Relationship lending takes on student debt

Relationship-lending could be making a comeback starting with student loans. Two start-ups, SoFi and CommonBond, are working to build a lending model around a community of alumni lenders and student borrowers. They sponsor networking, mentoring, and career development events all to support their borrower’s ability to pay back their loans.

“People don't like to default in their own community so you can address issues of adverse selection and moral hazard. But at the same time you create a lender who is engaged not because of economics but because of affinity,” said SoFi Co-Founder & CEO Mike Cagney.

Jennifer Beall is an early beneficiary. Beall graduated from Northwestern University’s Kellogg School of Management with more than $40,000 in loans serviced by several different lenders. SoFi helped guide her initially through the federal consolidation program and then refinanced that one loan at a lower rate.

“I was able to reduce my loan interest rates from 8.5 percent on some of my loans down to 5.5 percent with SoFi,” she said, adding, “This saved me over $5000 in payments over the lifetimes of the loans.”

Beall admitted that she was initially attracted to the potential savings SoFi offered but she's become a frequent attendee at SoFi events and has even recruited her friends.

SoFi launched in 2011 with a pilot program at Stanford University's Graduate School of Business. It raised $2 million from 40 alumni and lent that money to 100 students. Today, the firm has funded $140 million worth of loans for nearly 2000 graduate and undergraduate students at 100 schools.

Compare that to the millions of students who graduate with debt every year and Beall is one of the lucky few. As a graduate from a leading MBA program, she is exactly the kind of low-risk, high-potential borrower SoFi targets.

“It sounds good, but the reality is that these lenders, like all new lenders, are trying to get the borrowers that are least likely to default and are most likely to be profitable,” said Mark Kantrowitz, a financial aid expert and publisher of Edvisors.com. “The students who are majoring in art at a little known university aren't going to be getting these loans.”

Kantrowitz is also skeptical alumni involvement adds much to the ability of the student to repay their loans.

Cagney wants to prove otherwise. “We actually believe that you do improve credit performance when you have alumni-borrower engagement,” he said. “What we hope is that we demonstrate the efficacy of this and we can go to a broader number of schools and get alumni convinced that the program will work.”

Brooklyn-based CommonBond has a similar strategy.

“What we decided to do was start with a group of students who are studying in a particular field where earnings potential and employment potential are quite high and default has historically been quite low,“ said David Klein, CommonBond Co-Founder and CEO. “If we can prove out the model with that group then we are actually given a lot more leeway to expand our model to a number of different degree programs, schools, and student credit worthiness.”

CommonBond began its lending program at the Wharton School of the University of Pennsylvania with $2.5 million and 40 MBA students. This year, it has expanded to into 20 different schools with hopes to disperse $100 million worth of loans.

It hopes to bring a personal touch to a market so overwhelming even MBA candidates don’t always know how to tackle it.

Lauren Lockwood, Harvard MBA candidate and CommonBond intern said loan angst is often a top topic among her classmates, in Facebook groups, and on blogs like “Poets and Quants.”

“People care about different things,” she said. “Some people are willing to have co-signers. Some aren't. Everyone talks about fixed [loans] versus floating. I think there's a lot of confusion about the benefits to those things.”

CommonBond and SoFi mostly refinance loans at lower rates, but do a small portion of new loans as well.

In exchange for their investments, CommonBond says its investors get returns north of four percent and SoFi's get returns of around five percent. In addition, investors also get access a network of talented up and comers.

“Let's put it this way. Say you want to invest in America. Are you going to buy T-bills or are you going to invest in graduate students coming out of the top schools?” said SoFi investor Uli Schmid-Maybach. “I would say the later. These are the people I want to do business with, too.”

That's exactly what Beall is hoping for. After consolidating her loans, she was able to focus on building her own start up—Clean Bee Baby. It’s a concept she developed while at Kellogg. She even won the school’s business plan competition.

Now she's looking to the SoFi community again for help. In fact, she was recently admitted to its entrepreneurship program.

“SoFi is going to provide us mentorship, 6 months of free loans payments and the opportunity to pitch our businesses potentially to a lot of the people who are backing the loan pool for SoFi,” she said. “So the people who are already investing in SoFi want to give back to the SoFi community and invest in the businesses from fellow MBA alumni. That's a tremendous opportunity for me.”