Avoid This Student Loan Problem When You Apply for Financial Aid

From the Houston Chronicle: First Marblehead Corp.’s (ticker: FMD) stock sank Monday after a Friedman Billings Ramsey analyst downgraded the student finance company, saying there may not be as much cash committed to covering unpaid student loans as previously thought.

First Marblehead consults to lenders such as Bank of America Corp. and JPMorgan Chase & Co., who package their student loans into pools and sell them to investors as bonds. (Quick finance lesson - let's say you borrow $100,000 in loans, paying 8.5%. You're paying, so someone's receiving the interest, right? Bank of America will take the $8,500 it earns in interest from you and sell the right to collect that interest to investors who want that rate of return. First Marblehead (pronounced "Mahhblehead" up in their neck of the woods - Boston) assists Bank of America find investors who have the appetite for these investments.

The prices the bonds command -- and in turn the commissions First Mahhhblehead charges -- are boosted by a nonprofit organization called The Education Resources Institute, or TERI, also a Boston-based firm.

(Deeply trivial personal disclosure from Andy: In between college and law school, I bartended in Boston. One job was at the Grill 23, a steak house located in the same building as TERI. Their management used to come down for happy hour quite frequently. Even non-profits run up large bar tabs!)

TERI is a guarantor – it promises to buy student loans that are in default, which, in turn gives the investors buying the bonds warm and fuzzies about their investments. First Marblehead benefits from TERI because the bonds safer and more appealing to investors - therefore, an easier sale for them to make!

So here's what happened. After TERI’s credit rating dropped last month, Friedman Billings concluded TERI does not have enough cash to stand behind all the loans that are likely to be in default. Bummer!

Much of TERI’s $612 million in cash is restricted. It can commit only $127 million, or less than 1%, of the 13.2 billion of loans it guarantees, to cover student loan losses, according to the analyst. If you were an investor, this change would be a major problem, don't you think?

If student loan defaults overwhelm TERI’s cash, First Marblehead would have to pledge more of its collateral, which would reduce its profits. Then fewer student loans would be securitized.

What does this mean for you? (You were wondering, weren't you? Hey, you're still awake, right?) It will be harder to qualify for private loans, since credit requirements of borrowers are probably going to get a lot tighter. If you do qualify, your terms are likely to be less favorable, as the investors who buy loan pools will demand higher coupons, or interest rates, because of the increased risk.

So in the short term, if the market believes that private student loans are a risky investment, credit available to First Marblehead will be more restricted.

Remember, private student loans are NOT your first loan of resort for paying for college. There is literally billions of dollars of free aid out there. After exhausting this type of aid, you should turn to federal student loans. They're not exactly a walk in the park either, but are still light years ahead of private loans!

Questions? Call either Pete or Andy at 954-659-1234 or stop by our college planning website, www.CollegePlanningAdvice.com for tips and tricks on how to maximize eligibility for financial aid, including scholarships and grants.