As borrowers go, you’d think an MBA student at Stanford University would be a lender’s dream. The school says fewer than 1 percent of its graduates defaulted on their loans in 2011, and 95 percent had jobs within three months of graduation. Yet Adam Potter, a former marine, couldn’t get a bank loan to help fund his second year at the Stanford Graduate School of Business without a co-signer. Then he heard about an unlikely source of money: the school’s alumni.
Within hours of submitting an application to SoFi, the startup that organized the alumni investors, Potter learned he’d secured a loan of $20,000 with an interest rate of 6.24 percent. “They had confidence I was a trustworthy client because I was associated with the school,” says Potter, who now works in San Diego for ADN Capital Ventures, a financial-services firm.
Mike Cagney, who founded SoFi in San Francisco last year, saw a business opportunity in the idea that not all of the record $1 trillion in student debt outstanding is created equal. Under the tag line “where social meets finance,” the firm raises capital from alumni of selective institutions to fund loans for current students or graduates who want to refinance—at rates that beat those offered by the federal government.
Prodigy Finance, based in London, has arranged $28 million in similar types of loans between alumni and students of the University of Oxford’s Saïd Business School and other MBA programs since 2007. This coming school year a new company called CommonBond, founded by a student at University of Pennsylvania’s Wharton School, plans to distribute $2 million in alumni-sourced loans to the school’s students. “We are certainly seeing more activity in this type of lending,” says Ankur Kumar, the school’s director of MBA admissions and financial aid.
Qualifying for a SoFi loan is meant to be simpler and more affordable than other options. Students don’t have to furnish a résumé, let alone the reams of documentation that other lenders typically require. SoFi runs a credit check; schools verify enrollment. Students can borrow at fixed interest rates of 6.24 percent—or 5.99 percent if they agree to have payments deducted automatically from their accounts. By comparison, the federal Stafford loan for graduate students carries interest of 6.8 percent, and the federal Direct PLUS loan, 7.9 percent. (On June 29, Congress agreed to extend a 3.4 percent rate on federal loans, but only for undergraduates.)
SoFi pays its alumni funders a 5 percent return and lets them invest through a 401(k) or IRA, making a SoFi fund more enticing than a money-market or savings account. In its first year the startup raised a little more than $100 million from about 100 investors, finding them through LinkedIn (LNKD) and word of mouth, Cagney says. The company has expanded from Stanford to business schools at Harvard, Penn, and Northwestern. Less than 1.5 percent of students at those universities defaulted on their loans in 2009, according to the most recent Department of Education data. “I’ve worked with [MBAs] from all of these schools, and I can’t imagine a scenario where one of them would not pay their student loans,” says Michael Xenakis, OpenTable’s managing director for Europe and a SoFi investor.
Mark Kantrowitz, publisher of the online guide FinAid, isn’t convinced the business can endure if interest rates improve, as that would give investors incentive to put their cash elsewhere. Says Kantrowitz: “This is a short-term opportunity.” But Cagney—who says SoFi will expand to 50 schools this coming school year and lend about $500 million—says the concept has staying power, not least because of the networking prospects. As David Bowman, a Stanford MBA who got a SoFi loan last year, puts it: “If I had to choose between borrowing from an institution or borrowing from alumni, I would pick alumni any day.”