The Millennial Lending Revolution
In the brave new world of millennial consumer finance, loans will be flexible, transparent, and hyper-personalized.
The Future of Money visited SoFi’s offices in San Francisco’s Presidio to meet the team of millennials responsible for designing the future of consumer finance. Here’s what we found out.
There’s a tendency toward abstraction in discussions about personal financial services — who offers what, at what rate, to whom — that often underemphasizes what these services are for: to help people get to the life they want. Our financial system was designed to help us do this — to free up capital for productive purposes — but the nature of our economy is rapidly changing. Young, ambitious, entrepreneurial women and men are flocking to major American cities, working in fields that may not even have existed 20 years ago.
Yet, for all this opportunity, there are also new challenges: student loan debt nearly quadrupled between 2003–2013, and housing prices in many major American cities have increased at a rapid pace. It’s not clear that traditional, large financial institutions — never the most nimble organizations to begin with — have adjusted their practices to reflect these new realities.
Is it possible to make personal financial services— one of the oldest and most deeply entrenched industries in the world — simultaneously more secure and more flexible? The Future of Money visited the San Francisco headquarters of financial tech company SoFi to understand the deep changes in consumer finance in the millennial age.
Amanda Wood is SoFi’s Director of Business Development. Unlike many brand evangelists, Amanda actually practices what she preaches: not only does she work for SoFi, she uses its original service, refinancing her student loans with the company. “The biggest problem with federal student loans today,” Amanda says, “is that the interest rate is the same for everyone; they don’t underwrite based on a person’s financial history or likelihood of repaying the loan in the future." She explains that financially responsible people who don’t default on their loans end up “subsidizing interest rates for people who are going to school and not graduating, not getting a job, or just choosing to not repay their loans.” This bucket of risky borrowers is larger than you might think — the estimated lifetime default rate for 2015 is 22.2% for Stafford loans.
SoFi’s solution to this problem is simple: eliminate the biggest drivers of student loan default from the people they select to refinance.
“Two of the biggest drivers of student loan defaults are whether or not the person graduates and whether or not they get a job. So we wait until they graduate and we wait until they either have started their job or just have a job offer letter that they have accepted and that has a stated salary. And amazingly enough, we don’t have a lot of people who [default].”
SoFi began at Stanford Business School, where students are very likely to graduate and find a job. The founders raised a fund from Stanford alumni to lend to current students. If a borrower lost their job, the alumni were incentivized to help them find a new one (thus the “social” in Social Finance). This early dynamic deeply informs the company’s conviction that a lender’s success must be bound up with its customers.
Amanda attributes the the company’s growth to this deep alignment with members’ lives and life goals. SoFi calls its customers “members” instead of “borrowers” because the latter implies an unequal relationship, in which the borrower simply owes the lender.
“[Ours is] a philosophy of mutual benefit and ‘holistic wellness’ in financial health.” This idea seems intuitive, but it’s not how finance companies have traditionally functioned. Amanda notes, “We call our borrowers ‘members’ because we’re vested in their success; and, honestly, the more successful they are, the more successful we are. Not only do we want to see them succeed, but from a business perspective, we succeed if they succeed.”
But student loan refinancing only captures one dimension of the changing landscape of millennial consumer finance.
Here’s a familiar scenario: you’re a college-educated millennial living in a Big Expensive City. You’ve got your onerous student loan debt paid off or at least under control, but you have a gnawing feeling that you’re stuffing money down the toilet, or throwing it out the window, or lighting it on fire, every month when you pay the rent. You want to buy a home, but the barriers to entry seem insurmountable, because you traditionally need at least 20 percent down to get approved for a mortgage. And in your city, where one-bedroom apartments routinely sell in the mid-to-high six figures, it’s extremely rare — no matter how financially responsible you’ve been — to have that kind of cash lying around.
“A lot of people talk about millennials not wanting to buy homes. But the reality is that the products and process and experience for millennials isn’t good, and we’re trying to change that. ”
Michael Tannenbaum thinks he may have the answer. He’s the guy who oversees mortgages at SoFi. He also helped lead SoFi’s billion-dollar investment round from Softbank Capital. Michael — who is young, energetic and whip-smart — joined SoFi in 2014 as VP of Finance. He was responsible for everything from financial operations and loan investor reporting to treasury. Now — along with mortgages — he oversees institutional investor relations and corporate development. His early experiences as an associate at a private equity firm and an analyst at J.P. Morgan no doubt color his understanding of SoFi’s position in the market.
Michael believes in what he calls a millennial approach to mortgages. “A lot of people talk about millennials not wanting to buy homes,” Michael notes. “But the reality is that the products and process and experience for millennials isn’t good, and we’re trying to change that.” What that means in material terms is the ability to get a mortgage of up to $3 million by putting as little as 10% down. Now, this sounds like a lot — and it is — but money doesn’t go as far as it used to in the housing market. SoFi is betting hard on a (largely) millennial pool of educated mortgage-seekers to bite on the offer and follow through. If they succeed, the entire narrative around millennial home ownership could change.
“What we’re trying to do is help our customers who often do live in major markets with both expensive and competitive real estate markets buy homes.”
“Our offer — our pre-approval letter — is as good as cash. So once you’re pre-approved, we’re willing to waive some of the appraisal contingencies and other things that tie up the process to help you compete with cash buyers.”
This raises the question: how can SoFi can offer these benefits without requiring mortgage insurance or charging lending fees?
“We’ve proven out the model with student loans, which are actually riskier than mortgages,” Michael explains. After all, mortgages are backed by a home — which cushions the risk. Put in financial terms, student loans are uncollateralized: they rely solely on a borrower’s credit history rather than a piece of collateral. “When we pioneered the student loan refinance product and were able to lower people’s rates, people said, ‘The student market has so many problems, how can you do this?’ But we designed an entirely new type of financial product and were able to convince the markets, and now we’re doing it for mortgages as well.”
This model — lowering fees for members by eliminating the risk that banks subsidize with fees and higher interest rates — extends into personal loans as well. Alan Donner, a Product Marketing Director at SoFi, explains this in the context of origination fees and prepayment penalties — neither of which are attached to a SoFi loan.
“Economically it makes a lot of sense for a lender to charge an origination fee,” Alan explains. These fees allow a lender to advertise an interest rate on a loan that is different from the actual APR, which will include fees. Furthermore, he tells us, “[banks] originate loans with the expectation that they’re going to be making interest over the life of that loan, and so if someone pays it back early, they’re getting less in interest. That’s a situation in which the customer’s interest is not aligned with the lender’s interest.”
The future of consumer finance sketches out a landscape in which the barriers of entry are lower, and the process more transparent. For a generation of working millennials who feel disenfranchised by the current system, SoFi’s working hypothesis (“if our members succeed, we succeed”) flatly contradicts the dominant logic of the financial services industry. It effects a kind of quiet revolution, and sometimes that kind of revolution ends up being the most effective.
In the next installment, The Future of Money looks at how millennials are building community through “social finance.”
Sponsored by SoFi, The Future of Money is a series of stories that explores a world in which banks no longer control our finances. Learn more at SoFi.com.
