In Q4 2016, total outstanding student loans topped $1.4 trillion—that’s more than auto loans or credit card debt. The student loan debt market is now only second to the mortgage market in terms of size.
A major reason student debt has shot up is skyrocketing tuition costs. While the consumer price index climbed 44% since 2000, tuition has soared 151%. Students now graduate with an average of $33,000 in student loan debt.
Over 40 million Americans are burdened by student loans. Normally, this wouldn’t be an issue. However, given 45% of recent graduates are underemployed and 10% are over 90 days late on payments… it’s a big problem.
There is little respite for students as the rise in tuition costs show no signs of slowing. But a new lending model has emerged that could potentially revolutionize the student loan arena.
Student Revolution 2.0
Peer-to-peer (P2P) lending is a relatively new industry that enables individuals to borrow and lend money without using a financial institution. Online P2P lending platforms connect borrowers directly to lenders. This adds ease and speed to the process.
P2P lending has gained traction in the unsecured consumer space and is now doing the same with student loans. SoFi and CommonBond, the two-main P2P platforms that service students, have issued $8.5 billion in loans. Around $6 billion of that has been securitized by the likes of Goldman Sachs and Morgan Stanley.
While total issuance is a fraction of the $1.4 trillion student loan market, it’s growing rapidly. In 2015, Morgan Stanley estimated that P2P student loan issuance will grow at a 20% compounded annual rate through 2020 and account for 14% of this market.
It’s worth noting that the total potential refinance market for P2P student loans is really about $480 billion. The headline $1.4 trillion is reduced because around 40% of loans are too small, and 42% have rates that are too low to be refinanced using P2P.
So, what explains the brisk growth of P2P platforms?
A Helping Hand
P2P can help students in two ways. They can use it to consolidate multiple loans after graduating. They can also get a loan prior to graduating if enrolled in a qualifying graduate program.
Many new lenders have entered this arena recently, but let’s focus on the established platforms: SoFi and CommonBond.
Students who refinance with SoFi save an average of $288 per month and $22,359 in total. Variable rates range from 2.35%–6.28% and fixed rates from 3.37%–6.74%. SoFi has services beyond just lending, offering programs like unemployment protection.
CommonBond offers variable rates from 2.35%–6.27% and fixed rates from 3.37%–7.74%. Borrowers enjoy average savings of $15,114 when they refinance loans through the platform. The minimum loan is $5,000. The maximum is the full balance of outstanding qualified education loans. Terms range from 5–20 years on both platforms.
In comparison, the interest rate on Federal Direct Loans for undergraduates is currently at 3.76%. Borrowers also pay an additional 1.069% on each disbursement they receive. While this rate is below those offered by P2P lenders, the majority of student loans were made when interest rates were higher, with many students paying up to 8.25%.
In 2015, Goldman Sachs estimated that $211 billion in loans could benefit from refinancing. With issuance having grown since 2015, experts peg the number closer to $230 billion—almost half of the potential market.
While P2P platforms are small players in the student loan market today, their innovative approach could disrupt the traditional structure in the near future.
Today, the vast majority of students are Millennials (aged 18–34), and they are 10 times more likely than Boomers to use P2P lending. Millennials are now the largest generation in America… and that means P2P has huge growth potential. We think this demographic shift is a major reason P2P is garnering so much attention from traditional financial institutions.
With P2P offering students an alternative way to fund their education, how can investors share the action?
Unfortunately, investing in the student loan revolution is reserved for accredited investors. But fear not, returns on student loans only average 3%–5%. This is much lower than what retail investors can earn in the P2P unsecured consumer space.
Investors in P2P consumer debt have been earning steady returns north of 7% on 36-month loans and 9% on 60-month loans. The consumer space has enjoyed the most rapid growth of any P2P sector thus far. Goldman Sachs is even launching its own P2P platform, called Marcus.
Another incentive to invest in P2P loans is its ease of entry. You can set up an account in one day and invest as little as $25 per loan. Once invested, you begin receiving payments within 30 days.
Like all investments, there are many nuances to investing in P2P loans. As loans are unsecured, you must fully inform yourself on how to enter and navigate through the market.
You can download our free report, Welcome to the Bank of You, which details all you need to know about P2P and how to get started.
In closing, P2P has the potential to transform the student loan sector. Although retail investors can’t yet join the revolution, by investing in high-grade consumer loans they can earn annualized returns of 5%–7%. Download our free report and learn how to earn market beating returns.
Free Report Reveals: How to Join the P2P Lending Revolution and Earn Yields of as Much as 10.39%
Article By Stephen McBride, Garret/Galland