Student loan startups are seeing tailwinds of new investment and new customers as the U.S. faces a continued student loan debt crisis.

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The Federal Reserve estimates $1.7 trillion in U.S. student loan debt. Students, on average, graduate with $29,000 of private and federal loan debt and default on their loans at a rate of 15 percent.

Startups in this space are developing technology to target both private and federal loan debt in areas, such as responsible lending, loan management and refinancing, as well as make it easier for employers to create benefits that aid employees with their loan repayments.

“A lot needs to be fixed,” Jeannie Tarkenton, co-founder and CEO of Atlanta-based Funding U, a merit-based student lender for career-focused college students, told Crunchbase News.

“For a lot of people last year, COVID-19 happened in the middle of college and their income was cut. True innovation in this market requires some money on top of federal loans and in the traditional market, which is not often available to a 22-year-old,” she added. “A majority of them can’t get a loan without a parent to co-sign.”

Creative solutions

Many fintech founders credit SoFi, founded in 2011, with kicking off new ways to refinance debt, including student debt, at a price that is right for the borrower.

Since then, new strategies have emerged, including Rightfoot, based in San Francisco, which secured a $5 million seed round in February, led by Bain Capital Ventures, to enable software developers at companies, such as Plaid, to add debt repayment capabilities to any application.

Financial wellness, payroll and employer benefits companies use Rightfoot’s API to create programs, such as the ability to route money from a borrowers’ paycheck toward a student loan account or creating tax-free student debt repayment programs as an employee perk.

In an interview at the time of its raise, Rightfoot co-founder and CEO Danielle Pensack said she and her team realized saving was not the main pain point for people, but getting out of student debt was.

“While understanding the landscape of how to make payments, we saw companies just sending out checks, but they were bouncing back or not going into the right accounts,” Pensack said. “We know we had the background of building infrastructure, so we got to work on an API.”

In the area of employee benefits, Goodly, a San Francisco-based company, launched in 2018 to provide student loan repayment as an employee benefit. The company raised $1.3 million in seed funding, led by Norwest Venture Partners in 2019.

Two years before Goodly, fintech FutureFuel.io was founded to enable employers and financial institutions to deploy digital tools aimed at eliminating student debt. It raised $10 million in Series A funding in early March, led by UBS.

Some employers provide tools to help employees better manage and accelerate their pay-down, with 63 percent of them already offering some form of tuition assistance programs. These programs often help employees go back to school to get an advanced degree or learn a new set of skills. However, these funds are largely untapped, FutureFuel.io founder and CEO Laurel Taylor said in an interview.

“Over the last four years, we think we have pioneered this category of student debt within the workplace,” Taylor said. “The first two years, employers tried to figure out what it is and how to address it. In the last two years, we’ve seen rapid acceleration of appreciation that debt is crushing. There is pent-up demand around offering benefits, and student debt is in the top three with salary and health.”

Aid in many forms

Going forward, workplaces will need a student loan tool to attract employees, and are turning to student loan startups for the tools to do that, Michael Barry, head of workplace solutions and managing director at UBS, said in an interview. Barry was involved in FutureFuel.io’s investment.

“It not only ties into student debt, but in financial well-being, which was a focus of corporate America before the pandemic,” Barry added. “Due to the pandemic, there is heightened interest, and human resources departments are more action-oriented to drive these solutions.”

The government is on board to assist employers: In December, Congress extended tax-free student debt repayment benefits for employers through 2025 under the Coronavirus Aid, Relief and Economic Security (CARES) Act. Within the $2.2 trillion stimulus package Congress passed in March, employers can receive a tax incentive to help their employees with student loan repayment. Also this week, the Biden administration said it would continue to pause student loan interest and collections to more than 1 million borrowers in default on loans made by private lenders.

Investors are there, too. In the Crunchbase dataset, we counted at least 35 known investments to startups in 2020 and 2021 — totalling $139 million — to global fintech companies focusing on student financing or lending. Since 2016, investors have pumped at least $517 million into companies in this space, with more than $294 million of that into U.S. companies, according to Crunchbase data.

Although global funding to student loan startups slipped 30 percent from 2019 to 2020, investment dollars allocated so far in 2021 are already creeping up to 2020 funding amounts, according to the data. It was a different story for domestic companies: Data showed investments grew nearly 10 percent between 2019 and 2020, despite the pandemic.

Defaulting before graduation

Typically, students with private loans begin paying them down while they are still in school. Many start off well their freshman year, but some fall behind in later years and are already defaulting on their debt before graduation, Funding U’s Tarkenton said.

Funding U’s approach to lending is managing the debt-to-income piece by leveraging academic and earnings data during the underwriting phase when resources like FICO are not useful, she said. FICO is an abbreviation for the Fair Isaac Corp., the first company to offer a credit-risk model with a score.

Since its founding in 2015, Funding U has made 900 loans, Tarkenton said. Potential borrowers can apply for a loan in minutes as long as they meet citizenship, school and academic requirements.

“Academic behavior is more indicative of their ability to pay back loans,” she added. “We can predict if a student will graduate, and we can project what their income will be, ensure borrowers are on track to graduate, and what their income-to-debt ratio will be.”

In 2020, Funding U partnered with Goldman Sachs Urban Investment Group, which infused $10 million in debt financing into the company, to provide “last gap” loans, credit education and career networking for more than 1,500 students attending four-year colleges in the U.S.

Margaret Anadu, head of Goldman’s Urban Investment Group, said the group’s purpose is to provide capital to create opportunities for underserved individuals and families, including  narrowing the opportunity gap.

She feels school lending should consider the student’s potential and opportunity, which is what the group liked about Funding U.

“They are asking the questions, such as ‘Is this amount of money something the student can repay, and is the student getting what they are paying for?’” Anadu said in an interview. “Education is important, but we have to figure out how to provide the capital for people to go to school, and what drives outcomes for the students that is also affordable.”

Illustration: Li-Anne Dias