With banks scrutinizing loan applicants with renewed fervor, students who need money to cover college tuition could start looking to friends, family, and social networking for cash.
Two start-ups are banking on the premise, with Web sites that help college students secure small loans for school from relatives, close friends, and their extended social networks. Their timing couldn't be better, given that banks and other private lenders are pulling up stakes on risky loans (e.g., those granted without a proven credit history) and students need to bridge the gap between a $40,000 tuition bill and a $20,000 government loan.
One such start-up, Redwood City, Calif.-based GreenNote, will officially launch its service Tuesday to help students solicit as little as $100 from friends and family at an interest rate that's on par with subsidized government loans. For a percentage fee, the site legally formalizes what would otherwise be a transaction sealed with a handshake or nod. Its rival, Fynanz, launched in March.
"They're essentially playing the role that banks had in the past," said Forrester Principal Analyst Brad Strothkamp. "Banks have tightened up lending standards, so if you're looking for a small loan, and you don't have a credit history, this may be the only option."
GreenNote and Fynanz are carving out a new niche in the growing market of person-to-person lending online. At least a half a dozen sites, such as Prosper.com and Zopa, have launched in recent years to help people secure "microloans" from individuals so that they can consolidate debt, start a business, or finance a car. The most well-known of the bunch would be Virgin Money. Then there are more charitable microfinance sites, such as Kiva.org, which connect investors with entrepreneurs in third-world countries.
Analysts say that microloans for students may make the most sense, given that teens and 20-somethings are most comfortable with the Web. Strothkamp said he's found through research that student loans are the product most likely to be applied for online. But, he said, lenders are likely older and less comfortable with tying their money to an unknown or unproven Web site.
"The student population is very Internet savvy, and this is closer in line with what those individuals want," he said. "The big question is whether (other) consumers will accept it...It's something to be watched, but it's going to take years before this takes off," Strothkamp said.
Akash Agarwal, CEO and founder of GreenNote, said he's applied some of the core principles of microfinance and social networking to the U.S. student loan market, which is worth about $100 billion annually. About $25 billion of that, he said, comes from private loans that can cost students anywhere from 11 percent to 20 percent in interest annually--and those loans have dried up in the credit crunch. With his site, students can get a government-loan rate of 6.8 percent from friends and family.
"We look at the student as an entrepreneur," said Agarwal. "People already help each other informally. We're trying to make it more efficient and take the stigma of asking for a handout and turning it into a loan."
Unlike traditional banks, GreenNote doesn't require a credit report, a co-signer, or proof of citizenship from the loan seeker. Rather, the student creates the equivalent of the college essay, Facebook-style page, with information on their school history, college they're planning to attend, areas of study, extracurricular activities, and other hobbies. They also attach a dollar amount they're looking to raise for school.
Once a member has lined up investors, GreenNote will perform checks on his or her lenders to ensure that they're legitimate. It will also call the student's university to confirm that the individual is enrolled and that the money will be used for the student loan. GreenNote then creates a promissory note between the student and lender.
Students get a fixed interest rate of 6.8 percent and are allowed to defer their payment for up to 5 years, as long as they're in school. They have 10 years to repay the loan without penalty. And GreenNote will send out reminder notes about the loan agreement, or help students publicize the progress they're making in school to their social network of lenders.
Christina Christopher, a single parent living in Abelanto, Calif., recently filled out a GreenNote profile to raise $2,050 to complete her MBA at nearby Keller Graduate School. This spring, she had found out that she didn't qualify any longer for Stafford loans because she's met the total amount allowed of $130,000 during her undergraduate and graduate years. She called the school to find out about other options and the office pointed her to GreenNote.
After filling out the profile, she sent an e-mail advertising her GreenNote request to everyone she knows, and the people that they know. So far, she's raised about half the amount from several individuals, including people she doesn't know.
"Everyone has surprised me," said Christopher, who wants to be an HR director when she's done with school. "In my experience of searching for financial aid with grants and scholarships, this service is meant for someone like me."
The company makes money by charging the student a one-time fee of 2 percent on the loan for processing documents. Then it also charges the lender a fee of 1 percent on the loan on an annualized basis, until it's paid in full. If the student defaults on the loan, the site will inform the credit authorities and transfer the debt to a creditor.
GreenNote has raised $4.2 million from Menlo Ventures, among others, and it plans to complete another round of financing later this year. It also has an impressive board of directors, which includes Bill Harris, the former CEO of Intuit. The company currently has 15 employees.
Still, student lending hasn't taken off on other person-to-person lending sites. Student loans on the site Prosper.com represent only about 2 percent of the lending contracts, according to CEO Chris Larsen. But the company doesn't offer Stafford rates, and college kids must start paying the loans off immediately through a Prosper contract, unlike GreenNote. Prosper largely caters to people aiming to consolidate debt or start a small business, and it has helped individuals lend about $145 million to people in need over the last two years.
Because of the credit crunch, more students are looking for individual loans, Larsen said. He's seeing an uptick in that niche.
"Student lending is the other shoe that's dropping in the credit crunch. So many lenders have exited, and peer-to-peer lending has the opportunity to fill that void," said Larsen.