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Easing Borrower Angst

August 7, 2009

For many students fresh out of college, the sense of possibility upon graduation is dampened by looming loan payments. But a new company hopes to change the way college grads repay their federal student loans, by easing the uncertainty about whether they'll be able to afford the monthly burden.

SafeStart, which today is opening its Web site for public viewing, asserts that with a simple up-front payment, student borrowers can be assured that if they are unable to make monthly loan payments in the first five years after graduation, the company will pick up the slack. Students who buy into the program generally pay between $40 and $60 for every thousand dollars of Stafford loans they take out. In return, they get an interest free line of credit that they can draw on as needed to avoid missing payments.

SafeStart jumps into action when the student proves he or she is facing financial hardship. To qualify for hardship, the student must have graduated from college and have monthly student loan payments that exceed 10 percent of the his or her income. The borrower can draw on SafeStart to make payments over the five-year window. In keeping with any federal deferment, this window is extended free of charge for those who, say, go back to school or join the Peace Corps. SafeStart will make up to 36 monthly payments over this time. After the line of credit closes, another five-year window opens, during which all of the borrowed money must be repaid.

The program also provides "financial literacy training" before graduation to help students manage their money, as well as "debt counseling services" after graduation to help reduce the risk of missed payments.

"Going to college is one of the best investments you can make. We want to take the fear out of borrowing," said Carlo Salerno, principal at SafeStart's parent company, BridgeSpan Financial. Salerno founded SafeStart with three other people. "One out of every five people turn away their first choice school primarily because of the cost.... If you want to go to college, cost shouldn't be a barrier to realizing one's potential."

SafeStart's informational page goes live around noon today; undergrads can buy Stafford protection for themselves or others can buy it for them beginning next week. However, as time progresses, Salerno wants to expand the program to engage with students through universities. These relationships could take many forms, including financial aid officers recommending the program to students or universities purchasing the product for them. He also foresees SafeStart expanding to cover other types of undergraduate and graduate federal loans.

"The neat thing about this product is that no one has thought of this before," said Brett Lief, president of the National Council of Higher Education Loan Programs, and a member of SafeStart's advisory board. "I've been in student aid for 30-odd years and never seen anything reach this stage of maturity. It's a possible game changer in terms of how defaults are moved in this country."

Though it is the first company of its type, SafeStart will probably find its biggest competition to be the government's federal hardship assistance program, which rolled out its income-based repayment plan at the beginning of July. Income-based repayment -- originally intended to help borrowers with large of amounts of debt who want to pursue lower-salaried jobs -- caps the borrower's payments at a determined percentage of income over a 25-year repayment period. Those employed in public service have their loans forgiven after 10 years; for others, remaining debt is forgiven after 25 years.

The federal government also provides a forbearance option for those unable to make their payments, which postpones payments but charges higher capitalized interest.

SafeStart's promotional literature comparing the three options shows the company's plan as being the least expensive, with loan payments through SafeStart costing over $15,000 less than income-based repayment for a student with $29,000 in federal loans. (This assumes a student earning $38,000 per year paid $1,450 to SafeStart for a line of credit on unsubsidized loans and took 22 months of draws in the 60 months following graduation.) SafeStart's credit line, like all other consumer credit lines, is dischargeable in bankruptcy, whereas the government offerings are excepted from discharge.

View From the Financial Aid Field

Lauren Asher, who as president of the Project on Student Debt helped to design the income-based repayment plan, said that SafeStart could make sense for some select students, depending on their financial situation.

But on the whole, she said she was "skeptical" of the relative benefits of the service compared to the new federal option. Since many of the students who might choose to sign up for SafeStart are those at risk of missing payments, they might be eligible for loan forgiveness through government programs, Asher said. "There are other options in place that don't require you to spend more money.... In some cases, IBR does completely erase financial repayment."

According to Salerno's calculations, income-based repayment ends up costing the borrower more money in almost all circumstances because of the additional capitalized interest resulting from a longer loan period.

"IBR requires those who qualify to extend their repayment term, much like [consolidating multiple loans into one] does. By requiring a longer repayment term, this increases the interest that is capitalized on the loan, thereby increasing the total amount required to pay it off," Salerno said in an e-mail. "The exception to this is for people who are committed to a career in public service because their loan debt is forgiven after 10 years.

"Note, however, that people still have IBR as an option even if they have a SafeStart account. We believe, as a lot of financial advisers do, that getting out from under your student loan debt in the fastest time possible is the best start to your financial future. We help make that possible. IBR doesn't."

There is no penalty for repaying one's loans in less than 25 years through income-based repayment, according to finaid.org.

Deanne Loonin, director of the National Consumer Law Center's Student Loan Borrower Project, noted that "the devil is in the details," and that the program as of now leaves a lot of questions to be answered. This being the case, she views SafeStart as less of a safety net and more of a deferment program. She noted that after the five-year draw window is over, depending on whether a borrower utilized a line of credit, that borrower could end up having to make loan payments and repayments to SafeStart for the line of credit at the same time. This creates further risk after the five-year safety period is over.

The prevailing reason for cutting the draw window off at five years, according to Salerno, is that statistics show people are at less risk of missing loan payments after the first five years out of college. "Seventy-five percent of students who fall behind on their loans do so in the first five years after graduation," he said. "Six or seven years onward, you get salary bumps and promotions, you're more financially stable."

Though this likelihood may not hold true for all borrowers, certain professions may be more apt to fit the repayment pattern than others. Doctors, for example, don't make a lot of money right out of school because they must complete residencies. But after those first few years, income -- and thus capacity to repay loans -- goes up drastically, said Tonio DeSorrento, an attorney at the law firm Orrick, Herrigton, & Sutcliffe. DeSorrento, who advises companies in the educational finance space, was not involved with SafeStart, but was briefed on the program prior to its release. Salerno said that SafeStart was not directed toward any particular niche.

As SafeStart hits the market, proving its worth to wary borrowers may be the hardest sell, DeSorrento said. "The biggest challenge will be selling people on their own fallibility, convincing students that one day they might be among the people who have trouble making payments," he said, noting that although few foresee themselves missing payments, 82 percent of borrowers have some sort of complication in the first year out of college. Because SafeStart requires an up-front fee, students would need to purchase the plans before ever missing any loan payments.

One key, DeSorrento said, may be marketing SafeStart through colleges and universities, as financial aid officers are often the main sources of information for student borrowers. Though entering into any financial transaction with a university would be illegal, getting university staff members to recommend SafeStart or provide information on it to incoming students could boost the popularity of the program, according to DeSorrento. And since colleges can be disqualified from participating in federal loan programs if their default rates are too high, this relationship could benefit both parties.

David Levy, director of financial aid at Scripps College, said that for him to endorse a private program, he would have to know all of the details of how it would affect students. Although he did not have enough information to assess the benefits or liabilities of SafeStart, the program to him sounded like "home mortgage insurance" for students. "Schools are very cautious about endorsing commercial products until they have all the facts," he said. "We encourage [students] to maximize federal aid eligibility before turning to private commercial products, which tend to be more costly."

For any student weighing the costs and benefits of different safety net programs, Asher emphasized the importance of putting SafeStart in context and knowing all the facts and fine print about each plan. "Without knowing one's personal financial circumstances," she said, "it's hard to know when it makes sense to pay an up-front fee."

 

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