Alternative lending options that are becoming increasingly popular among US MBA students may soon be available to their international classmates. The move could help to fill a gap in financing that has frustrated students and schools since the financial crisis.
SoFi, the peer-to-peer lender that hopes to lend $1bn this year, has been in discussions with several US business schools about extending loans to foreign students, funded by alumni from their home countries.
Pave, a crowdfunding start-up that allows “prospects” to raise money from backers in exchange for a share of future income, is also exploring options to expand to other countries.
That would open opportunities for borrowers whose options shrank when private student lending dried up during the financial crisis. While Sallie Mae, Wells Fargo and Discover have made a cautious return to lending to US citizens, there are few options for non-Americans who do not have relatives or friends in the US who are willing to pick up the tab should they default.
The loan programmes that do exist for overseas students are guaranteed by business schools themselves, although funded by banks or credit unions. That leaves schools exposed to the risk that a borrower will leave the US and not repay the loan, says Mark Kantrowitz, publisher of student finance website FinAid.org. In turn this makes some institutions reluctant to enter the lending game.
“The default rate is higher for international students” who take out loans in the US, Mr Kantrowitz says. “It is very difficult for any lender to collect from someone who’s overseas. In the US you could sue and get their wages garnished [deducted], but you can’t do that overseas.”
Columbia Business School is one of many schools that have shied away from international loans. “Unfortunately, due to lending changes requiring universities to completely underwrite loans for international students, we are not able to provide loans as an avenue of financial support for our international students unless they have a US co-signer,” says Christopher Cashman, director of public relations. The school points students to scholarships and loans from institutions in their home countries.
One of the most fundamentally broken things about student lending is that it’s done without understanding of a person’s ability to repay
Mike Cagney, SoFi chief executive, says his company “lends itself extremely well” to addressing default risk, because it exerts “social pressure” on borrowers who feel an affinity with alumni investors.
Defaults are “a huge issue and we’re hearing it from schools”, Mr Cagney says. One top-tier school recently told him that its “number-one issue is how do we fund international students?”. SoFi is talking to several schools about launching a pilot programme later this year.
Unlike their US classmates, international students are not eligible for federal loans, which made up 96 per cent of all graduate student lending in the 2011-12 school year, according to the College Board, a policy and advocacy centre. Private graduate loans peaked at $4.35bn in 2007-08, but contracted sharply when big banks and other lenders pulled back during the financial crisis, and in 2011-12 were down to $1.15bn. Private lenders have also tightened their underwriting standards. Nearly 60 per cent of private loans to graduate students in 2011 had a co-signer guaranteeing repayment, up from less than 40 per cent in 2007, according to the Consumer Financial Protection Bureau, the federal agency.
Some schools have stepped into the gap. In 2008, the Graduate Management Admission Council facilitated the creation of the Affiliated Loan Programme for Students, or Alps, which has made about $600m in loans funded by Deutsche Bank and guaranteed by schools.
The University of Chicago’s Booth School, an early participant in Alps, has switched to a similar plan with UBS. The school lends about $15m a year and about 60 per cent of international students participate, says Ron Gemkow, executive director of finance and operations at Chicago Booth.
“Every one of these programmes that I’m aware of is highly guaranteed by the school, even though the funding may come from a credit union or UBS or Deutsche Bank, so it’s pretty low risk to the investors,” he says.
As for defaults, he believes it is “just too early” to know the full picture. Students do not begin repayments until nine months after graduation and some are able to further delay paying, so the number in repayment is still quite small.
David Wilson, president of the GMAC, notes that this is true for all of the schools that have instituted lending programmes in recent years. “It’s four years out before you’ve established whether you’ve got an issue on repayment,” he says.
Among the 250 international borrowers from the first year Chicago Booth offered loans, three have defaulted and “a handful in forbearance could end up in default”, Mr Gemkow says. But he acknowledges that the default rates for international students are “absolutely higher than [among] domestic students”, particularly if an international MBA graduate is unable to find a job in the US.
Some schools turn to their alumni for guidance. At UCLA’s Anderson School of Management, a Japanese alumni group sends a welcome guide to admitted students from Japan that includes a chapter on financing, says Alex Lawrence, assistant dean of admissions and financial aid. Anderson makes no co-signer loans to about half of its international students.
Alternative lenders see an opportunity to address concerns over defaults as well as the longer-term prospects of MBA graduates. The emerging group of peer-to-peer lenders and crowdfunders, which include CommonBond and Upstart as well as SoFi and Pave, say their models offer a more attractive financial option as well as a social component that benefits – and obligates – borrowers and investors.
CommonBond’s and SoFi’s interest rates are about 6 per cent, lower than most federal or private loans, because they target MBA students and graduates from an elite group of schools whom they say are good credit risks.
Pave and Upstart tie payments to a borrower’s own financial success. They allow participants to accept money from investors in return for a pledge of a share of their income over 10 years. If a borrower does well, the backer receives the initial investment and more. If the borrower performs poorly no repayments have to be made in the years their income falls below 150 per cent of the US poverty line for Pave or below $30,000 for Upstart.
Income-based payments mean that a “prospect” cannot actually default and Pave co-founder Sal Lahoud says mentoring – including networking and job referrals – is a natural outgrowth of the financial relationship between borrower and investor. “I have an incentive to help him succeed,” he says.
“One of the most fundamentally broken things about student lending is that it’s done without understanding of a person’s ability to repay,” says Dave Girouard, Upstart founder.
Lawrence Cann, who is enrolled in Columbia’s Executive MBA programme – a degree for working executives – is one of eight participants in Pave’s initial round of funding, launched in December. He’s raised $40,000 from backers, which he has put towards tuition.
“I was trying to take on as little debt as possible,” he says, after graduating debt-free from college and starting Street Soccer USA, a non-profit that works with the homeless. “There’s not a huge downside to me – [Pave] enables me to take more risks and my backers can share in that, too.”