Refinanced student loans offer significant returns and risk

With stocks, bonds, and crypto struggling these days, wealth managers looking for the next investment opportunity with attractive returns can turn to an unlikely alternative: student loans.

Yrefy, founded in 2017, is building its fourth investment portfolio of refinanced distressed private student loans that are converted into income streams for accredited investors, who can commit at least $50,000 for one to five years. The company charges borrowers a 5% refinance fee on its reconditioning service, allowing borrowers to reapply for a new consolidated loan with an average interest rate of 3.9% and an average loan term of 8.6 years .

Yrefy offers annualized investment returns ranging from 6.25% for an investment term of one year to 10.25% for an investment term of five years in a secured and collateralized portfolio, significantly higher than the rate of five-year cash flow of approximately 2.7%. Yrefy is able to produce such returns because, while it buys distressed loans for around 35 cents on the dollar, borrowers refinance into new loans that are 105% of the principal they originally owed.

“We decided we needed to build something that would appeal to both the independent registered investment adviser, as well as direct consumers,” said Laine Schoneberger, chief investment officer and managing partner at Yrefy. “The financial advisor or investor can invest in any or all of the five individual investment tranches and can choose to earn interest or compound income monthly, giving full control to the RIA or the investor .”

While federal and private student loans are protected from bankruptcy, the Biden administration clarified that the extension of student debt forbearance only applies to federal loans, not private loans, which essentially renews the financial stress of students who have borrowed from private lenders and increases the demand for refinancing of struggling student debt. Schoneberger said Yrefy saw a 66% increase in call volume as a result of the private student loan debtor policy.

The United States alone has about $1.76 trillion in outstanding student loans from 46 million borrowers, according to government data. Despite the overall size of the student loan market, Schoneberger said Yrefy is only targeting the $21 billion slice of the defaulted private loan market, which he says comprises about half a million borrowers.

“We have a huge market ahead of us, and everything is available to us right now,” he said.

Student loan asset-backed securities are based on outstanding student loans that offer scheduled coupon payments much like a regular bond. The objective is to offer better access to borrowers and an additional financial instrument to investors.

However, the ability of this industry to sustain itself will depend on the ability of a sufficient number of borrowers to repay their debts. Although they often come with a higher rate of return, student loans do not come with collateral like most mortgages, which creates default risks for investors.

“You’re literally investing in the likelihood that a young, college-educated person won’t default on their loans and ruin their credit,” said Megan Kopka, owner of Kopka Financial, an RIA company.

For students in debt, federal loans with relatively lower interest rates than private loans are often paid off first. The Biden administration’s $10,000 student loan forgiveness is therefore likely to give private borrowers a chance to pay their debts and increase their creditworthiness, despite rising anger and disappointment advocates saying $10,000 isn’t enough to make a meaningful impact.

While opportunistic investors are betting on continued demand for education and the pricing power of universities to continue charging tuition fees that exponentially outpace inflation, some financial advisers remain cautious about investing in student loan products.

“Of course there could be potential to get a higher rate of return because private loans exist for a reason because schools have become so expensive, but when we’re looking for places to invest we’re looking for something that has stood the test of time,” Koka said.

Jarrod G. Sandra, owner of Chisholm Wealth Management, said the risks relative to the returns could be disproportionate.

“Student loans are unsecured, so even if I could access them directly as an investment, I’m not sure that’s the best place,” he said. “I would be more inclined to look at high yield fixed income securities and at least have the possibility of being on the front line in the event of a default.”