Presentation on theme: "Understanding Private Loans Default Prevention. Agenda Essential loan language Variable rate language ♦ Types of indexes Language for all types."— Presentation transcript:
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
What’s In It For You? Improve discussion with borrowers Better understanding of loans and terms Less stress
Loan Language APR Guarantee Fees Origination Capitalization Margin LIBORCap Adjustment Period T-Bill Points Prime Negative AmortizationVariable
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?
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
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
Interest Rates and Debt Secured ♦ Car ♦ Home Unsecured ♦ Credit card ♦ Personal loan ♦ Education loan
What’s in an Interest Rate Cost of funds + Operations + Inflation + Risk + Profit Borrower rate Index Margin
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.
APR Annual Percentage Rate (APR) ♦ Annual basis ♦ Up-front charges Guarantee fees Origination fees ♦ Compounding frequency Can make shopping easier ♦ Price tag
Variable Rate Language Floor CapLIBOR Margin Adjustment Period Index T-Bill Prime
Index Types Index and borrower rate T-Bill LIBOR Prime rate
Index Index ♦ Wholesale price Rate = price lender pays for money Name = where lender obtains money Borrower rate ♦ Retail price Price borrower pays for money
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
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
Margin Allowance to cover expenses ♦ Rate the borrower pays 10% ♦ Index (cost of funds) -4% ♦ Margin (covers expenses) 6%
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 +=
Floor and Cap Floor ♦ Lowest rate ♦ Rarely used Cap ♦ Highest rate ♦ Limits consumer risk ♦ Also called ceiling
Cap Example Prime + 3% with a cap of 12% ♦ If prime rate is 14% + 3% margin ♦ Rate is ____%
Adjustment Period How often rate changes ♦ Annually, quarterly, monthly Purpose ♦ Easier budgeting ♦ Keeps lender’s margin/markup level
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
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.
Language For All Loans Capitalization Negative Amortization Amortize Points Origination Fees Capitalize
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
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
Amortization Amortize = Pay off Reduction of debt ♦ Regular payments of Interest (cost of the loan) Principal (actual amount borrowed) Result = Loan balance decreases
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.
Capitalization Adding interest to loan balance Capital = Money borrowed Interest is paid on capital “Capitalized” = when interest becomes part of the capital
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.
The Right Choice LIBOR Prime rate T-Bill ?
Indexes Mirror Each Other Source: St. Louis Federal Reserve Bank and Federal National Mortgage Association
Rates Mirror Each Other Margin compensates for index variety Any index + Margin = Similar loan rates