How do student loan consolidation companies make money?

Michael Lux Blog, Consolidation, Student Loans 0 Comments

By now most borrowers have heard of lenders such as SoFi, Citizens, and LendKey… companies offering student loan refinancing and consolidation at interest rates well below 3%.  Interest rates this low give borrowers concern that these companies fall into the too good to be true category.

When a borrower is sorting through the many companies offering student loan consolidation services, it can be very difficult to separate the legit companies from the scams.  Today we will discuss the ways the legitimate companies make a profit and how savvy borrowers can potentially benefit.

The Big Rival: Federal Loans

While there are a ton of lenders offering student loan consolidation services, their main rival is the federal government.  In the United States, borrowers owe over $1.4 trillion on their student loans.  The federal government is owed well over a trillion dollars.

The federal government largely treats borrowers equally.  If you are a graduate student, the interest rate on your Graduate PLUS loan will be the same as other grad students.  Your credit score and ability to earn income do not play a factor.

In the private sector, ability to pay and credit score are major factors in determining a borrowers interest rate.  The private consolidation companies target the borrowers who can demonstrate the ability to pay off their student loans based upon their income and credit score.  These borrowers are significantly less risk, so they get a lower interest rate.

Essentially, the private companies are skimming the cream of the federal student loan crop.

Competition Among Student Loan Consolidation Companies

Over the last five years the student loan consolidation market has gotten much more competitive.  Five years ago SoFi was a year old company founded by a few recent business school grads.  Today it is a billion dollar company built largely on student loan consolidation.  Other new lenders to the student loan market include CommonBond, Earnest, and LendKey.

As the marketplace has gotten more crowded, lenders have been forced to lower interest rates to remain competitive with their peers.  This fierce competition is why we see lenders like LendKey offer $100 to new customers.  Not to be outdone, SoFi, CommonBond and Laurel Road all are offering $150 to new customers.

What this means for you…

As a taxpayer, this development isn’t ideal.  The most profitable loans that the federal government owns are ending up with private companies.

As a student loan borrower, this could represent an opportunity.  If you need an income-driven repayment plan or think you will take advantage of student loan forgiveness, you keep your loans with the federal government.  If you are sure you will be paying your loans off in full, you can start the bidding between companies to find out who will offer you the best interest rate.  Right now there are at least 10 national lenders in the business.

How do the student loan consolidation companies make money?

They target low risk borrowers with high interest rates.  They offer lower rates than the federal government because the government treats borrowers equally, and the consolidation companies can give special treatment to people with high incomes and credit scores.