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In a Tough Lending Environment, Students Turn to Startups That Pool Funds From Networks of Business Graduates

Business-school alumni networks have long been useful for finding jobs and securing startup funding. Now, students and graduates are tapping them to help pay for school.

Young companies are using crowdsourcing to call on alums to ease the debt burden of M.B.A. students from their alma maters, offering low-cost loans to students while rewarding investors with returns topping 4%. The startups use a "peer-to-peer" or "group-to-group" lending model, where multiple lenders invest money in funding pools earmarked for each participating school; the funds are then disbursed to groups of borrowers.

The new crop of lenders comes at a time when student lending overall has become a risky endeavor as unemployed college graduates struggle to meet repayment commitments. Even M.B.A. students—who generally have strong job prospects and high earning potential—have had a hard time getting loans from cautious lenders.

David Klein and Michael Taormina founded CommonBond LLC, a crowdsourced lender, last year after they were hit with interest rates topping 7% to finance their M.B.A.s at the University of Pennsylvania's Wharton School.

CommonBond is now distributing $2.5 million of alumni investments to about 50 Wharton M.B.A. students and graduates to use in place of traditional loans or to refinance existing student debt.

Investors can expect returns topping 4%, while borrowers pay a fixed rate as low as 5.99%. (Current students also pay a 2% origination fee.)

Those terms won over first-year Wharton M.B.A. usband-and-wife students Amy and Michael Daschle, who researched loan options to plug funding gaps not covered by savings or Post-9/11 GI Bill benefits.

Determining that CommonBond offered the lowest rate, they borrowed a combined $30,000 for the coming semester; the company's average loan amount is $50,000.

Mr. Klein says CommonBond is in talks with other business schools and may branch out beyond M.B.A.s in the future. He expects to lend up to $100 million to students from 20 schools by year-end.

M.B.A. borrowers are generally a good bet. Eighty-six percent of 2011 graduates from full-time, two-year M.B.A. programs were employed at graduation, according to a Graduate Management Admission Council report. Those from Europe and the U.S. reported median starting salaries over $80,000.

Another crowdfunder, Social Finance Inc., allows graduates of 79 schools, including Stanford University, Amherst College and the University of Michigan, to refinance existing loans but mainly limits loans for currently enrolled students to the reliable M.B.A. student pool.

The year-old company, founded by Stanford Graduate School of Business graduates and known as SoFi, banked nearly $80 million in venture financing earlier this year and is now lending $130 million. The average balance for refinancing borrowers is $100,000, while current students borrow an average of $35,000 a year. The company says it hasn't recorded any defaults.

SoFi's interest rates for refinance borrowers are on par with those from CommonBond, and in-school borrowers pay 6.49%. The company targets investment yields starting in the high 4% range. In a pilot at Stanford, 40 alumni investors put in $50,000 apiece.

Tova Jaffe, a 1997 Stanford M.B.A. who works at the Smithsonian Institution, says she has been pleased with the return on her five-figure SoFi investment, made in 2011.

"I loved my time at Stanford and I saw it as a way of helping others have the same experience," she says.

Companies say they target alumni investors because of their shared affinity for a school. Successful graduates can also strengthen the institution's brand—thus burnishing the value of alumni credentials. Alums have signed up after hearing about the programs through alumni networks.

Financial aid experts say the startups have yet to tap a key market: international students in the U.S., who can't access the federal student-loan market and are often locked out of private options.

CommonBond and SoFi say they are pursuing opportunities for those borrowers. At least one firm, London-based Prodigy Finance Ltd., already backs foreign students, but not in the U.S.

Founded by three Insead alums in 2007, Prodigy has amassed about $37 million in investments and has disbursed more than 800 loans to international students pursuing M.B.A.s at top European schools.

The firm, which hasn't had any defaults yet, charges interest rates between 6% and 9%, with a 1.25% origination fee. Investor returns run at about 5% a year.

Prodigy plans to issue a U.S. prospectus this month and begin talks with schools shortly thereafter.

The market is likely to heat up as lenders expand operations, but for now, Mr. Klein says he is grateful for the early market success. He and Mr. Taormina are using most of their CommonBond salaries to pay off their own student loans.

The Crowdsourced B-School Loan