The Latest Twist in Student Loans

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Because of the credit crunch, conventional lenders are making it tough for any but the most creditworthy borrowers to qualify for private college loans. Now, a new breed of student lender is trying to get students to return the snub -- by writing off the Sallie Maes and Citibanks of the world in favor of relying on friends, family, and even perfect strangers to finance their college loans. "It's not a solution to the credit crisis in student loans by any means," says Mark Kantrowitz, publisher of financial aid Web site finaid.org. "But the idea of using peer networks to raise money is intriguing."

In recent months, peer-to-peer lending sites (BusinessWeek, 4/23/08) such as Prosper and Virgin Money USA have introduced student loans or started marketing existing offerings to families looking for college funds. Others, including startups GreenNote and Fynanz, are focused exclusively on making college loans. Analysts say the sites are benefiting from the confluence of trends -- a growing acceptance of peer-to-peer lending and fallout from the credit crunch, which has caused lenders who account for more than 20% of the market for private student loans to stop lending.

The general idea is to facilitate loans between students, on the one hand, and either Good Samaritan friends and relatives, or strangers intent on investing in alternatives to stocks, bonds, and certificates of deposit. The sites take very different approaches, though. Some, such as Virgin and GreenNote, mainly seek to formalize loans between friends and family members. Others -- Prosper among them -- allow borrowers to publicize the amounts they wish to raise and the interest rates they're willing to pay. Then, lenders -- friends or strangers -- bid on funding even a small portion of these loans. As the competition among bidders intensifies for a piece of a loan, the interest rate a student will have to pay declines.

Yahoo

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1. Some of that is approaching loan sharking levels

Zopa: When a student or parent applies for a loan, the site (zopa.com) runs a credit check. Zopa charges no fees but interest rates can be high -- some 8.5% to 17%, depending on a borrower's credit score. Where's the peer-to-peer angle? Borrowers can ask friends and family to purchase one-year CDs from the site. Those who do are required to devote at least 0.10% of the current yield of 3.75% to helping a borrower meet his or her monthly payments. Because some CD holders are willing to part with far more than 0.10%, a borrower may see his or her monthly interest payments wiped out. A few even pocket enough to help pay down principal. As with other CDs, these are insured against losses. And when they mature, the principal is returned to the investor. The loans, which must be repaid over five years, are capped at $25,000. This summer, the company plans to launch a student loan product with a longer repayment term.

One more hurdle to keep kids from doing better than their parents.

I paid 1.5% on my student loans in the late 70's

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2. The larger sharks left the market

BofA, Citi Scale Back From Student Loans

Some 60 companies have exited or pulled back from the market, putting pressure on remaining players.

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BofA and Citi's decisions have a domino effect on companies that specialize in the roughly $85 billion education financing market. Some 75% of federal student loans are issued by lenders that primarily raise money by bundling those loans into securities that institutional investors had bought.

The Street