June 10 — Chris Winiarz, a 31-year-old money manager with a Northwestern MBA, jumped at a student-loan deal of a lifetime.
A startup called SoFi offered to refinance his $45,000 in federal debt, slashing his interest rate to 2.69 percent from 6.55 percent. Winiarz will pay off his obligation three years early, saving about $9,500 and helping pay for an engagement ring for his girlfriend. The company even threw in a free bottle of artisan olive oil.
“I really should have done this a lot sooner,” said Winiarz, who helps oversee the University of California's endowment and pension investments.
In a growing refinancing boom, a new generation of private lenders—backed by hedge-fund billionaires and Silicon Valley royalty—is targeting successful graduates with professional degrees and student loans. For the borrowers, “it's an uncashed lottery ticket,” said Brendan Coughlin, head of education finance for Citizens Financial Group Inc.
There's a catch. Their good fortune could cost taxpayers billions and damage the credit quality of the government's $1.2 trillion student-loan portfolio, the biggest pool of U.S. debt, except for mortgages. That's because professional-school graduates and other borrowers with successful careers subsidize the less fortunate, who are more likely to default.
“Cream-skimming by private lenders will remove these profitable loans and leave mainly—or only—the more risky loans,” said James McAndrews, executive vice president and director of research at the Federal Reserve Bank of New York.
Exodus of Top Borrowers
Traditionally, the student-loan program returns money to the U.S. Treasury. Now, the exodus of its most reliable customers could lead to losses.
“This is one of those looming financial bills that is going to come due,” said Jaret Seiberg, a Guggenheim Securities analyst. “If the best borrowers leave, taxpayers are going to have to ante up even more cash.”
The government will be left with a greater share of borrowers like Jennifer Rejon. A 29-year-old single mother of a 10-year-old daughter, she has $17,000 in federal loans. They helped pay for a medical-assistant degree from Corinthian Colleges Inc., a for-profit chain of schools that filed for bankruptcy in May (27 BBLR 659, 5/7/15). The U.S. Education Department this week said it may forgive hundreds of millions of dollars in loans to Corinthian students.
Under a federal program to help low-income borrowers, Rejon, who lives in Chicago and has struggled to find a job, isn't making payments.
“I'm trying to at least get my life on track and be able to pay my bills,” she said. “The loans are the last thing I'm thinking about.”
Federal Debtors Screened Out
Rejon wouldn't qualify for refinancing from private lenders because they screen borrowers based on creditworthiness and university quality. The government writes loans for any student who enrolls in an institution eligible for federal aid.
Borrowers holding about $150 billion in federal loans have strong enough credit that private lenders could offer a cheaper rate, Goldman Sachs Group Inc. estimated in a March report.
Refinancings are likely to reduce by as much as $10 billion to $20 billion the value of the federal portfolio because of lower income from loan payments, primarily for graduate school, according to Deborah Lucas, former chief economist at the Congressional Budget Office and now a Massachusetts Institute of Technology finance professor. Education Department spokeswoman Denise Horn said prepayments aren't yet significant, and the student-loan program's goal isn't to turn a profit for the government.
The situation is another consequence of historically-low interest rates, as well as a peculiarity of higher-education finance. Congress sets federal student-loan rates, and older obligations now demand as much as 8.5 percent annually. For decades, government loans undercut the private sector. Now it's the other way around.
Congress could let all federal student borrowers refinance at lower rates through the government itself, as Sen. Elizabeth Warren (D-Mass.) has twice proposed in the last year, to no avail. Republican opponents said the bill did nothing to curb the current and future cost of college.
That leaves an opening for newcomers like SoFi, formally known as Social Finance Inc., and established players such as Citizens Financial. Private lenders have refinanced about $3 billion to $4 billion so far, according to Stephen Dash, chief executive officer of Credible.com, a website that compares refinancing rates.
That number is sure to rise, since better-quality borrowers have no logical reason to stay put and subsidize others, said Vince Passione, founder of Lendkey Technologies Inc., which connects students online with private student-loan lenders. In April, an affiliate of Apollo Global Management LLC, billionaire Leon Black's private-equity investment shop, said it plans to invest $1 billion in refinanced student loans through LendKey.
Other big names are taking notice. A company called Earnest, which started online student-loan refinancing in January, has backing from Silicon Valley venture-capital firm Andreessen Horowitz, famed for helping seed Facebook Inc. SoFi's investors include another hedge-fund billionaire, Dan Loeb, and Peter Thiel, a co-founder of PayPal.
New York-based CommonBond Inc.—founded by three classmates from the University of Pennsylvania's Wharton business school—rewards borrowers with dinners at popular spots such as Grafton Street, an upscale pub near Harvard in Cambridge, Mass. It also offers $200 for referrals.
Average Income: $140,000
The average CommonBond borrower is a 32-year-old who makes $140,000 annually and has a near-perfect credit score of more than 760, said 34-year-old CEO David Klein. He took a break from Wharton three years ago to start the company, backed by education-finance company Nelnet Inc. and Vikram Pandit, Citigroup Inc.'s former chief executive.
Even for strong borrowers, there are risks to forsaking federal loans, which feature reduced payments for borrowers who get sick or lose their jobs, according to Rohit Chopra, the U.S. Consumer Financial Protection Bureau's student-loan ombudsman.
“They should be aware of what benefits they're trading away to get that lower payment,” Chopra said. The loans—such as the one to Winiarz, the California money manager—can be variable and reset monthly, exposing borrowers to the danger of a sharp spike if the economy shifts
For now, taxpayers will be funding a greater share of borrowers like Noelle Liptak, who lives near Akron, Ohio, and makes $40,000 a year as a marketing representative for a plastic-bottle manufacturer.
Liptak, 31, has almost $100,000 in federal student loans from college and an MBA from Point Park University in Pittsburgh. A government program currently lets her pay $46 a month, and her loans may be forgiven after 25 years.
“I don't expect to ever pay them off,” Liptak said.
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