal grants (e.g., Pell), federal loans (e.g., Stafford, PLUS or Grad PLUS), work-study and scholarship aid before considering private loans.
A quick recap on the process: Last week, I completed 6 private loan applications as a co-signer for a $5,000 private education loan for my nephew, who is currently attending a 4-year private non-profit institution. For those concerned that so many applications might harm your credit score, read this latest announcement from Fair Isaac. This study is not intended to have statistical validity but rather is intended to show one person's journey through the private student loan process. Given the lack of transparency in rates offered by private lenders, I thought this would at least provide a limited window into the variability in the rates that are out there. Remember that lender's make credit decisions based on the creditworthiness of the individual student and the co-signer as well as the institution the student is attending and other factors ("the secret sauce).
For those wondering, my FICO score is considered Average by the credit agencies. That 8 year old bill from the San Carlos city government for a false alarm on our security system on a windy night seems to have taken its toll. I also must admit that I am a bit debt-averse having gotten that trait from my Dad, who was born across the pond just as the 1929 Crash hit Wall Street.
So, drumroll please...., how did the rates and fees that lenders offered to me in their conditional approval letters stack up:
Starting |
Advertised | ||
Lender | Interest Rate | Fees | Interest Rate Range |
Discover | 7.00% | 0% | 2.75% to 8.00% |
SunTrust | 9.13% | 3% | 3.63% to 12.13% |
Citibank | 10.25% | 5% | 4.25% to 10.75% |
Chase | 11.57% | 0% | 6.07% to 13.57% |
Wells Fargo | 11.74% | 0% | 5.75% to 12.74% |
Sallie Mae | 12.13% | 3% | 4.63% to 13.13% |
-------------------------
Observations:
- With an average FICO score, most lenders provided me with a starting interest rate 0.5%-2.0% below their highest advertised rates (which were current as of today). The exception was SunTrust whose interest rate was 3% below their highest rate, however they did assess a 3% origination fee.
- The newest private student lender on the list, Discover, whose student loan operations started up in 2007, are the most aggressive in their pricing. Please note that lender approval rates are not publicly available, which makes it difficult to know the ease or difficulty of qualifying for this or any loan.
- The higher interest rate loans are particularly worrisome when you consider that all of these loans are VARIABLE-RATE loans. With interest rates at historically low levels, interest rates can be expected to average at least 2-3% higher than their Starting Interest Rate over the life of the loan.
- With little visibility into the loan approval rates for specific lenders as well as their underwriting standards, these rates are not intended to be representative of what a borrower with an Average credit score could be expected to receive.
- Sallie Mae indicated in their conference call today that average FICO score for private loans made in the 1Q of 2009 was 734.
- With the peak lending season (June/July) still several months off, these interest rates are certainly subject to change.
- A.P.R, a truer measure of the loan cost since it incorporates both interest rates and fees, is typically provided to the borrower in the Disclosure Statement provided just prior to the loan being consummated.
- This lender comparison does not include credit unions, which have become a more active provider of private loans at very competitive rates. I will be providing a separate post about this phenomenon.
- I find it somewhat ironic that the largest private loan provider with 40%+ market share, Sallie Mae, provided me with the highest starting interest rate and the most restrictive repayment policies, since their new Smart Option Loan requires interest-only payments during the in-school period.
- Sallie Mae noted the following in their Supplemental Information to their 1Q 2009 earnings announcement: "Typically a Private Education Loan is made in conjunction with a FFELP Stafford loan and as a result is marketed through the same marketing channels as FFELP loans."
- Hopefully, students are doing their homework and looking at each loan (FFELP and Private) separately when doing their research rather than just assuming that their FFELP lender has a good private loan also.
- Sallie Mae noted the following in their Supplemental Information to their 1Q 2009 earnings announcement: "Typically a Private Education Loan is made in conjunction with a FFELP Stafford loan and as a result is marketed through the same marketing channels as FFELP loans."
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
Posted by: David Kirby | April 23, 2009 at 07:08 PM
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.
Posted by: Tim Ranzeta | April 23, 2009 at 07:49 PM
Why Sallie Mae's interest is 12.13%? I'm sure people won't go after it at all.
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