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Preferred Lender Lists

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Many colleges publish lists of recommended lenders, called preferred lender lists. Usually there are several lists, with each list focusing on a different category of loans. The preferred lender lists can include lists for undergraduate Stafford loans, parent PLUS loans, graduate Stafford loans, graduate PLUS loans, consolidation loans, and private student loans. Most preferred lender lists include 4 to 10 lenders.

No Uniform Critera

Each college sets its own criteria for which lenders will appear on its preferred lender list. Although the process is in most cases objective and unbiased, it is not necessarily focused solely on cost. Many colleges consider other factors, such as the quality of customer service, the speed of problem resolution, and counseling activities. For example, most students want 24/7 customer service via toll free phone numbers and online interfaces, but don't realize this until later. Likewise, when alumni encounter problems with a lender, they usually turn to the financial aid office at their alma mater for help.

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The college may also consider the availability of tools from the lender to ease their administrative burden, such as an online interface to streamline the certification, processing, disbursement and management of loans borrowed by the school's students. Some colleges may receive payments or other benefits from the lenders, and should disclose this prominently with any publication of the preferred lender list.

To see some of the criteria colleges use to evaluate lenders, see the Guide to Developing a Preferred Lender List published by the National Association of Student Financial Aid Administrators in May 2005.

New York Attorney General

In 2007, New York Attorney General Andrew M. Cuomo said that the cooperative relationship between some lenders and colleges was a bit too cozy, with the lenders paying referral fees or providing other benefits to colleges in the fierce competition to get on a college's preferred lender list. While the colleges argued that they used the money to provide need-based financial aid to students who otherwise would be ineligible for assistance, several colleges and lenders enterred into settlements with the attorney general, partly in order to avoid the prospect of expensive litigation.

The settlements included an agreement by the colleges and lenders to comply with a College Code of Conduct. This code of conduct establishes a standard concerning acceptable and unacceptable behavior. This will likely lead to an improvement in the objectivity of college preferred lender lists.

FinAid has a separate section that discusses the laws and regulations concerning prohibited inducements and preferred lender lists.

Borrowers May Pick Any Lender

Federal law requires colleges to certify federal education loans without regard to the borrower's choice of lender or the guarantee agency used by the lender. So you can choose any lender, including those that are not on the college's list of recommended lenders. Colleges are prohibited from introducing artificial delays into the loan certification process.

If a college or lender provides you with a loan application that has the lender name and code already filled in, you are not required to use that lender. You can substitute the lender of your choice (or better yet, get a blank loan application by calling the lender you wish to use).

Shop Around

So while a college's preferred lender list is a good starting point, prospective borrowers should also look at other lenders, such as lenders that advertise in print, on air, online and by mail. Which lender you choose does make a difference, as lenders offer loan discounts that can save you hundreds or thousands of dollars of interest over the lifetime of the loans.

FinAid has comprehensive lists of education lenders, including lists of education lenders, student loan discounts and private student loans, sorted alphabetically, and a list of the largest FFEL lenders, sorted by loan volume. FinAid also maintains a Lender Code Database of lenders that participate in the Federal Family Education Loan Program (FFELP). There are also other sites that offer much smaller lists of lenders, such as eStudentLoan and SimpleTuition. It is important to recognize that all of these sites have ties to lenders, who may advertise on the sites or pay referral fees.

State guarantee agencies and non-profit lenders sometimes have some of the lowest interest rates on federal and private student loans. These rates may be restricted to students who are state residents or attend a college in the state. Be sure to compare these rates with the rates available from banks and other for-profit lenders.

So do a little research on the lenders, instead of blindly picking the first lender on the preferred lender list. Visit the lender web sites for the latest information on their discounts and services, and put together a chart comparing and contrasting the lenders according to the features that are important to you.

Tips on Choosing a Lender

FinAid has a separate section that focuses on tips for choosing a lender. There is also some discussion of the tradeoffs between federal and private student loans.

Here are a few additional tips:

  • Federal loans are cheaper than private loans. They have lower interest rates and fees. The federal loans also have fixed interest rates and more favorable repayment terms. Exhaust federal education loans, such as the Perkins, Stafford and PLUS loans, before turning to private student loans. The Perkins loan is the least expensive, followed by the subsidized Stafford loan and unsubsidized Stafford loan, and then the PLUS loan. Private student loans are more expensive than federal education loans, but less expensive than credit cards. The unsubsidized Stafford loan and the PLUS loan are not based on financial need.

  • Lenders may offer discounts on the interest rates and fees on federal education loans. Federal law sets the maximum interest rates and fees a lender may charge on the Stafford, PLUS and Consolidation loans. Nothing prevents a lender from charging lower rates and fees. Many lenders offer discounts to attract borrowers.

  • Focus on immediate discounts and discounts you can't lose. Lenders offer many different discounting schemes, and it can be difficult to evaluate which discounts are better. (FinAid provides a Loan Discount Analyzer which can help you identify which loan discounts are best for your situation.) It is best to focus on discounts which you can't lose, such as 0.25% to 0.50% interest rate reductions for having the monthly payments automatically debited from your bank account, unconditional interest rate and principal reductions, and on discounts that are immediate, such as loan fee waivers and rebates. But beware of fine print that requires you to repay a fee rebate if you consolidate the loan with another lender. Very few borrowers qualify for the full amount of prompt payment discounts, as it is difficult to make all your payments on time. Delayed onset of the discounts also significantly reduces their value, since they are in effect for a shorter period of time. If the lender offers such prompt payment discounts, focus on those that have as short a delay as possible and which do not require ongoing behavior after you reach the milestone (e.g., prefer principal reductions to interest rate reductions).

    Also be sure to tell the lender when you move to a new address. Anecdotal evidence suggests that most borrowers who lose prompt payment discounts do so on the very first payment.

  • Pick as short a loan term as possible. While a longer loan term will reduce the size of the monthly payment, it will significantly increase the interest paid over the lifetime of the loan. For example, increasing from a 10 year loan term to a 20 year loan term may cut the monthly payment by a third (34% reduction), it comes at a cost of more than doubling the interest paid over the lifetime of the loan. The maximum reduction in the size of the monthly loan payment is 50%, at a cost of more than tripling the interest paid over the lifetime of the loan. Keep the loan term short to save money. Also, do you really want to still be repaying your own student loans when your children are ready to enroll in college?

    You can change the repayment schedule on your loan once per year. So FinAid recommends starting off with standard ten-year repayment on your consolidation loan. If you find it difficult to afford the payments, you can always switch to extended repayment later.

  • Discounts on unconsolidated Stafford and PLUS loans are often better than the discounts on consolidation loans. Lender margins are 0.75% tighter on consolidation loans than on unconsolidated loans, leaving them with less room to provide discounts. This is one of the reasons why consolidation lenders encourage extended repayment, since it compensates for the lower margins. So it is best to compare your current loan discounts with the discounts on a consolidation loan before deciding whether to consolidate. A consolidation loan is a new loan, with a different set of discounts than the original loans. Also, some fee waivers or rebates offered by originating lenders may have to be repaid if you consolidate with another lender, so be sure to ask your current lender about that as well.

  • You don't need to consolidate to get extended repayment. A little known provision of the Higher Education Act of 1965, in section 428(b)(9)(A)(iv), allows borrowers to get extended or graduated repayment without consolidating their loans. The borrower must have accumulated more than $30,000 in federal education debt since 1998. The extended or graduated repayment plan may have a loan term of up to 25 years. Per the regulations at 34 CFR 682.209(a)(6)(ix), the borrower must not have had any outstanding federal education debt prior to October 7, 1998 at the time of obtaining a new education loan subsequent to that date. Many lenders also offer unified billing, so that you get one bill for all your loans from that lender.

  • Apply for private student loans with a cosigner. Private student loans based the interest rates and fees on your credit score. So even if you can qualify for a private student loan on your own, it is better to apply with a cosigner, as this can result in a lower interest rate and fees, saving you money. This is especially true if the cosigner has a better credit score.

  • Private student loans pegged to LIBOR are better than those pegged to the Prime Lending Rate. Prime + 0% may sound better than LIBOR + 2.8%, but they are in the same ballpark. The Prime Lending Rate is the interest rate lenders give to their best credit customers. The LIBOR rate is the interest rate at which lenders can borrow money from other banks. Since the spread between Prime and LIBOR has been growing, a variable rate loan pegged to the LIBOR index will grow more slowly than a loan pegged to the Prime Lending Rate.

  • Some private loan interest rates and fees depend on the school you attend. While most private loans consider your credit history, some may also consider other factors such as the college you attend. In particular, these lenders will consider your college's cohort default rate in addition to your FICO score when determining the interest rates and fees that you pay. From the lender's perspective, higher default rates yield loans that are less profitable, and some lenders compensate for that by charging higher rates and fees. (It is unclear why borrowers at high default rate schools are more likely to default than borrowers with the same credit score at low default rate schools. It may be an indication of the likelihood that students at the school will graduate and get a good job.) If your school has a default rate that is more than twice the national average (i.e., more than 10%), you may wish to focus on lenders that don't consider the college's default rate, as these lenders are more likely to offer better interest rates. Shop around to get the best interest rate and fees, as there is considerable variation from lender to lender.

  • Don't apply for too many private student loans. Many students find that their credit scores go down with each year's loans, causing their interest rates to increase. While loan applications don't have as big an impact on your credit score as funded loans, applying for too many loans may be enough to tip you from one credit tier into the next, especially if your credit score was close to the threshold between credit tiers. (Lenders don't publish their credit tiers, but typically have 5 or 6 tiers for credit scores between 650 and 850. This means that a change of just 30-50 points in your credit score is all that is required to change from one tier to the next.)

    Given that private student loans do not have up-front pricing, the only way to tell what interest rate you'll get is to apply. But if you apply for more than 2 or 3 private student loans, it may impact your credit score. This is a bit of a catch-22 situation. But here are a few rules of thumb that can help, based on an analysis of private student loan securitizations:

    • Look at the lender's best and worst rates, and use them to calculate the spread between the two. If a lender has a very low rate for the most creditworthy customers, but a large spread between best and worst rates, most borrowers will end up with a higher interest rate than at a middle-of-the-road lender with a much tighter spread between best and worst rates.
    • Between 40% and 60% of the typical lender's funded loans get the worst rate, and more than three-quarters of the approved loan applications. So put more emphasis on the worst rate when comparing private student loans, since the odds are good that that's the rate you'll get.
    • Less than 10% of the typical lender's funded loans get the best rate.
    • On average, borrowers receive interest rates that are 2.5% to 3.0% higher than the best advertised rate.

    So to have a good chance of getting a good rate, one of your loan applications should be at a lender with one of the best rates for the most creditworthy customers, another at a lender with a narrow spread between the best and worst rates and the third at a lender with one of the lowest worst rates.

    According to Fair Isaacs, the company that produces the FICO score used by most education lenders, one "inquiry" will generally result in a 5 point reduction in the FICO score. However, since people with six or more inquiries are eight times more likely to declare bankruptcy than people with no inquiries, it is best to keep the number of inquiries small. Also, if your credit history is short or involves very few accounts, an inquiry is likely to have a bigger impact. On the other hand, when you apply for a loan, they ignore any inquiries within the 30 day period prior to scoring and treat any inquiries within a short period of time (e.g., 14 or 45 days, depending on the version of the FICO score) as a single inquiry. This compensates for the impact of shopping around. They do not say whether applying for different types of loans (e.g., credit card, mortgage, student loan) counts as separate inquiries, but that is likely the case. So the best advice is to apply for all the private student loans within a short time period (e.g., a week or two) and to not apply for too many loans.

    [Warning: Fair Isaacs says that while they conflate inquiries for auto loans and mortgages, they do not yet have enough historical credit data to do this for private student loans. This is partly because private student loans are relatively new and partly because lenders have not been distinguishing private student loans from other forms of unsecured credit. So you still need to limit the total number of private student loan applications and to apply for the loans in a short time span. More than five inquiries is likely to reduce your credit score enough to have an impact on the interest rates and fees for subsequent applications. More than eight inquiries will definitely have an impact on the interest rates and fees. FinAid recommends limiting your private loan applications to one bank, one non-bank specialty lender and the nonprofit state loan agencies in your home state and the state where your college is located.]

  • Minimize fees if you intend to prepay the debt. Education loan fees, like points on a mortgage, are effectively a form of up-front interest. If you intend to pay off the loan early (i.e., just a few years into repayment) you should prefer a loan with lower fees, as this will save you money.

    For example, consider a student loan with a ten year repayment term, where the loan fees are added to the amount owed to yield net proceeds of $10,000. At 7.5% interest and 7% fees you'd have total payments of $15,316.15 over the lifetime of the loan. At 8.5% interest and 3% fees you'd have total payments of $15,338.46 over the lifetime of the loan. So the loans have similar costs. But if you were to pay off the remaining balance after just three years, your total payments on the 7.5% loan would be $12,916.32 and your total payments on the 8.5% loan would be $12,672.79, or $243.53 less.

    The longer the repayment term and the longer you wait to pay off the loan, the more time there is for the loan fees to be amortized over the term of the loan. So the impact of loan fees on total costs decreases the longer you wait to pay off the loan. Given two loans with similar APRs, you should prefer the loan with the lower fees if you intend to pay off the loan within the first few years of entering repayment.

  • It is cheaper to save than to borrow. If you save $200 a month for ten years at 6.8% interest, you will accumulate more than $34,400 to help pay for college. If instead of saving, you borrow this amount at 6.8% interest, you will pay almost $400 a month for ten years. So start saving for college as soon as possible. FinAid's Saving vs. Borrowing Calculator lets you explore the tradeoffs of saving versus borrowing to pay for college.

  • Borrow no more than your expected starting salary. If your total college debt is about the same as your starting salary after you graduate, the monthly loan payments will be affordable. If you borrow more than your starting salary, you may find it difficult to repay your debt. While one can choose alternate repayment terms that reduce the monthly payment by stretching out the term of the loan, these increase the total amount of interest you will pay over the lifetime of the loan. For example, increasing the loan term from 10 years to 20 years may cut the size of the monthly payment by about a third, but it will more than double the amount of interest you pay over the life of the loan. If you borrow more than twice your expected starting salary, you will be forced to seek extended repayment terms and will be at high risk of defaulting on your debt. You should consider transferring to a less expensive school.

  • Minimize debt. Live like a student while you are in school, so you don't have to live like a student after you graduate.

Fixed vs Variable Interest Rates

There are several tradeoffs between fixed and variable interest rates.

  • Fixed rates offer predictable monthly payments. With variable rate loans, the monthly payment can jump after a rate reset, making the monthly payment less affordable. This is especially true after the end of a low introductory or "teaser" rate. For example, a 1% increase in the interest rate typically leads to a 4% to 9% increase in the monthly payment.
  • Variable rate loans may offer low introductory rates that don't last for long, either for the duration of the in-school period (an average of about 2 years) or just a year.
  • Variable rates can cut costs when interest rates are declining, letting variable rate loans seem low compared with fixed rate loans. However, variable rates can increase costs when interest rates are increasing. One must be concerned about the average rate over the life of the loan, not interest rates that are temporarily low or high compared with fixed rates.

In Case of Difficulty

If you are encountering problems getting a college to certify your loan because of your choice of lender, contact the FSA Ombudsman at the US Department of Education. You can contact the ombudsman online, by email at fsaombudsmanoffice@ed.gov, by phone at 1-877-557-2575, by fax at 1-202-275-0549, or by mail at U.S. Department of Education, FSA Ombudsman, 830 First Street, NE, Fourth Floor, Washington, DC 20202-5144.

You can also report suspected fraud to the Office of the Inspector General at the US Department of Education by calling 1-800-MIS-USED.

 

 
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