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Sherri Cruz

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SoFi's Novel Approach to Student Debt

Sherri Cruz, Business Journalist 5/24/2012 33 comments
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Social Finance Inc. offers investors a way to earn 5% to 8% in return for helping cash-strapped students. The premise of SoFi, as it's known for short, is that successful alumni will fund the education of current students, as long as they receive reasonable returns on their investments.

In the world of social investing it's called a "double bottom line" because there is a financial reward and a social reward -- something that helps lift a community of people and solves a social problem. Social investors consider both to be equally important. Otherwise, it's just philanthropy. "For double bottom line to work, you need to have an economic return that stands on its own," says Mike Cagney, co-founder and chief executive of San Francisco-based SoFi. Social investing comes in a variety of forms, such as micro lending and venture philanthropy. Some social investments have a "triple bottom line," meaning positive social and economic returns as well as favorable environmental effects. And there are other companies similar to SoFi, including Collanthropy LLC. "The reason we decided to focus on student loans is because it's a $1 trillion industry but completely broken," Cagney says. SoFi connects students attending participating schools with potential investors. The investors have the option to engage with students if they like, perhaps by mentoring students, providing career guidance, or eventually tapping them as future hires. "We want to encourage interaction but not make it contrived," Cagney says, adding that SoFi gives investors interested in creating relationships the tools to do so.

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How does SoFi work? Investors -- alumni of a particular school -- pool their money to lend to students who attend their alma mater. The investors will share in the returns when the loans are repaid. The investment opportunity is open only to alumni, which bolsters the social aspect of SoFi. The idea is that alumni, who care about a particular school and its students, are more likely to be involved, which makes the students more likely to pay back their loans. "It yields to a better set of behavior than what you get out of an anonymous student loan program," says Cagney. "We're borrowing from micro-finance -- you don't want to default on your own community." Transparency is key, notes Cagney. SoFi investors will always know the status of a given student loan repayment. To lessen the possibility of loan defaults, SoFi has only established loan programs at schools that have low student loan default rates. These are schools the SoFi founders define as ones where students get "fair market" value for their education -- in other words, where the education is worth the tuition and students graduate with a debt burden that isn't so large that they end up defaulting on their loans. "This program works really well in schools where students are graduating and are able to service their debt. We think it's a signaling mechanism to the school to think about the level of debt versus the education value to the student." Last year, when SoFi was founded, it piloted a $2 million program at Stanford University's Graduate School of Business, in which 40 alumni funded loans for 100 students. In the first half of this year, SoFi will be lending $100 million in refinance (consolidation) loans across five schools: Harvard Business School, Kellogg School of Management at Northwestern University, MIT Sloan School of Management, Stanford Graduate School of Business, and the Wharton School at the University of Pennsylvania. In the second half of the year, SoFi will broaden its refinance lending to $400 million in at least 40 schools, for a total of $500 million in loans. Next year, SoFi is targeting lending programs at 325 schools. Right now the program is limited to accredited investors, but that restriction could be lifted in the future, according to Cagney. SoFi has two programs for investors, who have the option of investing through a tax-deferred IRA or a 401(k): 1. A whole loan finance program, where investors are considered "whole participants" in the loan pool. For example, if 10 investors chip in $100,000 each, it's a $1 million pool, and each investor owns 10% of the cashflow of the loans, which spreads the risk.

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2. A refinance program, where SoFi uses the pooled capital to refinance student loans for graduates. Refinance loans are funded by both alumni and institutional investors, but alumni investors earn a higher rate of about 8%. For enrolled students, the loan interest rate is 6.24%, and a consolidation loan for graduates has a 5.99% interest rate. Both rates are lower than unsubsidized federal student loan rates and most private loans from lenders. SoFi makes money on the difference between the interest rate the student pays and the investors' return, or about 1%. This year, SoFi has the potential to loan $500 million with a 1% spread, equal to about $5 million in revenue. What do you think of the concept? Would you be willing to invest in students attending your old school?
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Re: Details and the devil chapAnjou 5/31/2012 1:13:11 PM

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@mInvestor, well, sadly I'm nowhere near that point, so I'll be holding off as well. I'm closer to trying to tap the funds than dole them out haha.

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Re: alumni involvement and understanding chapAnjou 5/31/2012 1:11:17 PM

"I am as philanthropic as the next person but I prefer to give to organizations that I understand the dispersion of funds and the implications."
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@impactnow, I agree but I also have to say that I appreciate the weird dichotomy going on here where you have the rich people involved in a venture with a grassroots vibe to it.
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Re: Details and the devil mInvestor 5/31/2012 12:52:01 PM @cahpAnjou, Yeah, it's too bad this is only for rich people.

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Before I become an accredited investor, I won't spend too much time to look into this.
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Re: alumni involvement and understanding mInvestor 5/31/2012 12:50:06 PM @impactnow,

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The SoFi program is limited to accredited investors only. That means you can get more info only when you are qualified for it. Hehehe... a strange regulation from government.

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alumni involvement and understanding impactnow 5/30/2012 11:20:04 PM

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I agree that it's a good option for those already wanting to contribute as an alumni but I would want to understand the value and risks of my investment in much more detail. I am as philanthropic as the next person but I prefer to give to organizations that I understand the dispersion of funds and the implications.
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Re: Details and the devil chapAnjou 5/30/2012 11:12:11 PM

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@mInvestor, you bring up some very good points about the money involved here. The funny thing is I totally glossed over where they mentioned Stanford, so you're totally right about what kind of alumnis they'd be able to tap for investing. It's also just nice to know that there are people out there with money that are putting towards something legitimately worthwhile.
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Re: Student Loan industry is broken chapAnjou 5/30/2012 11:09:34 PM

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"Never mind that a particular student may have a richer, better future by spending their first year in USER RANK IRON

1. 2. 3. 4. 5.

Semi-professional sports or Pursuing a career in acting or music or Traveling internationally or Starting a small business or Joining the military"

Reading this, it makes me feel like students should be encouraged to take a year off from school and do something else for a while. It's amazing how liberating it is to realize there's no more school and that you're able to focus your attention on something that's personally rewarding. It's this approach that led to me web programming - I honestly program in my free time (for money or for fun) because I genuinely love it and not because a curriculum is forcing it down my throat.

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Re: Student Loan industry is broken chapAnjou 5/30/2012 11:05:32 PM

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"Most High School counselors are focused on increasing the % of graduates that go on to college. This is viewed as a measure of success for their high school."
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@PredictableChaos, there's the problem right there! As someone who took a very non-traditional path to a college degree, I can honestly say that this broken system is why something like SoFi is both a breath of fresh air and a sign that something is seriously wrong. This is why I said earlier that I think high schools should teach about options in life post-high school that don't necessarily involve college. I went to college because it was the logical next step and all I have to show for my initial attempt is a waste of $5000...and that's absolutely nothing compared to what it could have been (and eventually became with attempt #2, sigh)
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Re: Details and the devil mInvestor 5/30/2012 10:16:36 PM

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The program is limited to accredited investors, that is a million dollar requirement. So the investment probably won't be just $100. And from the post, 40 investors loan moeny to support 100 students. That means significant money. So I guess it's not easy to use this program to replace donation program. And not many people can actaully invest in this program. No wonder SoFi started from Stanford business school. You will find more almini there to be able to invest in this kind of program. Still I think this is a great idea to help students in needs and may provide some ROI for lenders.

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Re: Student Loan industry is broken PredictableChaos 5/30/2012 12:36:02 PM @ChapAnjou,

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Most High School counselors are focused on increasing the % of graduates that go on to college. This is viewed as a measure of success for their high school. Never mind that a particular student may have a richer, better future by spending their first year in 1. 2. 3. 4. 5. Semi-professional sports or Pursuing a career in acting or music or Traveling internationally or Starting a small business or Joining the military

All of these options will be discouraged by most HS counselors, who just want everyone to start at a college.
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