Matching Borrower With Lender, Social-Network Style
As the fall semester rapidly approaches, students worried about covering tuition in an increasingly volatile loan market will have a new set of options to try. All they have to do is go online, create a personalized profile and friend the right people.
The answer to students' educational finance woes aren't to be found on Facebook, necessarily, but the popularity and influence of the social networking model undoubtedly influenced the latest crop of private loan companies aimed at students, dubbed "social lending" or "social finance."
Rather than marketing loans to customers in the traditional sense, the companies facilitate a more direct connection between individual borrowers and lenders, building upon the "peer to peer" or "people to people" model that's used in applications from downloading music to offering microloans to entrepreneurs in developing countries.
The social approach to lending has previously been adopted outside the student loan sphere by start-up ventures aimed at anyone who needs a loan. Prosper, for example, lists would-be borrowers whose loan requests range from consolidation to moving expenses. Lenders, in that model, can then bid on individual loans at interest rates they're willing to accept. Another personal loan service, Lending Club, even has a Facebook application and allows its borrowers to find potential suitors based on their "network" (or location) and "friend" status.
MyRichUncle, the private lender that in 2006 sought to upend the student loan market and helped jump-start the investigations into relationships between lenders and college financial aid administrators, initially attempted early in the decade to adopt a more personalized model, in which investors would finance students' education in return for a share of their future earnings.
In effect, the social lending model, as now applied to college loans, is operating on a similar principle. The companies, which are in the midst of packaging loans for students about to start their semesters, are betting that the growing popularity of social networking -- as well as a downturn in the traditional loan market -- will position them to become a viable alternative.
"What’s new this year is the addition of several sites that are focused on education lending, as opposed to Prosper, which is more general," said Mark Kantrowitz, publisher of FinAid.org and a close observer of the student aid market's latest entrants. At the companies' nascent stage of development, the share of student loan volume is a "drop in the bucket," he added, estimating that peer-to-peer lending for education purposes currently accounts for less than $10 million per year. FinAid notes that under 2 percent of Prosper's $135 million in outstanding loans are for educational purposes.
Part of the reason for the low volume in educational loans at general-interest peer-to-peer lending services, according to FinAid, is that the one- to three-year repayment period for most types of loans is much shorter than the typical 10- to 30-year window typical of loans for college tuition. That discrepancy leaves a potential opening for more focused services.
"I really like the idea of investing in individual students, I like the idea of these sites and it’s going to take a year or two before there’s some shakeout of the industry to see which of the models resonate best with consumers," Kantrowitz said.
The companies are expanding, but from a relatively small base. GreenNote, one of the prominent contenders in the student loan social lending space, has had thousands of students sign up since June when it opened for business, with millions of dollars in loans requested so far, said Akash Agarwal, the CEO. Borrowers come from a cross-section of institutions, including for-profit and not-for-profit, with 300 or 400 colleges and universities represented so far.
And the colleges aren't necessarily sold yet. Some of the services are heavily marketing themselves by contacting financial aid offices and in some cases soliciting links back to their Web sites on colleges' online lists of "alternative" loan providers. Colleges -- and the companies themselves -- are quick to remind students that they should exhaust their federal loan options first, before considering options in the private market.
"We felt it was an interesting concept to handle private loans, though I’m uncertain whether it will be something our students can get into," said Doug Severs, director of financial aid at Idaho State University, which lists GreenNote on its alternative provider list. The university's student body is heavily nontraditional: 70 percent are considered "independent" under federal guidelines, meaning that they don't rely on parents for support, and 60 percent are on federal aid.
'Stranger to Stranger'
The main contenders in the student social lending scene so far include GreenNote, Zopa and Fynanz, each with its own variation on the theme. Broadly speaking, the sites fall into two categories: one in which the focus remains on people the borrower knows, and one that relies on the goodwill -- or enlightened self-interest, perhaps -- of strangers.
Fynanz (pronounced like "finance") falls into the latter group. Founded by a former Citigroup investment banker who made a living packaging student loans, and backed with his own personal assets, the company markets to people on both ends of the loan transaction: students who need to borrow, and those with money to invest.
"Our belief and the reason why we even started this is we believe that students are overall low-risk and improving," said Chirag (CC) Chaman, Fynanz's founder and CEO.
Individual lenders can invest their money and determine the rate of return they prefer based on the risk they're willing to take on. “You don’t have to have a million dollars," Chaman said, pointing out what he called the "Obama effect" of small, accumulated amounts. But unlike political fund raising, of course, the company isn't soliciting donations.
"We are not doing charity. It’s not my or Fynanz’s goal or business to bring in people who we think are of very high risk," he said, adding that “as lenders get burned, it’ll spoil the party for everyone.” So far, Kantrowitz pointed out, there are no data on default rates in social lending, leaving open the possibility that supporting students in this way could be a "very risky investment."
Fynanz rates students based not only on typical financial indicators, but on parts of their academic record as well. Chaman explained, "[W]hat we found is that [there are] certain academic characteristics that are a very good indicator to whether a student is going to pay their loan back or not.” The result is the proprietary "Fynanz Academic Credit Score," which takes into account GPA, the borrower's course of study and the educational institution's profile. That approach could actually benefit good students without a stellar credit record. (Aspects of a student's credit record only set a bare minimum requirement and otherwise don't play a role in the "FACS" number.)
So an applicant for a student loan could fall within the Platinum, Gold and Silver categories -- and within those, Honors or Plus. Fynanz guarantees 100 cents on the dollar for Platinum Honors lenders, but less for those in lower grades, whom lenders would see as a riskier but potentially more rewarding investment; as risk increases, so does the rate of return.
In a twist on that model, Zopa offers a branded CD for investors in the United States, who can set a 1-year annual percentage yield up to 3.75 percent (which is lower than that offered by some online-based consumer banks). Its model is based on partnerships with credit unions, whose interest rates for borrowers can be lowered by contributions from individual investors. Chaman said that based on the risk, lenders using Fynanz can make up to 7 or 8 percent on their loans.
With a Little Help From Your Friends ...
Rather than allow investors to set the terms of their loans by picking or bidding on whom to lend to, GreenNote keeps the borrower-lender relationship personal. It works essentially the same way as asking a friend or family member for a loan, but it also provides tools for managing those relationships as well as services for packaging the final loans.
GreenNote's lending model, unlike the others, doesn't rely on credit and doesn't establish a market place by allowing lenders to bid for borrowers' requested rates. Instead, it relies more heavily on pure social networking -- both offline and on. Agarwal, the CEO, calls it a "completely democratic model": "We expect the student to reach out to some of the people who will potentially help him or her, and depending on the student’s choice," he said, the student can decide to make a public profile or choose who can view it online.
All GreenNote rates are initially set at 6.8 percent, the rate for unsubsidized federal Stafford loans, with similar terms. But lenders can go further: They can choose to lower or waive interest, or waive the principal, Agarwal said. Currently backed by venture capital, the company makes revenue from the loan amount raised by students up front ($49 or 2 percent, whichever is greater), in addition to 1 percent of the outstanding loan amount from the lender.
The company hopes there will be another benefit of borrowing from people you know: lower default rates, "because they know that the money is coming from some known entities," Agarwal said.
He acknowledged that GreenNote can't compete with traditional lenders, but added that the current economic climate has sent more students looking for alternative loans. The company was founded last year, before it was clear that market turmoil might affect the availability of loans. "To our surprise and to our favor, we obviously realized that there was a credit crunch and all that other good stuff that’s going on," he deadpanned.
With a potential influx of new customers, the social lending model, especially as it applies to loans from friends or acquaintances, certainly benefits certain types of students. Like the go-getters who broke all the Girl Scout cookie sales records, students who can effectively market themselves and reach out to as many contacts as possible are the ones who might win the peer-to-peer money race.
And unlike other sources of private loans, that takes effort.
Chaman, of Fynanz, said services like his separate students who have the "drive" to save money on loans from those who don't. "[O]ur biggest challenge is to get students out of that stigma of instant gratification," he said, where a single loan application results in an instant check in the mail.
He is already finding that some of the most successful borrowers -- those whose requests get funded the quickest -- aren't necessarily the ones with the best credit scores but those who have the most interesting stories to tell, penning mission statements, for example, with a "personal touch."
"That’s one of the things which has been a very interesting thing for us to see," he said: "people believing in somebody else" based on who they are and what they want to accomplish.