NEW YORK (MainStreet) — The fall-out from the financial crisis is still being felt in the lending industry, where tight loan standards and empty borrower pockets have led to some necessary innovation in recent years. Among the innovations are a new breed of student loan lenders that aim to revolutionize the student loan industry by providing lower interest rates than traditional banks and some unexpected perks, such as career placement support.
By some estimates, borrowers who take out loans or re-finance with lenders such as SoFi and CommonBond can save thousands over the life of their loans. But do the numbers tell the whole story?
Crunching the Numbers
SoFi and CommonBond offer both fixed and variable rate student loans and loan re-financings with rates as low as 2.65%.(CommonBond now also offers a hybrid loan with a similar structure to ARM mortgages.) The rates they offer, by almost any account, are significantly lower than most federal and private loan providers, especially for graduate loans – SoFi’s variable rate MBA loans start at 3.91%, for example vs. the roughly 7% to 8% some borrowers of federal loans paid for Grad Plus loans in recent years. While Direct loans and some private loans offer lower rates than Grad Plus options, many borrowers often choose the latter to supplement their total cost of attendance.
Let’s take the example of an MBA student who borrows $100,000 to finance his or her education, borrowing at an average rate of 7% from the federal government vs. one who borrows at an average of 5% from a non-traditional lender with a standard 10-year repayment plan. The former would pay approximately $139,000 over the life of the loan; the latter about $127,000. That’s a difference of about $12,000 over ten years. That number goes higher for extended debt repayment terms, of course; borrowers who pay over a 15-year term can expect to save even more by choosing a non-traditional lender.
Beyond the Numbers
Saving thousands of dollars sounds great, but there are other benefits to be had with non-traditional lenders, too. Both CommonBond and SoFi offer personalized career placement assistance should a borrower become unemployed, as well as halting payments during periods of unemployment. Borrowers may also qualify for additional loan rate reductions by choosing autopay, for example. And unlike the federal government or mega banks, non-traditional lenders tend to be smaller and more client-focused, creating more responsive customer service experiences. Plus, you can consolidate both federal and private student loans.
But there are some limitations borrowers should be aware of. Unlike federal loans, there are no income-sensitive repayment plans similar to the government’s Pay As You Earn or Income Based Repayment plans. That means that if you should encounter financial difficulty in repaying your loans, your only option for lowering your monthly payment would be to refinance for a longer, 15-year term. Speaking of repayment terms, federal student loans offer extended repayment plans of up to 30 years - a big help for cash-strapped borrowers.
Also unlike federal loans, non-traditional lenders don’t offer any loan forgiveness for say, public service or non-profit jobs. And graduate loans tend to be limited to students or graduates of elite institutions. If our hypothetical M.B.A. grad above had attended anything other than a top school, he wouldn’t even qualify for a non-traditional loan. Non-traditional lenders say that their focus on graduates of top professional school programs reduces default risk in their loan pool, thereby enabling them to offer lower loan rates to everyone, including undergraduates. Plus, it creates a stronger network for their career placement assistance, a benefit from which all of their borrowers can benefit.
Who Benefits Most?
Lenders like SoFi and CommonBond say they’re working to expand their loan products to address the needs of more borrowers, but for now, potential borrowers should be aware of their limitations. While they can offer substantial savings, an enhanced customer experience and career placement help, some borrowers may be better served by other options, such as traditional federal loans.
So who stands to benefit the most from non-traditional lenders in their present form?
- Students or alumni of elite graduate institutions, such as top M.B.A. or J.D. programs.
- Borrowers who do not expect to need a repayment term of longer than 15 years. Those who can repay in 5 years are offered the lowest interest rates.
- Borrowers who do not expect significant fluctuations in income that may impact their ability to repay. Those who do suspect their income may fluctuate or that they may encounter financial hardship at some point may be better served by federal PAYE or IBR programs, which reduce payments based on need
- Borrowers who have borrowed most or all of their loans from private lenders. Non-traditional lenders tend to offer more perks and a better customer experience than many of the big banks.
- Borrowers who are strongly motivated by non-traditional lenders’ social mission. CommonBond, for example, donates heavily to underprivileged students’ education expenses, such as their 1:1 study abroad program.
Non-traditional lenders aren’t for everyone – yet. But for some borrowers, they can provide one of the most efficient and cost-effective ways to repay or refinance loans. Given the trends favoring smaller, peer-to-peer lending, non-traditional borrowing and other financial innovations, it’s only a matter of time before we can all benefit from them.
--Written by Janet Al-Saad for MainStreet