As President Biden continues to taunt student loan borrowers with varying promises of debt forgiveness, at least one enterprising operation is capitalizing on what some are describing as a crisis.
Yrefy, founded in 2017, is putting together its fourth portfolio of refinanced student loans that are being converted into income streams for accredited investors willing to commit at least $50,000 for terms of between one and five years.
The strategy, which focuses on the portion of the $200 billion private student loan market that is delinquent or in default, won’t make a big dent in the $1.5 trillion government student loan market.
But it does present a path to loan repayment for borrowers in the private market, while getting the delinquent loans off the books of lenders and providing relatively attractive income streams.
For financial advisers working with accredited investors, the net annualized yields range from 6.25% for a one-year commitment to 10.25% for a five-year term.
From the investor’s perspective, the private placement offering works like a bond that distributes monthly interest payments, with the principal being returned at the end of the term.
The investor also has the option of turning off the interest payments and reinvesting that income back into the fund.
Citing the ability to reinvest income for compounding, Laine Schoneberger, managing partner and chief investment officer at Yrefy, said the strategy “could be considered fixed-income or a growth product.”
“We built this with the intention of taking it to RIAs and directly to consumers,” he added.
Despite the overall size of the student loan market, Schoneberger said he is only targeting the $21 billion slice of the private loan market that is in default, which he estimates includes about half a million borrowers.
Yrefy builds its portfolios through a multipronged approach that connects with both lenders holding the distressed debt and borrowers that are in default status.
On the lender side, Yrefy networks with banks, law firms and collection agencies to identify student loans that qualify for the investment portfolios and then negotiates to buy the loans for an average price of 35 cents on the dollar.
Yrefy also identifies distressed borrowers by pulling credit agency data, and then sends a letter to the borrower offering to refinance the loan.
The company also connects with borrowers by linking Yrefy to certain internet search terms that lead people to the website for more information.
Key to the strategy is refinancing the loan in a way that enables the borrower to keep making payments. To accomplish that, Schoneberger said borrowers essentially reapply for the loan through a refinancing process that results in an average interest rate of 3.9% and an average loan term of 8.6 years.
Yrefy is able to produce such attractive yields to investors because while it is buying the loans for 35 cents on the dollar, the borrowers are financing loans that represent 105% of the principal they owed when they refinanced.
While that might seem callous and even predatory to some critics, it’s important to understand that the borrowers are in or near default by the time they reach Yrefy and are at maximum usury rates, which can be north of 20%
As part of the refinancing process, the borrower is required to set up an escrow account to make between two- and six-months’ worth of payments while the loan is being processed.
Once the loan is approved, the money in escrow is used to pay down principal, which Schoneberger said is usually enough to cover the extra 5% added to the loan.
“We’re only looking for people who want out of this situation,” he said.
And because 70% of the loans have co-signers, Schoneberger said, “sometimes it’s mom or dad who is calling us to help refinance the student loan.”
The private student loans, just like the loans from the federal government, can’t be wiped out through bankruptcy. But Schoneberger said the same strategy cannot be applied to the much larger federal student loan market because of the constant risk that those could be all or partially cancelled. Plus, he added, “the federal government will not negotiate.”
The refinancing screening process, which Schoneberger compared to applying for a mortgage, has restricted access to only those serious about paying down their debt. And that, in turn, has supported the income streams to investors in the funds.
In five years, the default rate of Yrefy portfolio loans has been less than 2%, and more than 10% of borrowers are making extra payments on their loans.
“These borrowers are paying us back on time,” Schoneberger said.
And for that, the borrowers are seeing the benefit in the form of improved credit scores. Schoneberger said the average borrower comes to Yrefy with a credit score ranging from the high 400s to the low 500s, and within nine months the average jumps by 125 points.
For co-signers, who are often the underrecognized victims of student loan defaults, the average credit scores start in the high 500s to low 600s, and gain about 140 points within nine months.
“We’re taking subprime borrowers and turning them into prime borrowers,” Schoneberger said.
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