March 19, 2008 Comments

New Peer-to-peer Lender for Student Loans

Techcrunch has an article today about a new peer-to-peer lender for student loans called Fynanz. According to the lender FAQ, they will guarantee 50-100% of the loan if the borrower defaults. There are a few reasons why I have my doubts that Fynanz will work:

  • Interest rates on student loans tend to be pretty low. It will be difficult to attract students to Fynanz, when they can just get a traditional student loan at a lower interest rate.
  • If the rates do get bid down low enough to compete with traditional student loans, the rates may not be high enough to attract investors, even if a minimum of 50% of the principal is guaranteed.
  • As with traditional student loans, the term of the loans are long. At a glance, I looked at some of the loans and I saw them ranging from 10-20 years. This is an extraordinarily long time for an investor to lock up money in an illiquid investment. They will need to eventually provide a secondary market to provide liquidity, otherwise they will most certainly be doomed to the deadpool.
  • As with traditional student loans, borrowers have the option to defer payments. Many investors won’t like the idea of waiting for up to several years before receiving their first payment.

Time will tell if Fynanz will survive, and I will certainly be watching with great interest.

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    • Viewing 9 Comments

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      You're completely right about the 10-20 year lock-in being a turnoff. I could never imagine committing my money for such a long period without a cash-out option.

      I only popped by Fynanz a couple of days ago without studying it in-depth, but I'll treat it like every other P2P so far - an interesting experiment that really needs to react to the first few big issues and economic cycles it faces before it will really take off.
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      I don't know, if this was 3 years ago i would have checkout their rates . I was getting 8%.
      With all the interest rate cuts i don't think that they will be about to survive. Bad timing but a good idea
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      I read an article recently that speculated that the credit crunch may hit the student loan market next and that student loans will be more difficult to find, with cash strapped banks no longer falling all over themselves to fund student loans. If that's the case, it may have a chance, but I definitely share the same concerns. How wants a 10 year loan with no way to get out of it.
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      I just visited the site and discovered that their interest rates are variable!. They are linked to the Libor rate. So that provides some form of inflation protection, but also means that the rate could go down over the life of the loan.
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      Chrisfs:

      It seems that the interest rate has two components, the base rate and the margin. As you said, the base rate is based on LIBOR and the investors bid on the margin. My guess would be that as the LIBOR is adjusted up and down, the margin remains the same and the rates the investors receive remain the same as well. The loans will have to strike a careful balance in order to remain competitive for borrowers as well as provide enough return for investors.
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      "My guess would be that as the LIBOR is adjusted up and down, the margin remains the same and the rates the investors receive remain the same as well."
      I don't quite understand your meaning. If the Libor changes and the margin remains the same, the rate the lender is getting has to change.

      I took it to mean that the margin is what is bid down during the bidding process, but when the loan is made, it remains fixed and the rate the lender receives changes as the base rate (the Libor) changes. In this way, it would act very much like a credit card or variable rate mortgage.
      http://www.fynanz.com/help/faq/fynanz#q4
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      The total rate that the borrower is charged would be 1-Month LIBOR + investor margin + guarantee fee. For instance, if the 1-Month LIBOR is 2.72%, the investors bid the margin down to 8%, and the guarantee fee is 1%, the total interest rate the borrower pays is 11.72%. I don't think it can work the way you mentioned, because if the LIBOR were to go up high enough and investors bid the margin low enough, it would result in a negative interest rate for the investors.

      The guarantee fee works somewhat similar to PMI on mortgages. Once the borrower has enough equity in the loan (10%), they will no longer need to pay the fee. The guarantee fees are collected into a pool of funds just like insurance premiums, and the funds will be used to pay claims as defaults occur.
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      How would it result in a negative interest rate?
      The margin is either a positive number or zero, and it gets added to the Libor not subtracted, so you will always get a positive result. You will never get a negative interest, but you will get an interest that goes up and down through out the life of the loan. The blog Prosper Lending Review seems to see it the same way.
      http://prosperlending.blogspot.com/2008/03/fyna...

      I'll call them Monday and get it from the horse's mouth.
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      You're right, the borrower's rate will be adjusted as the LIBOR moves. I'm not sure what I was thinking. I believe the margin would always remain the same for the lenders though. Similar to how home equity lines of credit are usually tied to WSJ Prime plus some number. The "plus some number" always remains the same, but the underlying rate will adjust along with the WSJ Prime rate.

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