Inside Higher Ed: Invest in What You Know

By Kevin Kiley, for Inside Higher Ed

April 2, 2012

Daniel Macklin thinks an MBA from Stanford University is such a good bet that he has made the investment more than once.

Macklin is one of several Stanford business school alumni who last year pooled their money through a company they created called Social Financial, or SoFi, to make private loans to current Stanford business students. The students get a loan at a rate lower than the going rate for other private and federal loans, and the alumni investors generate a return of 5 per cent.

The company is announcing today that for next year it is expanding the programme to 35 other universities – mostly top-ranked research institutions – to lend a total of $50 million (£31 million) to undergraduate and graduate students. It is also providing an option for students to refinance their loans through the company, and hopes to refinance about $100 million worth of loans.

At the moment, SoFi is accepting students on a first-come, first-served basis, taking the student’s enrolment in a particular college or university as a proxy for their creditworthiness. They are currently planning to operate only at colleges and universities that have low default rates, even for students in fields that are not traditionally associated with a profession. If the company expands beyond these, Macklin says, it might start making other considerations.

Macklin and the company’s other founders hope to grow the company and upend the $1 trillion loan market, which they view as inefficient. “It’s a broken industry in need of innovation and fresh thinking,” Macklin says. “We saw that an untapped source of capital was alumni, and connecting with them could also help us provide some accountability within the system.”

Social Financial does not really do anything to decrease the cost of attending college, and several private loan programmes already exist, so there is some scepticism about the extent to which it can really transform the loan market. Students in the programme would still need to borrow to pay high tuition costs, which for graduate schools such as Stanford Business School can be more than $50,000 a year.

The company is also currently operating at colleges and universities that already have high graduation rates and fairly low default rates for graduates, so they are not dipping into the risky pools of students who are least likely to pay off loans. Rather than dramatically transform the loan market, SoFi seems likely to serve as another private loan option for students, albeit one with an interesting twist that might appeal to both alumni and students.

In its first year, operating only at Stanford’s business school, the company raised $2 million to lend from 40 alumni, and Macklin says the company has waiting lists for both students and investors.

The company’s main selling point is that the interest rate on its loans is lower than that of unsubsidised federal loans and private loans. The company offers a 5.99 per cent fixed interest rate, which is several basis points lower than unsubsidised Stafford loans, which carry an interest rate of 6.8 per cent. The subsidised Stafford loans are also expected to increase to 6.8 per cent on 1 July. Other forms of government loans can carry higher interest rates.

In addition to the low interest rate, the company’s other major sell is that it gets a large pool of alumni invested in the success of the students to whom they lend, Macklin says. Because the alumni have a financial incentive to see the student land a good job and continue to repay the loan, they are more willing to help. And because SoFi pools and distributes alumni money instead of having investors directly pick students to invest in, all alumni have an interest in students’ success, Macklin says. The company has worked to line up students with alumni investors who may be able help them with their careers, connect them to employers or potentially provide them with jobs.

Benjamin Kessler, a Stanford business school student, says those factors were the main reason why he chose to take out a loan through SoFi rather than a private lender for the second year of his MBA programme. In his first year, he took out a combination of federal loans and a private loan from Citibank. In his second year, he replaced the Citibank loan with one from SoFi.

“The fixed rate was helpful for me, but it was really the opportunity to interact and be paired up with investors in SoFi who were also Stanford alumni that was really appealing,” Kessler says. “When you’re accessing your financing from a commercial bank, it’s very different from when you get to see the faces of the people you’re lending to, and vice versa.”

Kessler, who will graduate in June, hopes to take over a company in the Midwest. He says staff at SoFi have begun connecting him with alumni in the area who can provide him with advice on how to do so. Because the experience has been so good, he plans to invest in SoFi when he gets out of school, he says.

While the connections are mostly done through the SoFi staff at the moment, Macklin says the company hopes to build other tools that promote communication between investors and students and graduates, such as a social network.

Consumer protection groups urged students interested in getting loans through SoFi or other private lenders to seriously consider the benefits that come with federal loans, which carry several deferment options and protections that are not available through most private loans. “Given that federal loans are widely available and come with so many repayment options and borrower protections, students should be cautious about any type of non-federal loan,” said Lauren Asher, president of the Institute for College Access and Success, a non-profit group that works on college affordability issues.

Macklin says that SoFi includes many of the same kinds of deferment options as federal loans, including a six-month grace period upon graduation, but notes that federal loans likely provide better benefits to students entering certain careers, such as the military and public service. He says SoFi hopes to set up a system through which graduates can appeal to alumni investors to waive payments on a case-by-base basis.

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