Income Share Agreements: A Solution to the Student Debt Crisis?
July 17, 2019
As seen in the graph below, this figure has nearly doubled since the mid-2000s.
Increased college tuition has contributed to the rising student debt, impacting graduates’ abilities to pursue careers of their choice and support their families. Additionally, the student debt negatively impacts the economy as they have less money to spend on goods and services.
Policymakers have been scrambling to figure out a solution in addressing the student debt crisis, and several presidential candidates have even made the issue a central component of their campaign platform. However, several educational institutions and coding academies may have already stumbled on a mechanism that can alleviate this problem: income share agreements.
What are Income Share Agreements?
The concept of income share agreements (ISA) is not a novel idea. In fact, its origins can be traced back to the 1950s when economist Milton Friedman developed the framework as a model of repayment. Essentially, ISAs are contracts between the student and school where the student receives educational funding in exchange for promising to share a percentage of their post-graduation income. Coding bootcamps, like the Lambda School, have started offering income share agreements and building alumni repayment plans directly into their business model. In 2016, Purdue unveiled the “Back a Boiler” program and became the first four-year higher education institution to introduce an ISA program. According to Vemo Education, the industry leader in Income Share Agreements, there are now 42 schools that offer a type of ISA program to support their students.
How do Income Share Agreements work?
As part of an income share agreement, students borrow a certain amount of money in exchange for agreeing to pay off the loan with a certain percentage of future earnings. The ISA payback rates and length of repayment contract are determined by each university and by each college major. For example, majors that result in lower starting salaries such as history, English, or social sciences will have higher payback rates and longer terms (e.g. 5%-7% over 10 years). In contrast, majors that typically result in higher starting salaries such as STEM will result in better payback terms (e.g. 3% for 8 years).
Unlike typical student loans, students under an income share agreement only pay when they have secured employment. If students are unable to work, whether due to a family emergency or changing jobs, they are able to halt the ISA payments without accumulating interest until they have found employment again. Additionally, most ISAs have a minimum income requirement, meaning students who fall below this income level are not required to make payments. This creates an interesting dynamic where educational institutions become more outcome-oriented as they are incentivized to improve the quality of education and help students secure lucrative jobs. Furthermore, this leads to increased transparency as incoming students have more data based on future potential earnings by major and are able to make decisions best for their financial situation.
Of course, there may be students who actually end up paying more than they have borrowed – although most institutions have capped the payback rate around 2.5x. In essence, these “high-earning students cross-subsidize the losses that investors suffer on low-earning students. This level of cross-subsidization is not present in traditional student lending, where borrowers make the same payments on equivalent loan balances, regardless of their income levels.”
There are many potential benefits for both students and higher education institutions. For students, they have more transparency in choosing majors and are able to make well-informed decisions. Most ISAs have minimum income requirements and students are able to stop payments without accumulating interest if they find themselves unemployed. Similar to an insurance policy, an income share agreement “reduces financial risks for students…”
For the educational institutions, they are essentially buying a “share” in a student’s future, meaning they are highly incentivized to improve their educational offerings and help promote the conditions that lead to graduate success: “if the student makes little or no money in that time, the investors lose out, and the student is free from obligation.”
While there are many potential benefits with income share agreements, the reality is that this is an emerging field and there is not much evidence to suggest that this will work. Purdue was the first four-year educational institution to introduce an ISA program and that was only three years ago – public data isn’t available to suggest whether their program (or other ISA programs) are successful and sustainable. To date, there are only about 1,000 students total that have signed up for ISAs at US colleges and universities.
Additionally, the ISA market is largely unregulated, meaning there is room for potential abuse of power. For example, future ISA programs may not offer protections like capping the payback rate or offering a minimum income threshold, resulting in students facing severe financial difficulties. Without regulations, “funders can shape ISAs to quietly push much of the risk back onto the students by crafting contracts that work to their advantage, avoiding consumer protection laws and aggressively marketing the alleged advantages of ISAs.”
The emergence of income share agreements have led to calls for action on the legislative end. In February 2017, Sens. Marco Rubio (R-FL), Tom Cotton (R-AK), and Todd Young (R-IN) introduced the Investing in Student Success Act (S. 268), which would provide a legal structure for ISAs. While the bill was referred to the U.S. Senate Committee on Finance, Congress ultimately did not enact it. In early June 2019, Senator Elizabeth Warren (D-MA) and Democratic representatives Ayanna Pressley (D-MA) and Katie Porter (D-CA) requested information from four-year colleges offering ISA programs, including Purdue University, to learn more about the type of protections they offer to students. In late June of 2019, a bipartisan group of 20 organizations, such as Purdue University, the U.S. Chamber of Commerce, and Social Finance, submitted a letter to Congress “asking for sensible legislation that provides protections for student consumers and a legal framework to guide the work of institutions and providers.”
Purdue’s President Mitch Daniels stated that for ISA programs to become a viable option, “…we need scale. And we need other schools and many more students participating so that the marketplace of potential investors sees repayment history and we all learn more about how well this works.” While the early reports of ISA programs are certainly promising and potentially offer an interesting alternative to traditional student loans, there needs to be more studies and research into these programs. This is where the government could step in and provide incentives for other schools and universities to pilot ISA programs at their institutions. In doing so, we will have much needed data in understanding the effectiveness and sustainability of these programs, and whether they offer a real solution in tackling the student debt crisis.
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The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Wharton Public Policy Initiative’s strategies, recommendations, or opinions.