Sunday, August 16, 2009

A New Credit Program to Help Repay Student Debt

The challenge of financing a college education has spawned many proposals on how to help students finance and achieve their college dreams. One of the newer and more innovative ideas received some press in this past Saturday's New York Times (Aid for Students Facing Mountain of Debt). The featured start-up company, SafeStart, has developed the concept of providing interest-free credit lines to student loan borrowers. The company's objective is to offer students a way to protect their credit and ease their cash flow should they experience financial hardships within the first few years after graduation. SafeStart also offers financial literacy training and debt counseling services to assist its student clients.

Here’s how the program works: Undergraduate students with guaranteed Stafford loans who face financial hardship after graduation or who go back to school during the repayment period can draw down on an interest-free line of credit. Advances under the line of credit are available to cover loan payments for up to 36 months over five years. After the five year borrowing period, the student must repay the SafeStart loans in 60 monthly payments.

The cost of the program ranges from $40 to $70 per each thousand dollars of principal borrowed, payable up-front. So a student who borrows $20,000 and is charged $70 per thousand will end up paying $1,400 for access to the line of credit. This is roughly equivalent to one year of interest on $20,000 in unsubsidized Stafford loans at 6.8%. The variation in fee charged is a function of whether the student opts for the financial literacy and debt management offerings, but the charge will also vary by college, presumably reflecting a specific school's student loan default history. To qualify to drawdown under the line of credit a borrower's monthly loan payment must exceed 10% of his or her income. One's credit score has no bearing on the ability to take advantage of this service, but a student’s college must participate in the program. While the company claims to have more than 600 schools signed up, I went to the website and typed in my alma mater, Wesleyan, only to discover that it presently does not participant.

The principals of SafeStart assert that they do not compete with the federal government’s income-based repayment plan that began July 1 of this year. Under that program, which was discussed in my June 5, 2009 blog posting, borrowers can cap their Stafford loan payments at a maximum of 15% of the amount by which family gross income exceeds the poverty level (currently $16,245 for an individual), and any amounts borrowed which remain outstanding after 25 years will be forgiven. With the income-based repayment plan, debt payments that are deferred due to the payment cap will continue to accrue interest, unlike borrowings under the interest-free SafeStart line.

So I decided to do a little calculation to test how eligibility to borrow under the SafeStart line compares to the payment cap on the federal government program. What I determined is that a student making $30,000 a year with a $230 monthy loan payment ($20,000 loan at 6.8%) would only have to pay $172 and could defer $57 a month, or $685 annually under the income-based repayment (with interest of course). Under the SafeStart program, the monthly loan payment would have to be $250 (higher than the actual $230 payment) in order to render the line eligible for borrowing. In other words, SafeStart only really has value for students who have a lot of debt!

Still, the SafeStart program may be a good option for some students, especially if they anticipate choosing a career where income is likely to be low in the early years, though the government's income-based repayment plan addresses the same issue. However, here are some caveats that should be considered before signing up for a SafeStart credit line. This works essentially like an insurance policy. One may end up paying a premium or fee for a policy that he or she will never access. In that case, the company says it will refund 30% of the fee paid. The programs is currently only available to cover undergraduate Stafford loans, though SafeStart’s website claims that it will roll out similar programs for graduate student Stafford loans, graduate PLUS and Perkins loans either this fall or by winter 2010. Also as mentioned, many schools do not currently participate, though that may change over time if the program catches on.

However, one of my prime concerns, as a former bond insurance executive, relates to SafeStart's future financial health. A company that extends credit must have ongoing access to liquidity (cash) and financial resources. SafeStart collects an up-front fee with a promise to extend credit for future drawdowns. What does that mean for someone who has paid the $1,400 in advance? The company may not have available funds to lend at the time the student needs it. I would just want to know more about the long-term financial viability of this company before I signed up for its loan repayment plan.

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