NEW YORK, July 8 (Reuters) - Student borrowers are so often underemployed after graduation, they have a hard time paying back their loans and building a good credit history, so they get saddled with high interest rates.
Even for students who have solid credit scores and could qualify for lower rates, cheaper choices are few and far between. Now two lending start-ups, SoFi and CommonBond, are looking to refinance the high-interest rate deals for the cream of the crop of student borrowers in graduate programs at top schools.
Tonio DeSorrento is one of these borrowers. A graduate of the U.S. Naval Academy in Annapolis, Maryland, he served six and a half years as a Marine captain. He’s now 36, married with three children, and earned a law degree from Georgetown University Law Center in Washington in 2008.
While his undergraduate education was fully paid for by Uncle Sam, DeSorrento’s graduate degree cost much more than the government benefits that were available to him at the time. He took out about $100,000 in loans, including $15,000 in PLUS loans at the government-set rate of 7.9 percent.
Rates are also high for federally subsidized Stafford loans, having doubled this week to 6.8 percent.
While most families opt for government loans first, private loans are also available at a wide range of mostly higher rates. Since Congress was unable to reach agreement on holding Stafford rates at 3.4 percent the advantage of subsidized loans has narrowed sharply.
DeSorrento doesn’t consider himself much of a risk since he is employed as a lawyer, but he was still subject to the prevailing rates. That is, until SoFi () was able to refinance the existing loan with a new one offering better terms at 6 percent.
SoFi, along with smaller start-up, CommonBond (), is trying to tap into the low-risk end of the $1 trillion student loan market, using a peer-to-peer model, although in this segment, “peer” is loosely defined.
Both companies raise money from wealthy alumni, with a pitch that investors can get a relatively secure return while they help students at their alma maters. For the investors it is like putting money in a fund that pays it back as student loan payments come in.
The companies then add to that pooled money with investments from institutional players like banks and hedge funds, and refinance the loans at below-market rates. They both also offer ancillary benefits, like networking and mentoring.
It is a new approach in a market that has very little competition, according to a recent report on student loan affordability by the Consumer Financial Protection Bureau. It is also a way to reach lower-risk borrowers and get them rates reflecting their creditworthiness - an option the CFPB report says is lacking in the current marketplace.
SoFi, which started in 2011, expects to fund 7,000 to 8,000 loans this year to the tune of $500 million. That will be spread among 78 schools and could go up to 100 by year’s end, says Nino Fanlo, chief financial officer of SoFi.
CommonBond, which launched in 2012, expects to refinance 1,500 to 2,000 existing loans worth $100 million in 2013 at 20 top-ranked master of business administration (MBA) programs. The company plans to expand next year to other graduate programs, and it will also refinance undergraduate loans, says Chief Executive David Klein.
SoFi said it raised $41 million from Bancorp inc and $60 million from Morgan Stanley. The two firms did not break down how much of the money they raised came from alumni and from institutions.
Members of the military are another customer segment. In June, SoFi launched a new affinity program for former military members who go on to graduate school, with a goal to fund 400 loans in 2013.
At CommonBond, the borrowers number in the hundreds. “Without doing any targeting, they are finding us,” says Klein.
A good example is Michael Daschle, an 8-year Army veteran who served in Iraq and Afghanistan. He left the service in 2012 and now, at 31, is pursuing a MBA degree at the University of Pennsylvania Wharton School in Philadelphia. He receives about $20,000 toward his tuition from the government, leaving him to privately finance the remaining $30,000 or so to complete his degree.
“Because of the GI Bill, I don’t have to take on the size of debt I would have otherwise, but it doesn’t cover nearly the entire cost of going to school,” Daschle says.
While shopping for private loans, the best rate he could find was one for 9.8 percent that required a co-signer. “It was clearly not a good rate, especially in today’s environment,” Daschle says. Government loans offered lower rates, but lots of paperwork.
Then he found CommonBond, which offered a rate of 5.99 percent. He signed up.
Military members face many problems with their students loans, Rohit Chopra, assistant director & student loan ombudsman for the Consumer Financial Protection Bureau, said in testimony before Congress on June 25. Rate caps and deferments are often not applied correctly, and checks don’t always arrive on time.
The paperwork can be confusing, adds Scott Halliwell, a financial adviser for USAA, the financial services firm that mainly serves current and former military, “It’s kind of a patchwork,” he said, “And lay that on top of what is sometimes a stressful military life - deployments and moving - and that can be overwhelming at times.”
Michael Kane sees military members in high-end graduate programs as a good loan risk, which is why he helped seed SoFi’s Veteran’s Fund with a $50,000 investment. A graduate of Rice University in Houston, he is now a private equity investor based in San Francisco. He has already invested $500,000 into a SoFi fund for Rice graduates.
So far, the return on all of his loans is about 4.5 percent. And while they are not risk-free, both SoFi and CommonBond say they have had no defaults since they launched.
“It’s proving to be a pristine group of assets, as expected,” says Klein.