Silicon Valley Sees Business Opportunity in Student Loan Mess

PALO ALTO, CALIF. — Upstart is no Sallie Mae. The two companies manage student loans, but that’s where the similarity ends.

Far from the stuffy corporate culture of East Coast financial institutions, Upstart feels unmistakably Californian. An office dog roams the company’s Silicon Valley headquarters, and a pool table beckons employees to roll up their sleeves. Employees dressed in jeans walk into the office around 10 a.m., and their business cards boast unorthodox job titles such as “Marketing Ninja.”

There’s a reason Upstart feels like a tech startup: it was launched in 2012 by ex-Google employees and a Peter Thiel fellow who dropped out of Yale. Two year’s later, it’s one of a growing number of new alternative-lending companies entering the student loan market, traditionally dominated by beltway insiders and old-money behemoths.

Whereas many view the nation’s student debt problem as a mounting crisis, Silicon Valley sees a business opportunity. And they’re tapping a huge market; some 40 million Americans are coping with $1.2 trillion in student debt.

Upstart and other West Coast companies such as Social Finance (SoFi), based in the same swanky San Francisco office complex as Lucasfilm, are able to venture into the student-debt market thanks to deep pockets. Since it’s launch in 2011, SoFi has issued $600 million in loans to more than 7,000 borrowers, according to co-founder and CEO Mike Cagney.

SoFi, which is already profitable, recently secured $80 million in Series C funding from well-known billionaire Peter Thiel and major hedge funds including Discovery Capital Management. It’s an early front-runner in this growing marketplace, but others are quickly getting in the game.

Upstart and SoFi were recently joined by Santa-Monica based Tuition.io, which launched in early 2013. But not all the newcomers are based in California. Boston-based Prime Student Loan entered the market about a year ago, and Brooklyn-headquartered CommonBond has been on the scene since 2011.

The companies claim to offer better loans, better interest rates, and better services.

Though they vary in style, their M.O. is the same: identify borrowers who are likely to repay a loan and reward them with a low-interest rate.

SoFi, for instance, lends primarily to well-employed graduates to refinance existing student loans. Upstart is also looking to lend to safe-bet recent graduates by looking at GPA and other factors like employment history. The company thinks that certain young people, even those without long credit histories, are worth the investment.

“Intuitively, it just makes sense,” said Paul Gu, co-founder of Upstart. “The same sort of person who is going to care about their GPA in college is later going to care about their FICO score. That same person tends to be somebody who is very organized and is going to be disciplined with their money.”

The loans from these companies are great if you can get them. The interest rates are competitive, and an actual person answers the phone when borrowers call with a question. Some of the companies even offer advice if you lose your job.

But not everyone is eligible. The alternative lending market is managed with the exclusivity of a velvet-rope nightclub. Most loans are given to those who have already graduated and been employed — meaning the borrower has already cleared two of the biggest hurdles that would prevent him or her from repaying their loan.

Most of the two-thirds of college students who borrow money to help pay for college are left to slog through the federal loan bureaucracy, or to take out costly private loans from companies that are less-than-flexible.

Brandon Wolfe, an investment firm employee in New York who borrowed from Sallie Mae before refinancing with SoFi, said he had trouble getting any human response from Sallie Mae when he had questions. SoFi, he said, bent over backwards to help. It was “my first positive borrowing experience,” he said.

Wolfe said he first heard about SoFi when he was a J.D./M.B.A. candidate at nearby Stanford University. The company was born out of a fellowship that Cagney, the SoFi CEO, did at Stanford’s business school, while Wolfe was studying there.

“One of the things that was very apparent to me was how broken the student lending marketplace was,” Cagney said. “In particular, I was looking at a lot of my fellow graduates who were coming out of school not being able to pursue their ideas of entrepreneurialism or other aspirations, and then going into jobs to pay their loans. That was the catalyst.”

The company prides itself on not only its product, but on the sense of belonging it offers its customers.

“We’re providing a very strong community support for the borrower,” Cagney said.

The government can never compete with the “cool factor” of startup culture, and it’s never going to be as selective about who can borrow. But critics of the loan system say something needs to be done to help students. These new companies work precisely because they have figured out ways — from data analysis to strict limitations on who they work with—to minimize risk. SoFi isn’t really interested in lending to an unemployed archeology major (although Cagney says his employees would be interested to hear all about dinosaur bones).

Private lending companies are not trying to substitute the role of the federal government in the student loan market. The private lenders do business by picking “certain schools and certain programs to help those folks,” said Brian Stewart, a spokesman for Generation Progress, the youth arm of the left-leaning Center for American Progress.

“It is really important that the federal government gets involved because the federal government will be able to offer resources and relief to low-income borrowers who may be going through a period of unemployment, whereas private companies may not be offering them any relief right now,” he says.

Lawmakers such as Sen. Elizabeth Warren (D-Mass.) have turned their attention to addressing student debt and college affordability. But they’ve failed to drum up enough bipartisan support for their proposals to gain much traction. A Warren-sponsored bill to allow borrowers to refinance their loans failed—in part—due to Republican resistance to more taxes on wealthy Americans.

President Obama would like to tie federal aid to graduation and employment rates, so that schools that fail to graduate employable young people lose access to federal student loan money. But that will take an act of Congress, and the proposal has faced steep opposition from colleges and universities.

Companies such as Upstart are not going to solve the greater problem of rising student-loan debt, Gu says. The private sector aims to address a narrower aspect of a giant, non-competitive market.

“I don’t think that we’re going to be able to solve the entire student loan problem or the entire debt problem,” he said. “I don’t think any private sector company is going to be able to do that. But I think that for certain parts of the problem, we will be able to do a much better job than any public institution and we’ll be able to do it much faster.”

Despite their limited scope, the new start-up businesses are already starting to transform what former Sallie Mae borrower Wolfe calls “a noncompetitive service market.”

“They don’t have to try,” Wolfe said of most major student loan providers. “There’s going to be a lot of innovation in this space.”

Geneva Sands and Sara Hussain contributed reporting.

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