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How Do Student Loan Refinance Companies Like SoFi Make Money?

Understanding how student loan refinance companies make money can help borrowers find the best deal and avoid scams.

Written By: Michael P. Lux, Esq.

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Before doing business with a student loan refinance company, it is good to know how they make money.

The world of student loans is full of scammers offering borrowers opportunities that are too good to be true. As a result, borrowers have to be extra careful with many student loan-related decisions.

Today we will peel back the curtain on refinance lenders and explain how they turn a profit.

Holding the Loans and Profiting Off Interest

Many borrowers wonder how a company can profit by lowering interest rates.

The key detail is time. If a borrower has a $30,000 loan at an 8% interest rate, they might be able to refinance and get a 5% interest rate. When the refinance lender pays off the old loan, they pay off the entire balance. At the point the loan is paid in full, it stops generating 8% interest. Meanwhile, the borrower now has a new $30,000 with the refinance company. That refinance company collects 5% interest on the new loan.

In this scenario, the borrower benefits because they get a lower interest rate, and the refinance lender profits on the 5% interest. The only loser in this situation is the original lender, who loses out on the opportunity to collect 8% interest.

Surprisingly, this revenue strategy is becoming increasingly rare in the student loan refinance marketplace. Lenders still using this traditional business model are bank-based lenders such as Laurel Road and ELFI.

Selling Loans as Assets to Investors

Many of the tech-based refinance companies use a different strategy to make money. These lenders package loans into large groups and sell them to investors. The investors pay an upfront cost to get the monthly payments made on the loans. This is the securitization process.

In this scenario, the investors get the revenue from the interest, and the refinance lender gets cash upfront for the loan.

While this process may sound unnecessarily complicated, it doesn’t usually impact borrowers. From the borrower’s perspective, the loan servicer stays the same, and the loan contract terms do not change. The only difference is where the interest profits ultimately end up.

Many tech lenders prefer this approach because it gives them a steady flow of cash coming in and allows them to refinance more loans. Companies that use this strategy include SoFi, CommonBond, and Earnest.

Connecting Borrowers to Lenders

Other refinance companies profit by getting a commission for connecting an interested borrower to a lender.

Some companies lean into the marketplace model like Credible. Part of the credible sales pitch is that it is a one-stop location to check out many refinance lenders.

Other companies advertise under their name but use many different lenders to fund the loan. This is how Splash Financial works. This approach helps Splash offer some of the lowest rates on the market.

Finally, there is the LendKey approach. LendKey works with a nationwide network of smaller banks and not-for-profit credit unions. LendKey connects interested borrowers to these smaller lenders that don’t have the resources to advertise on their own.

How Does the Way Refinance Companies Make Money Impact Borrowers?

There are two major takeaways for borrowers.

First, seeing the different approaches helps explain why rates change with various lenders. For example, if there is a ton of investor interest in student loan products, the tech companies will offer very low interest rates.

Second, this knowledge should help borrowers shop around more efficiently. If you want to qualify for the best refinance rate possible, a smart strategy would be to check rates with multiple lender types. Investor interest may push rates with the tech-based lenders up or down. If you apply with CommonBond, SoFi, and Earnest, it might seem like you have shopped around, but in reality, you have only checked with one corner of the market.

If you understand how the various refinance companies make money, you can be a more informed consumer.

About the Author

Student loan expert Michael Lux is a licensed attorney and the founder of The Student Loan Sherpa. He has helped borrowers navigate life with student debt since 2013.

Insight from Michael has been featured in US News & World Report, Forbes, The Wall Street Journal, and numerous other online and print publications.

Michael is available for speaking engagements and to respond to press inquiries.

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