FFELP and DL Update
A Financial Aid Administrator's Guide to
Comparing "Alternative" Loans
by Tom Quinn, Vice President for USA Group

The term "alternative" loan may be a misnomer. These types of loans are not alternatives to federally guaranteed loans, rather they are to assist students when Title IV and institutional funds are not enough to cover the cost of higher education. These loans should more appropriately be called private loans.

Unfortunately the confusion over private loans is not limited to their name. Private loans come in a variety of shapes and sizes. Many financial aid administrators work to select the best loan option for their students but have questions on how to compare the available private loan options.

The following list notes the features you may want to consider when selecting a private loan for your students.

• Interest rates - Rates are typically variable, tied to the prime rate or three-month Treasury bill rate.
• Fees - Fees vary widely. Typically charged as a percentage of the loan balance, they can range from as low as 0 percent to 8 percent or higher. Fees may be discounted from the loan amount or added to the amount borrowed. In addition, some lenders may opt to charge a fee when the loan is disbursed or collect a fee when the loan enters repayment.
• Multi-tier pricing schedules - Lenders are increasingly offering multi-tiered loans that tie rate and fee levels to the borrowers' creditworthiness. The stronger the credit record, the better the terms.
• In-school deferment and grace period - Some loans allow borrowers to defer payments while they are in school and during a post-school grace period.
• Interest accrual terms - The frequency of interest capitalization while a student is in school and/or during grace periods can significantly affect total interest costs. More frequent capitalization accelerates the growth of the principal balance, in effect requiring the borrower to pay interest on interest. The best deals accrue interest on a simple basis and capitalize interest on a lump-sum basis at the end of the deferral period.
• Borrower benefits - A number of loan programs reward borrowers for consistently making their payments on time. These benefits may take effect after a period of one to four years. The benefits may take the form of reductions in the interest rate or a rebate of origination fees. Some lenders have begun offering up-front benefits, such as a preferential interest rate from the outset. The borrower keeps this rate as long as he/she makes on-time payments. A late payment causes the rate to rise under a specified formula. Borrowers should understand the importance of always making on-time payments. Borrower benefits are theirs to use or lose.
• Quality of loan servicing - Borrowers want good service in the form of accurate billings, electronic funds transfer (EFT) payment capability, friendly customer support provided via toll-free phone lines, repayment counseling, and online account inquiry capability. Do borrowers receive a payment coupon book or monthly billing statements? Another important service feature is the ability to offer a single monthly billing statement that can combine payments owed under both federal and private loan programs. The borrower gets one monthly statement and mails back only one check.
• Default prevention expertise - Private loans tend to be declared in default sooner than federal loans. Default prevention expertise is a critical factor for schools to consider in selecting private loan programs.
• Repayment terms - How long does a borrower have to repay: 10 years, 15 years, or longer? Does the private loan lender offer graduated repayment schedules as well as the standard, equal-installment plan?
• Deferment and forbearance options - An important feature for many graduate students is the ability to defer principal and interest payments during a post-school residency or internship. Private loans can vary in the length of deferment and forbearance periods.
• Cosigner terms - Does the loan allow a borrower to qualify for a better interest rate by obtaining a cosigner? This is important, because many young people simply don't have a strong enough credit record to qualify on their own. Some lenders allow cosigners to be dropped from the loan after a specified period of on-time payments, provided the borrower is deemed sufficiently credit worthy.
• Credit Criteria - Virtually all private loan providers check the credit record of a borrower. The terms of the loan may be different depending on how a student meets the lender's credit criteria. For example, "creditworthy" borrowers might have a documented credit history, while "credit-ready" borrowers simply do not have a credit record to review. For some private loans, creditworthy borrowers may be required to have a three-year employment history and a debt-to-income ratio of 40 percent or less. Credit-ready borrowers do not have to meet these criteria.
• Acceptance rates - Schools need to understand that price is not the only way to evaluate a private loan. The expected acceptance rate is also a key issue. The loan may not be much of a deal if very few students actually qualify.
• Late charges - Penalties and rules for imposing late charges can vary widely among lenders. This key detail in the fine print should not be overlooked.

When it comes to private loans, one size does not fit all. When selecting a private loan option for students, financial aid administrators need to consider the unique features of their students and institutions, and select a private loan provider with a proven track record and the customer service necessary to best meet the needs of both.