Income share agreements (ISAs), which require universities or private investors to assume financial risk by advancing funds to students for college costs, are gaining steam as an alternative to traditional education loans.
Under the ISA model, the student pays little or no tuition up front. Investors cover the student’s costs directly or, under some arrangements, schools fund ISAs with their endowments. After graduation, the student pays the money back as a percentage of each paycheck. Unlike a traditional loan, an ISA lender is repaid only if the student is employed.
ISAs were first proposed by economist Milton Friedman in 1955, and in the age of ever-rising college costs, Friedman’s idea is finally catching on. Degree-based institutions such as Purdue University and The University of Utah, non-traditional providers such as Lambda School, and various coding bootcamps have all begun offering ISAs.
Creating Right Incentives
ISAs align the interests of lenders and students, says George Leef, director of editorial content for the James G. Martin Center for Academic Renewal.
“ISAs make perfect sense,” Leef said. “Rather than having government throw taxpayer dollars into loans to students no matter how weak or indifferent they might be, ISAs put the money of people who stand either to gain if the student succeeds or lose if he doesn’t, into college education. Moreover, if the student doesn’t work up to expectations, the funding can be withdrawn far more easily than can government student aid. The incentives are all to the good.”
‘Insurance Policy’ for Jobs
The rules of ISA programs vary. Generally, the student must make regular payments at a set rate until the full loan is paid back. If the student does not make enough income to pay it all back over the fixed loan term—typically seven to 10 years for degree-based programs—the remaining balance can be forgiven.
The model works because the lender essentially guarantees the student’s employment, says Richard Price, a higher education research fellow at the Christensen Institute, in a November 19 article on the organization’s website.
“Even if an ISA does cost more in total, it may be worth it: ISAs essentially have an embedded insurance policy,” Price wrote. “Many would willingly pay that extra cost.”
Graduates who make higher-than-expected incomes pay more, which makes an ISA a worse deal for more successful students. ISAs could create incentives to earn less, says economist Devon Herrick, a policy advisor to The Heartland Institute, which publishes School Reform News.
“Though well-intentioned, ISAs could have unintended consequences because, in effect, they create a higher marginal tax on working or earning more,” Herrick said. “It could give graduates an incentive to minimize their income, say, by taking an easier, lower-paying job or taking years off to raise a child.”
Solution to Information Problems
Lack of information in higher education markets is a problem, says Alana Dunagan, a former senior higher education research fellow at the Christensen Institute.
“Students should be able to make an informed choice about their educational investments,” Dunagan said.
Sponsoring an ISA program shows a higher education institution is confident in the value of its degrees, Dunagan says.
“Offering ISAs allows [schools] to demonstrate to students their belief—in many cases, a very well-evidenced belief—that the educational experience they are offering will pay off,” Dunagan said.
Lower Chance of Default
U.S. student loan debt has surpassed $1.5 trillion. Under federal student loan rules, students typically take out the maximum amount allowed by the government. All students in a given graduation year pay the same interest rate, regardless of their credit score, major, or other factors that would normally affect an interest rate. Regardless of whether a graduate lands a job that earns enough to pay off the debt, the individual is responsible for the loan, and student loan debt is not dischargeable in bankruptcy.
Under ISAs, agreements can vary by academic major or other measures of a student’s expected ability to pay. A math major who is likely to earn a higher income could pay a lower income share and have a shorter payment term than an art history major. Thus the value of a student’s deal is directly tied to the earnings potential of the student’s major.
“Students benefit because it ‘de-risks’ their educational investment,” Dunagan said. “ISA funding models link revenues to outcomes—as opposed to the current funding model that is almost entirely based on enrollment.”
Inflexible federal loan payments are a burden on debtors, Dunagan says.
“A million students default on their loans annually, and millions more struggle to make payments or delay key milestones like marriage, children, and home-ownership because of their debts,” Dunagan said. “In an ISA, this simply doesn’t happen—if students are making below the income threshold, they simply don’t pay.”
Federal Income Share Experiment
U.S. Department of Education officials discussed a federal program that would allow individual students to pay off their government student loans through income share agreements, at a meeting held December 3 through 6.
The experiment would be conducted at designated schools which would assume responsibility for their students’ loans and allow student borrowers to repay their debt through a type of income share agreement with the institution. The program had not been formally announced by the DOE as of press time.
Harry Painter ([email protected]) writes from New York City, New York.
Michael Brickman, “A New Experimental Site: Institutional Investment in Student Success,” Session # 32, 2019 FSA Training Conference for Financial Aid Professionals, U.S. Department of Education, December 2019: https://heartland.org/publications-resources/publications/a-new-experimental-site-institutional-investment-in-student-success