The Newest Trend in Loan Financing and Why You Should Care

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I listen to a lot of podcasts and news media in the area of finance and economics. Lately I keep hearing ads for this company called SoFi. With a tag-line like “this is the beginning of a bankless world,” I had to find out more about what was going on here.

Turns out SoFi, which stands for Social Financing, is a tech startup that specializes in student loan refinancing. More on the re-fi thing that later. SoFi helps its customers, exclusively deemed “members,” get better rates on college loans or mortgages. They also sell mortgages and private loans in their own right. This all sounds pretty boring and ordinary, I know. Why should you care? You should care because we’re seeing loan financing being thrusted into the 21st century before our very eyes and in my opinion it means big changes for the lending market.

From Brick and Mortar to The Internet Age

Much like one of SoFi’s Super Bowl ads this year points out, banking has long been kind of low tech. It’s this traditional setup of waiting in line to be seen, mountains of paperwork, frivolous questions, and needlessly complicated and untransparent loan approvals. There was definitely a weak spot in the banking system that was bound to be exploited eventually. The internet brought us these great new online only banks like Ally that, due to not having any physical locations to pay for, could offer us better deposit interest rates.

Pretty much the same thing is starting to happen for loans. Companies like SoFi, LendKey, and Earnest offer better interest rates on loans than the big banks. They appeal to millennials who like their high tech feel and great customer service and it’s no coincidence that the very same group they appeal to happens to be the section of our population with the most student debt. I love what the internet has done for banking. It’s made the market more competitive which is generally in the consumer’s favor. The more players we have competing for our business, the better rates we’ll get.

How Does This All Work?

The biggest question I had when I first heard about these new loan financing companies was how do they make money on loan refinancing? In other words, how do you take one loan at a high interest rate and issue out a loan with a lower interest rate and make money on that? It doesn’t make sense mathematically. Maybe I’m naive but I had never really considered how the economics of loan refinancing actually works.

The answer is when a company offers you a re-fi they are actually paying off your original loan for you. So they pay off your loan incurring no interest themselves, then issue a new loan to you at the lower rate. Ah, that makes sense now. As of late, SoFi’s interest rates on various loans range from 2.14%-7.74%. With recent estimates of U.S. student loan debt at $1.2 trillion, with your average federal loan at around 6% interest that is a huge market to be exploited. For us millennials that means our loan agreements are going to get sweeter in the next few years.

We’re Not For Everybody

Now for some sucky news. Unlike a lot of traditional bank lending (oh, you’re 20 and going to college? Here’s $50,000!), SoFi is actually pretty picky about who they choose to invite into their club. I haven’t done any research on the other firms in this area so I’m only speaking for SoFi here. There is a simple yet pretty strenuous set of qualifying criteria for membership such as what subject your degree is in, what school you went to, and what your cash flow is.

There is definitely a sense of exclusivity that comes with being a SoFi customer. They tend to look for young professionals like doctors, lawyers, or financial professionals who have a lot of disposable income but would jump on the opportunity to get lower rates. Being rejected for a loan isn’t a new thing. We see it all across the industry…if you’re not credit worthy they would be dumb to give you a loan. On the other hand, I don’t like the attitude that SoFi seems to project. It’s an attitude of you’re not cool enough to be in the club.

My Analysis

As I wrote earlier I see this new trend as a great reformation of the way we think about borrowing. We are already in a borrower’s market. Even private student loans are at all-time lows, even beating federal rates at the moment. More companies offering loans is good for the economy and it offers us a whole new range of choices.

But there is a flip side to this student loan coin. Often federal student loans come with some cool perks. If you’re at a certain income level your federal student loan interest is tax deductible. Also, if you’re in a qualifying job your federal student loan could be completely forgiven after 10 years of paying. Remember, when you refinance a loan you’re essentially taking out a new loan and you won’t get some of those nice government perks with these private student loans.

To sum up, I think the financial climate is changing everyday and I’m glad loan refinancing is keeping up with the changing times. People have no loyalty to the big banks these days, it’s just how things have always been. We want a transparent process with a company that feels cutting edge and that’s what firms like SoFi are offering.  We’re seeing record low interest rates and record high levels of debt and the market for lending is bound to be an area of growth for our economy in the next few years. As I’ve always told my Gundomoney readers, don’t get into debt unless you have to. You can live a rich life by saving up your money and buying the things you want when you can. However, if you need the money and you can qualify, these new tech lenders might be for you.

 

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