Student loans are about as well-liked as mosquitoes, so any potential alternative has some built-in appeal. There are two big problems with the loan system, says Zakiya Smith, a strategy director with the Lumina Foundation. Some people borrow for an education that doesn’t pay off. At the same time, there are innovative programs — think coding boot camps — that can raise participants’ earning potential but are not eligible for federal financial aid.
Income-share agreements are an alternative to traditional loans that proponents say could help solve both problems. Under an income-share agreement, or ISA, an investor pays for all or part of a student’s education upfront. In return, the student gives the investor a certain percentage of his or her income for a set number of years. Supporters say the agreements could be a good alternative to private or Parent PLUS loans, and some even think the federal government should offer them instead of mortgage-style loans.
For now, a handful of companies offer such contracts, but it’s a pretty small market. One reason: a lack of legal clarity around this kind of financial product. A bill introduced last year by U.S. Sen. Marco A. Rubio and Rep. Tom Petri (who has since retired), both Republicans, sought to respond to that concern.
Whether or not ISAs will catch on remains an open question. For now, income-share agreements are unfamiliar to many in higher ed, and there’s a lot of confusion around them. For instance, critics often imagine that investors would want to finance only students at elite schools. Proponents say that that’s a misunderstanding and that the model can work as long as the educational investment provides a good return. Here’s a guide to help clear up some other questions about the agreements:
How are ISAs different from traditional loans?
Under an ISA, payments rise and fall with the recipient’s income. The recipient cannot know at the outset what either monthly payments or the total repayment amount will be.
Here’s the shorthand that Alexander Holt, a policy analyst in New America’s education-policy division, uses: With a private loan, a student knows what the payments will be but not if they will be affordable. With an ISA, the payments are unknown but will be affordable.
That sounds a lot like the controversial Pay It Forward financing model, under discussion in some states.
It should. They are similar ideas. The main difference is that in Pay It Forward a state, rather than a private entity, is the provider. One criticism of Pay It Forward is that it would be very difficult for a state to come up with enough money to get the program off the ground.
Why do supporters think ISAs could be better than traditional loans?
They see two main advantages: improving students’ choice of colleges and providing risk protection.
Because providers stand to make more money when recipients do, they have an incentive to direct them toward good college options. That might lead providers to offer ISAs only to students attending certain colleges or pursuing certain credentials. It could also lead providers to price contracts such that colleges they deem of higher quality would be more affordable for students.
So a student might be asked to pay back 10 percent of income for 10 years at one college, but 12 percent at another. Even if the student didn’t realize that the provider was charging more at the second college based on the assumption she will earn less if she goes there, she would still prefer to pay back a smaller percentage of her income.
Michelle Asha Cooper, president of the Institute for Higher Education Policy, points out that if the private sector wants to help point students toward good colleges or programs, no one is stopping it from doing so now with scholarships.
Because payments are linked to earnings, income-share agreements offer a kind of insurance.
Doesn’t that same protection already exist under income-based repayment?
Yes. The government’s income-based repayment plan, or IBR, and income-share agreements are similar models. Kevin James, a research fellow with the American Enterprise Institute’s Center on Higher Education Reform and a former staffer for Mr. Petri, describes ISAs, IBR, as well as Pay It Forward, as being in “the same family of ideas.”
Here’s the key difference. While borrowers in IBR might pay back more, in total, than they would in standard repayment, their monthly payments will never exceed the monthly payment they would owe under standard repayment.
Depending on how they are structured, ISAs might have a maximum payment of some kind, but proponents say the model works for investors only if the cap is quite high. If investors can’t fully reap the benefit of the recipients who are the most successful, they’ll have to charge everyone a bit more to make the model work, says Miguel Palacios, an assistant professor of finance at Vanderbilt University’s Owen Graduate School of Management and a co-founder of Lumni, an ISA provider.
So recipients who make a lot of money will pay a lot of money back — potentially much more than they would have under a traditional loan.
Then why would a student choose an ISA when there’s already IBR?
There are restrictions on who can get federal student loans and on the amount that undergraduates can borrow, so there could be room for ISAs around the edges of the federal loan system. That said, most college-finance experts agree it’s hard and maybe impossible to beat the borrower protections of federal student loans.
Would ISA providers be able to tell which programs and colleges are good? And would prospective students listen?
Maybe. ISA proponents certainly would like to have better student-level outcome data than is currently available. Lifting the ban on a federal student unit-record system was one of the recommendations of a 2014 paper on income-share agreements from the American Enterprise Institute’s Center on Higher Education Reform co-written by Mr. Palacios.
And tying information about quality to what students would repay, which could inform students’ choices even if they weren’t personally seeking the financing, might be more compelling than conventional disclosures. Right now, “the information is floating around,” says Mr. Palacios, “but it doesn’t get to the students in a sharp way.”
How else might ISAs change student behavior?
Some observers wonder if ISAs could appeal to debt-averse potential students, whose concerns about carrying loans keep them from borrowing, and perhaps from going to college at all.
“We have talked about student loans in a way that’s created a very negative perception for new students considering going to college at this point,” says Beth Akers, a fellow at the Brookings Institution’s Brown Center on Education Policy, who wrote an interesting blog post on ISAs. Income-share agreements, she says, are “free and clear of the negative perceptions.”
Ms. Cooper thinks things would go in the opposite direction — ISAs could make debt aversion worse — since students wouldn’t know what they would have to repay. “We can’t underestimate the uncertainty problem for low-income students,” she says.
One question is whether students worry more about what they’ll have to pay if they are financially unsuccessful, or if they are very successful. It’s only natural for them to think, “Oh, man, what happens if I make a lot of money?” says New America’s Mr. Holt.
What problems might ISAs introduce or exacerbate?
ISAs are a pretty new product, and everyone agrees that developing strong consumer protections for them would be critical. Otherwise, it would be possible for the provider — who most likely would have better information than a prospective student — to create a contract with horrible terms. In the textbook case, ISAs can be structured to be a good idea for both providers and students, Ms. Akers says. But that doesn’t mean that’s how things would play out in the real world.
One problem for investors is that an ISA structure gives students incentives to be less than honest about their intentions, says Mr. Palacios, for example saying they plan to be computer scientists knowing they really will become social workers.
Providers, for their part, might pressure students to pursue a field that’s highly paid rather than something they are good at or interested in, or that’s good for society. Mr. Palacios gives the hypothetical example of persuading the next Shakespeare to become an engineer. Still, he says, “I don’t think we want people to become Shakespeares out of ignorance.”
Adding ISAs to the mix would also make paying for college more complicated, Ms. Cooper says, working against many continuing efforts to simplify it.
Beckie Supiano writes about college affordability, the job market for new graduates, and professional schools, among other things. Follow her on Twitter @becksup, or drop her a line at beckie.supiano@chronicle.com.
