The high costs of higher education have many students and parents crying uncle or, at least, crying that they wished they had a rich one. As if on cue, enter My Rich Uncle, a company whose stated aim is to relieve some of the pain when arranging financing for college.
Haven’t heard of them yet? That’s sure to change, as My Rich Uncle recently began to ramp up its advertising campaign. And it’s what the ads say that causes financially strapped students to drop their calculators.
In a two-page ad that ran in the New York Times in July, My Rich Uncle didn’t mince words. In black and white, the company said it is the first student loan company to cut the federal loan rate by up to two percent at repayment. That means a potential 1.25 percent off the fixed rate for Stafford loans, which is now set 6.8 percent, and a potential two percent off the federal PLUS loan — which is made available to parents of undergraduate students, as well as to graduate and professional school students — where the fixed rate is now set at 8.5 percent.
If this isn’t startling enough, the ad continues to say students can apply directly to My Rich Uncle for their loan and cut out the "middleman" which, in this case, is the financial aid office.
Understanding the part about the middleman gets to the heart of the matter.
People looking for student loans generally find their way to a certain lender based on a lender’s name on a resource list provided by the financial aid office of a college or university. Although banks do not have full autonomy in setting all the terms of the loan, they do have a certain amount of leeway about setting rates.
“The law set by the federal government states that a lender is not prohibited from charging less than the federal rate of interest for the Stafford or PLUS loans,” says Raza Khan, My Rich Uncle’s president, noting there’s very little motivation for these lending institutions to lower rates and inject some healthy competition into the mix. The lender providing the loan, he explains, has a relationship with the guarantee agency, and the guarantee agency is further insured by the federal government. In other words, the lenders can’t lose. “The banks are making enormous profits from this without any risk whatsoever,” says Khan, who underscores that the lender’s name on the college or university’s resource list is enough to bring traffic to the lenders, without the lenders having to market themselves.
“What we realized was we could provide a federal loan and be profitable and not charge what the government has specified as the rate of interest,” says Khan. “If you want to compete, why not introduce a lower rate?”
Banking on students
My Rich Uncle’s owners — Khan created the company in 2000 with Vishal Garg, who’s the CFO — because, in Khan’s words, they “wanted to finance students in a variety of innovative ways.” Classmates in an elite New York City public high school, Khan and Garg had seen many of their fellow students without adequate credit histories give up spots at the country’s top universities for lack of adequate financial loans. The duo, now in their late twenties, wanted to improve the odds.
My Rich Uncle, which is not a bank, offers two types of products. One includes loans that are guaranteed by the federal government, which are the Stafford and the PLUS. On the Stafford, for example, a student would pay one percentage point lower at repayment. “The one-percent discount goes into effect immediately,” says Khan. Students can further lower their rates on a Stafford by an additional one-quarter percentage point for choosing the automatic debit option. There also is a two-percent principal balance reduction on the loan itself after the student makes 48 payments. On the PLUS loan, says Khan, a student can get a 1.75 cut immediately.
This past May, My Rich Uncle introduced two types of private loans, which are not federally guaranteed. The standard private loan is for students who have good credit histories and/or can provide a credit-worthy co-borrower. The second type is for students who lack or have a bad credit history, and who may qualify for an My Rich Uncle PrePrime loan. The company’s standard private loan has variable rates based on the three-month LIBOR index (based on a standard lending rate between banks) with a margin of about 1.8 percent, which could translate into a rate of about seven percent. The PrePrime loan is based on the prime rate.
Are Khan and Garg on a fast track towards losing their shirts, especially because their private loans aren’t guaranteed? Not according to Khan. “We spent a lot of time understanding credit risk, specifically with respect to students,” he says. But his big concern is more about the lack of understanding that students and their parents have about student loans in general.
Many people believe that, because a reputable institution of higher education recommends a lender, that the rate given by that lender is the best one out there, says Khan. That’s not the case, he says emphatically. “The New York Times ad let people know that, if colleges or universities are recommending a particular lender, that they’ve taken a fiduciary responsibility,” he says. “Unless they’re certain that the lender is providing a better deal, they should let their students know to shop around.”
What rubbed some educational institutions the wrong way was the ad’s suggestion that students ask staffers in financial aid offices whether the college or university was accepting “inducements” from lenders on the resource list. In other words, My Rich Uncle’s ad introduced the possibility that the college or university might be getting a kickback from a favored lender. Khan says: “There are a number of lenders on lists who are not exactly happy.”
What do financial aid officers think about these upstarts? “My colleagues are offended, because the questions [in the ad] imply underhanded tactics,” said Kurt Wolf, director of financial aid at the Ringling School of Art and Design, in Sarasota, Fla. Wolf, who confirms that My Rich Uncle is on his school’s lender list for private loans, does not believe that “consumers necessarily have the time, expertise, knowledge and inclination” to look for the best deals on their own. Steven Sharp, associate director of financial aid at Utah State University, in Logan, Utah, believes that financial aid officers were upset about the ad because “the innuendo or implication was that they were on the take.” He also concedes that few students are savvy enough to do their own research and, therefore, rely on their financial aid office.
“There are schools out there that are not engaged in nefarious practices, and a few of them do a pretty good job of letting students know they should shop around for loans,” Sharp says.
But, if Khan had his way, financial aid offices would not be recommending lenders at all. “Financial aid offices cannot guarantee that the recommended lenders will provide students with the best rate,” he says. That means students should be doing comparison shopping, something experts say may be increasingly common in the years to come.
Peter Bielagus, licensed financial advisor with a practice in Bedford, N.H., and the author of “Getting Loaded: A Complete Personal Finance Guide for Students and Young Professionals" says that, these days, anyone can be a banker. “I see the lending industry changing,” he says. "If someone is a lender, they can charge their own rate. It’s commercializing the notion of ‘I need a loan from Uncle Joe.’" Over the next few years, Bielagus believes that banks will be laying down the cards they’ve been holding. “When anybody can be a banker, that’s going to make the market more competitive,” he says.
“There’s too much blind trust among financial consumers,” says Russell Wild, a fee-only financial planner from Allendale, Pa. Many schools, he suggests, are taking advantage of “financial gullibility.” As an example, he suggests that students and parents who share the same religious affiliation as the college might be more inclined to believe information provided by that institution. There’s no excuse not to do some research, says Wild. “It’s so easy to shop online. Loans list the APRs, and you can check with several sources.”
A more open marketplace for student loans suits Khan just fine. “We’ve shown consumers now that all federal loans are not the same and not all private loans are the same,” he says. “And that it pays to inquire about every option.”