How It Works: How SoFi Makes Money
How It Works is an ongoing series here on our blog, exploring and demystifying topics about which we hear often from our members and the public. Today, we’re taking a look at how SoFi makes money.
By Gary Pelissier
SoFi is able to offer products and services at competitive rates to members because we’re more efficient than traditional financial institutions. As with any time a company invents a new way of doing things, people may wonder, “Is there a catch?” We’re here today to explain how we make money‒it’s something we think every consumer should know about the companies they do business with, in finance or any other sector. Since we offer a variety of products, we’ll break this down by product area.
First, our lending products (that’s Student Loan Refinancing, Personal Loan, and Mortgage). There are many different ways companies make money in lending – some make their money on origination fees and get paid when a borrower takes a loan, others by holding the loans and making money from the interest the borrower pays, and others by selling loans after they’re made to investors while maintaining some ownership for themselves.
We employ a blend of the last two approaches at SoFi, but primarily make money the third way, through securitizations and whole loan sales. The buyers in these securitizations are institutions like pension and insurance funds, as well as other asset managers, who pay a premium upfront for the future potential cash flows from the loans. We’re able to make money through securitizations because investors trust the quality of our loans.
This enables us to have access to funds at a very competitive rate – often, on par with large commercial banks with big balance sheets—without “selling” our relationship with our members. We then pass those savings on to our consumers by offering them loan products at an interest rate below their current rate, but above our cost of financing. This represents a win-win: the member saves money on their loan payments and SoFi makes enough money to keep doing what it’s doing.
Who buys SoFi’s loans? Investors like pension and insurance funds, as well as other asset managers. They are willing to pay a premium above the principal value of the loan upfront for the future potential cashflows. We sell these loans in two ways: (1) “whole loan sales” where we sell a group (called a “pool”) of loans in their entirety to investors, and (2) “securitizations” where we group the loans together and their combined cash flows pay specific groups of investors (called “tranches”) in a specific sequence. Having multiple ways to sell our loans ensures we have cost-effective financing and reduces the risk that the market disrupts our business.
To break the process down more simply, here’s an example: let’s say SoFi extends a student loan that pays 5% APR for five years with the principal due at the end of those five years. Because our borrowers were paying 7% APR originally, they now save a whopping 2% APR each year. Nice!
The value of the total loan is 125% of the original loan amount (5% APR x 5 years in interest; 100% in principal). We sell the loan to investors for 105%. For taking on the risk of loan repayment, investors will get 20% (125% – 120%) over five years; SoFi will get 5% upfront to cover its cost of borrowing funds, its operations, and the memberships perks it offers to its clients. Double nice!
For SoFi Wealth, we make money from management fees, which are typically calculated as a percent of assets that we manage on behalf of our members (“assets under management”). For our SoFi borrowers that have a Personal Loan, Student Loan, or Mortgage with us, we waive that fee for the life of the loan. For non-borrowers, we typically charge 0.25% per year and the first $10,000 in assets are at no cost, but in 2018 we’ve waived those fees for members and non-members alike. Because Wealth is a newer product for us, we expect to expand the offering significantly over the next few years, so we’ll be the first to let you know if any of our offerings or fee structures change.
We also offer Term Life Insurance through our partnership with Protective Life. For life insurance, we make a set percentage of the first year of premiums our members pay into the policy.
SoFi Lending Corp. is licensed by the Department of Business Oversight under the California Financing Law, license number 6054612. NMLS #1121636.