Nothing shows the explosive, tech-driven revolution in student loans better than the presence of SoFi, Earnest, and CommonBond in the top 20 of Poets&Quants’ top 100 MBA startups for 2016. SoFi, No. 1 in the ranking, has $1.37 billion in equity investment. Earnest, No. 11, has $97 million. CommonBond, at No. 18, has $46 million. SoFi has loaned out more than $1 billion to MBAs, its CEO says. Earnest has refinanced more than $400 in student loans; its CEO did not specify the portion of refinancing for MBAs, but said they are “a really big segment of our clients.” Common Bond expects to hit $1 billion in refinancing and MBA-program loans this year.
None of these online-refi companies, all founded by MBAs, is even five years old.
These three financial technology firms offer a product in high demand: freedom from excessive interest rates on large amounts of student debt. Many MBA students and graduates still owe money from college – average debt for 2014 college grads was $28,950, according to the Institute for College Access & Success – along with piling on debt for their MBA programs, which averaged $56,000 for 2015 graduates, according to U.S. News & World Report.
U.S. student debt, the vast majority of it in federal loans, hit an estimated $1.3 trillion in 2015. The debt is owed by some 40 million people. That’s quite a lot of people owing quite a lot of money in high-interest loans. And until SoFi and CommonBond came along in 2011 (Earnest appeared two years later), all that debt was, you could say, just sitting there.
PILLAGING THE STUDENT LOAN MARKET
SoFi, Earnest, and CommonBond have literally pillaged the student loan market, exploiting intense customer dissatisfaction with the higher interest rates and poor service of the federal government and traditional banks. The financial technology upstarts have a particular advantage over the feds. While the government issues student loans to anyone going to college or graduate school, the refinanciers can pluck the cherries and reap a bountiful harvest of some of the worlds’ most sought-after debtors – borrowers with lots of debt but virtually no risk of default.
Company officials tend to downplay the skimming of the cream from the federal student-debtor pool. Earnest founder and CEO Louis Beryl focuses instead on the fact that MBA students and graduates, like other student debtors likely to have successful, high-paying careers and possibly already having significant investment and retirement savings, have improved their own credit-worthiness. “It’s just not the same loan as potentially the loan they took 10 years ago,” says Beryl, a 2012 Harvard Business School MBA. “The person who made the loan 10 years ago was assuming a different level of risk, when that (debtor) was still going to school and wasn’t yet employed. The large incumbent players, whether it’s the federal government or the large private student loan lenders … they weren’t really taking account of the dramatically decreased risk of someone after they’ve graduated from school.”
AN OLDER, MORE MATURE BORROWER
As SoFi co-founder Dan Macklin says, “We’re lending to the good people who can pay back their loans.” Macklin also points out that investors see a strong return, as the company has “almost negligible default rates.” Fewer than 15 of SoFi’s 100,000 clients have defaulted, Macklin says. Earnest has never had a student loan refinancing default, Beryl says, and neither has CommonBond, according to CEO David Klein. “We haven’t even had a 30-plus-day indicator of default,” Klein says.
The average Earnest student loan refinancing client is 30, carries $70,000 in student loan debt, and saves an average of $18,000, Beryl says. To receive refinancing from Earnest, which has 200 employees in a San Francisco building it shares with Uber and Square, a job or job offer is required. “We’re looking at their employment and education, cash flow, income-less-taxes-and-expenses, their savings – retirement and non-retirement accounts,” Beryl says.