The Case for Income-Share Agreements
At a time when a college degree is table stakes for the information economy, our backward-looking system of private lending presents a daunting barrier for low-income students who are faced with a stark choice: Take on expensive loans with burdensome interest payments that will follow them for years, or take a pass on a college education.
But a bill before Congress may soon shift the student lending paradigm from parents to potential and enable students to finance their education with a share of future earnings. Introduced by Florida Senator Marco Rubio, who famously needed 16 years and a book deal to pay off his student loans, the legislation codifies treatment of loan alternatives called Income Share Agreements (ISAs). These agreements allow colleges to share risk with students by underwriting tuition costs based on the amount the student is likely to earn, not who their mother is or what their FICO score may be.
ISAs start with a simple premise: The amount that students pay for college should be based on the value that they receive for their education. It’s a concept conceived in the 1950s and more recently embraced by innovative university leaders, including Purdue President Mitch Daniels, who launched the university’s Back a Boiler program in 2014.
The Back a Boiler program extended ISAs to all 79 undergraduate majors, but priced each major differently (for a quick look at how your major would fare, check out Purdue’s comparison tool). GPA, attendance, and other information about each student also contribute to the value assigned to each degree. At no point is a parent asked to co-sign a loan, so the dreaded FICO score is irrelevant.
Through an initial pilot program, Purdue achieved a 10-percent reduction in students using non-federal, high-interest private loans often required to bridge the gap between federal aid and tuition. The students who are now using ISAs come from all walks of life, roughly mirroring the demographics of Pell grant recipients at the university. And the stories are remarkable. One student from a working-class family, Amy Wroblewski, explained recently how her ISA is allowing her to compete the last mile of her Purdue education.
That last-mile funding is currently the best use case for ISAs. As students enter their junior and senior year, they frequently max out available federal and state aid programs. Colleges often limit attractive aid packages to the first few years of school; later on, students have little or no choice but to rely on private loans that carry credit-card-like interest rates without support from a well heeled cosigner.
The risk to students from these loans is severe—high loan balances and default rates force many graduates to take less advantageous jobs or forestall home buying or even starting a family. Perhaps even worse, they cannot be discharged in bankruptcy, which means many students will be saddled with the debt even if they experience extreme economic hardships.
ISAs are designed to reduce the burden faced by students who would otherwise rely on private loans. And institutions share the risk. If students make below a certain dollar threshold (in the Purdue case it’s $20,000 annually), then they don’t owe anything. The more money a graduate makes, the more they pay. It’s a simple premise that, according to a recent AEI report, students embrace.
In this environment, it’s no wonder that a growing number of institutions are looking to follow Purdue’s lead. Last month, the university announced a center of excellence designed to share its experience with other schools, based on the high number of queries about how to set up similar programs.
Moving from a loan-based student financing system to an outcomes-based ISA ecosystem will require some fundamental rethinking of the entire student aid process. First, colleges will have to adapt to the new reality: Students care about outcomes and return on their investment in education. Next, financial markets need to develop and reduce the “price” of ISAs. Finally, while government theoretically has little place in the ISA universe, there are a series of tweaks that would enshrine ISAs in law in a way that encourages the creation of a more equitable financing mechanism for students. In the interim, ISAs will increasingly be used as a competitive advantage by schools seeking to show (not tell) their students that the college cares as much about the long-term success of their students as they do about a student at the time of enrollment.
It may be a matter of time before student loans will be a historical footnote as we move to a future state where a student’s own skills and future earnings drive the cost of college.
Author Perspective: Analyst