For online lenders, the business model of targeting Ivy League student borrowers is starting to backfire.
The problem isn’t that graduates of these and other prestigious universities are deadbeats. Rather, these customers, who the lenders covet for their superlow default rates, are proving savvier and more anti-debt than anticipated.
Borrowers are prepaying their student loans at a quicker pace—in some cases three times faster—than some companies expected, a potentially bad outcome for the lenders and investors that wanted to collect higher interest payments over time, according to people familiar with the industry. Not only are customers aggressive about refinancing at lower rates, some are paying more than required each month in an attempt to get rid of their debt faster.
“It surprised me,” said Gary Lieberman, chairman of Darien Rowayton Bank, a community bank based in Darien, Conn., with a national online lending platform where student-debt borrowers are paying 15% to 17% more than they are obligated. “The nature of these borrowers is that they really want to pay off their debt.”
To some extent, online lenders are victims of their own business plans. Lenders including Social Finance Inc., known as SoFi; Darien Rowayton, CommonBond Inc. and Earnest Inc., generally charge lower interest rates than what borrowers are paying on the student loans they initially received from the federal government or large private lenders.
The lenders initially focused on borrowers who attended the most elite schools who in many cases had graduate degrees, high credit scores and relatively high incomes. The idea is that these loans would be perceived as reliable by investors who buy them in bulk or through securities backed by the loans.
Unlike traditional banks, online lenders don’t hold on to most of their loans, but rather sell them to investors. Some 65% of loan dollars in the pool of loans SoFi securitized in 2013 belong to borrowers who attended 10 selective schools, including Columbia University, Harvard University and Stanford University.
To attract these customers, some lenders repeatedly slashed interest rates over the last couple of years. They also haven’t been charging fees that typically accompany refinancings in areas such as mortgages, making it essentially costless for borrowers to get better rates.
Jacob Donnelly, a private-equity investor in Boston, said he refinanced his loans in September 2014 with Earnest, about six months after he first refinanced them with SoFi. Mr. Donnelly, 33, says he received an email through a Harvard University alumni group about Earnest’s refi program. Mr. Donnelly attained two master’s degrees at the university.
Mr. Donnelly says he sent an email to a senior Earnest executive saying he could apply if the company would lower the variable interest rate of about 3.7% he was paying SoFi. Earnest offered him a 2.97% variable interest rate—a switch Mr. Donnelly says he is happy to have made.
Earnest, SoFi, Darien Rowayton and CommonBond have refinanced more than $6.5 billion of these loans since 2012, often to rates as low as 2% to 3%.
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