I like to share some of the interesting situations clients bring to my attention (with their permission of course). Especially if it brings to light something I have never seen before and may help others who are facing the same choices.
Recently one of my clients called. Her daughter, who finished college within the last couple years, has both federal student loans and private student loans. The private loans were originated by Iowa Student Loan with variable rates based on their cost of funds (COF) index. I had never even heard of a COF index before but here is what Iowa Student Loan said about it in the correspondence she received:
"Your interest rate will increase and will adjust at the beginning of each quarter based on Iowa Student Loan's variable cost of funds index (COF Index). The COF Index is determined by periodic auctions of Iowa Student Loan's bonds. We cannot project whether the COF Index will cause your rates to increase or decrease in the future. It is important to note that Iowa Student Loan ceased offering the COF Index on new loans in May 2005."
It does make some sense that the borrower pays an interest rate based on the organization's underlying cost of capital, but I think it exposes the borrower to some additional risks. For example, what if the organization is involved in a controversy or mismanaged? Wouldn't that negatively affect their ability to issue bonds at a lower rate and therefore push the COF Index higher? Adverse economic conditions, like our current credit crunch, could also push the COF Index higher even when interest rates are dropping.
Even though Iowa Student Loan has no direct influence in the matter, I have to give them credit for both recognizing the adverse affect the current economy is having on the COF Index as well as offering an alternative.
The letter they sent my client was to offer a one time opportunity to switch from a variable rate based on the COF Index, to one based on the 3-month average of the LIBOR (London Interbank Offered Rate). It would be tempting to make a decision based on which formula offered the lowest current interest rate, but I think prudence requires looking a bit deeper. Using the LIBOR rate as the index removes the risks associated with the individual organization, but since LIBOR is based on banks doing business primarily in the UK, it also exposes the loans to economic influences of a struggling European economy. Given the ability of the creditworthiness of any institution to crumble without warning (or sometimes even cause) I'd personally bear the influence of the EuroDollar and choose the LIBOR rate.
Current interest rates, by the way, also benefit from choosing the LIBOR option. Right now, her current interest rates range from 7.77% to 9.86%, but most are at 8.36%. Using the COF Index they will rise to 8.42% to 13.09% with most of the notes at 11.59%. The current 3 month LIBOR average would put the rates at 5.56% to 7.65% with the majority at 6.15%.
I strongly suggested that she look into consolidating her loans into a low rate, fixed interest loan. Apparently the tight credit market has limited Iowa Student Loan's ability to offer consolidations on private loans, but they did suggest a competitor who is still making private consolidation loans.
The Student Finance Corpration helps students to get school loans for post secondary education. The eligibility is based on the student's financial conditions, repayment ability, credit and the college that the student is applying.
David from the Get a Personal Loan Website http://bodocs.com
Posted by: David | January 21, 2009 at 07:35 PM