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What SoFi's $1 billion news means for the student loan refi business

Mandi Woodruff
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Student loan refinancing juggernaut SoFi announced Wednesday it has raised a whopping $1 billion in its latest round of fundraising.

It’s a milestone for the San Francisco startup that nearly triples its haul from three previous funding rounds which altogether netted $365 million. CEO Mike Cagney says the influx of capital will help the company keep pace with its rapid rate of growth. Founded in 2011 by a group of Stanford Business School alumni, SoFi has funded more than $4 billion in loans and aims to top $6 billion by year end. Cagney says the company plans to grow its 400-member staff to 500.

In just a few years SoFi has led a wave of new startups looking to fill a void in the lending market for younger borrowers looking to refinance high-interest student loan debt. Their success is proof positive that consumers are hungry for alternatives. As it stands, federal student loan borrowers can consolidate their loans but can’t refinance to lower interest rates available today as one would with a mortgage. Meanwhile, companies like SoFi, CommonBond, LendKey and Earnest, and Darien Rowayton Bank, have stepped in and flourished by targeting a specific group of student loan borrowers: young, affluent workers with great credit who graduated from schools with low loan default rates.

For borrowers with graduate school loans, both SoFi and CommonBond (which is on track to originate $500 million in student loans by year’s end) work with borrowers who have earned a degree in a specific field like medicine, accounting, law, engineering, or finance. And that degree must be from a school on a list the companies have preselected. Compared to traditional lenders, these newer companies offer lower rates (fixed-rate loans at SoFi, CommonBond and DRB start as low as 3.5% compared to 6% charged by some credit unions).

These lenders have thrived on a customer base eager for refinancing alternatives. And with increased competition (there are well over a dozen companies, including banks and credit unions, in the space now), consumers can expect to see a shift in types of products being offered. SoFi began peddling consumer loans and mortgages last year, and predicts these loans will outpace its student loan business by December. In addition to student loan refinancing, LendKey offers home improvement loans and Earnest offers consumer loans. It's likely Commonbond will soon be in the mortgage and consumer loan space as well.

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“They’re offering something these retail banks aren’t offering, which is an enhanced approach to lending through a combination of better rates, a simple application process and exceptional customer service,” says Jon Riber, a senior vice president in the global structured finance group at credit rating firm DRBS. “I definitely think it’s a good thing they’ve received incremental capital to support a higher pace of growth.”

A unique perk offered by SoFi is a program that supports entrepreneurs looking for a break on loan payments while pursuing a new business venture. SoFi has offered six-month loan deferments to 40 entrepreneurs and new funding will help expand this offering, says co-founder Dan Macklin. The company also helps borrowers who are financially struggling or become unemployed through its Career Services team, which has matched 140 borrowers with new jobs.

“The funding is great news for borrowers—it will enable us to lower rates, create new products, improve the overall SoFi experience and deepen community engagement among our members,” Macklin said in an email.

Playing the long game

Growth in the refi market has been further fueled by widespread demand from institutional investors to securitize the pool of loans issued by companies like SoFi. Similar to mortgage-backed securities, the lender — be it SoFi or a private bank — packages student debts and sells them to investors who expect to get their money back, plus interest, as students repay their loans. SoFi was the first online refi lender to securitize student loans in 2013, raising $152 million in the process. It’s since raised $1.7 billion through a handful of securitizations. Darien Rowayton Bank and CommonBond followed suit in 2015, completing their first securitizations of $126 million and $96 million, respectively, according to DRBS.

Securitizations are simply another way for these companies to raise funds and issue more loans to borrowers, Riber says. “As competition heats up in this industry, lenders that can access the securitization market definitely have an advantage,” he says.

Because of these companies’ strict underwriting practices (borrowers need a minimum credit score of 700 or prove they have at least $2,000 in monthly disposable income), institutional investors generally see them as a safe bet. DRBS, Moody’s and Standard & Poor’s have rated SoFi’s securitization rounds favorably. The three-year default rate for all federal student loan borrowers is 11.8%, compared with 2.98% for SoFi borrowers, according to DRBS. More than half of SoFi’s borrowers earn at least $100,000 a year and have an average FICO score of 774.

The glowing ratings for student loan refi securitizations shouldn’t be confused with news last week that credit rating firms, including Moody’s and Fitch Ratings, placed more than $36 billion worth of student-loan-backed bonds on watch for a possible downgrade, as reported by the Wall Street Journal. Lenders like SoFi and CommonBond, which securitize private refi loans, are an entirely different beast, says Mark Adelson, former chief credit officer for S&P.

Unlike private loans, government-backed student loans are available to just about any borrower and have relatively loose underwriting standards (‘So you’re enrolled in college? Great. Here’s your money!’). Rating agencies are nervous about these types of student-loan-backed bonds because borrowers are more likely to default and, thanks to an expansion of flexible repayment plan options, may be less likely to pay back debts over the usual 10-year repayment period. Some income-driven plans can extend repayment periods up to 25 years. It’s possible to refinance federal student loans through SoFi and CommonBond, but in doing so the borrower is signing up for a private loan, has to undergo a tough underwriting process, and forfeits their eligibility for income-driven repayment plans.

In the meantime, we should expect to see continued growth from startups like SoFi, Riber says.

“The evolution of the online marketplace has challenged entrenched industries like retail banking for a reason,” he says. “Consumers don't have as much loyalty for retail banks anymore… and excitement, especially among millennials, for alternatives has been growing.”

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Mandi Woodruff is a reporter for Yahoo Finance and host of the weekly podcast Brown Ambition. Follow her on Tumblr or Facebook.