Today’s WSJ headlines with a story on how even the mass affluent are struggling with student debt. Our summer associate, Aaron Mercurio, has been working on a private student lending investment thesis for us, and opines the following:
We know student loans are important and we’re often reminded that they’re big business: The student lending market recently exceeded total credit card outstandings by surpassing $1 trillion in debt on the heels of $110 billion in new debt issued in 2011. Meanwhile, tuition increases don’t seem to be slowing down.
If students and parents are voting with their wallets, then federal loans are the preferred means of borrowing both for students and the universities that push them. 93% of new debt in 2011 was issued by the Department of Education under the Federal Direct Student Loan Program. But federal student loans come with a myriad of challenges:
Overview of Terms of a federally student loan issued after July 1, 2012 (simplified for brevity):
|Type of Loan:||Subsidized and Need Based (Stafford, Perkins):||Unsubsidized (Stafford, Direct, PLUS, Parent-PLUS)|
|Loan Amt. Limit||$3,500 – $6,500 / year||Based on school tuition + expenses|
|Interest Rate||3.4% – 5% Fixed||6.8% Fixed|
|Origination Fee||0% – 1%||Up to 4% (w/ 1.5% rebate)|
|Collections||Cannot be discharged in bankruptcy, wage garnishment allowed|
Source: Department of Education, Direct.ed.gov website
The average student has $25,700 in debt, including graduate school debt, according to the Department of Education. While subsidized Stafford/Perkins loans are attractive – students need to qualify and it may only cover a small amount of tuition.
Key issues with Federal Student Debt today:
- Not all loans are created equal: Fixed, flat rate loans are inefficient; don’t account for risk, macro-environment, or student/university performance
- Lack of price competition: Up to 4% origination fees and fixed-rate loans in a market where prime has remained flat at 3.25% since Jan, 2009
- Extreme collection practices: Defaulters are almost never able to discharge loans in bankruptcy and co-signers credit is impacted
- Inconsistent borrowing caps: Like the rates, desire for simplicity creates inefficiency in terms of meeting students’ individual borrowing needs
The silver lining? Major problems drive major opportunities, and this market is ripe for innovation. With start-ups like Fynanz creating a platform for credit unions to aggregate lending power to compete, SoFi connecting alumni with current students to create lower cost opportunities, and Tuition.io providing sophisticated software for managing student debt and repayment, I’m excited to see if these and other companies can drive the PSL market and compete head-on with federal loans.