The further education financing system in the U.S. is broken. There are currently $1.6 trillion of student loans outstanding, owed by over 44 million borrowers. The average borrower in the Class of 2018, according to a recent study by Student Loan Hero, graduated with a debt balance of $29,800. Over two million borrowers have defaulted on their student loans in the last six years, and it is estimated that nearly 40 percent of borrowers will default on their loans by 2023. The tuition at private nonprofit four-year institutions has increased from $17,010 in the 1988-89 academic year to $35,830 in the 2018-19 academic year; tuition increased from $3,360 to $10,230 in public four-year colleges in the same timeframe. These tuition increases have meant that students have become more dependent on federal student aid and loans to finance their education.
The Income Share Agreement Landscape
The growth of this crisis has had policymakers, parents, students, and the general public looking for solutions. Senator Elizabeth Warren has proposed a plan that would provide up to $50,000 in loan forgiveness to people who earn less than $100,000 per year, and would provide partial loan forgiveness for those earning up to $250,000. Senator Bernie Sanders has proposed a larger plan that would forgive all student loans, and make tuition free at public universities. However, free college plans, although lucrative, fail to address the root causes of the student loan crisis, and may result in even higher tuition increases — the taxpayer will be responsible for paying these, too. As the student debt crisis looms, another proposal has been made: to expand access to Income Share Agreements. In July, Senators Todd Young (R-Ind.), Marco Rubio (R-Fla.), Mark Warner (D-Va.), and Chris Coons (D-Del.) proposed the ISA Student Protection Act, which would institute safeguards for ISAs and create a strong regulatory framework under which these agreements would operate.
Through an Income Share Agreement, a student agrees to share a certain percentage of their future income in exchange for being given the money they need to cover their tuition. Students will only pay if they earn over a certain amount — over the minimum income threshold — which protects them from making payments when they are not in a financial position to do so. Income Share Agreements have recently been used in both higher education institutions, and private coding bootcamps to help expand access to their offerings, and align the incentives of the school and the student. Lambda School, for example, allows students to enter into an ISA and share 17 percent of their income for two years after graduation — students will only pay if they earn over $50,000 per year. Purdue University also launched their “Back a Boiler ISA Fund” in 2016, which has since issued over 750 contracts to students and offers ISA-based financing alternatives to students who have exhausted their federal financial aid options.
These agreements are directly linked to the income of a student, which means that the school will only earn a good return on their investment if the student commands a job with a high salary after graduation. Schools are therefore incentivized to provide a higher quality education to their students, and will not earn a return from students who did not succeed after graduation. In a student loan, students are required to make payments toward their loan on a consistent basis, with interest added on. If a student does not make a payment because they cannot afford to do so, interest may continue to accrue and their loan may go into default. ISAs, on the other hand, do not accrue interest and the school assumes the risk if a student does not succeed after graduation. Schools who offer ISAs are held fully accountable for student success, unlike schools that offer access to federal aid, where they will receive no punishment if a student does not succeed after graduation — the student assumes all of the risk from pursuing their education.
Legislation for Income Share Agreements
As these agreements become a more popular method of financing — around 40 schools are offering ISAs right now, although that is expected to quadruple to 175 by the end of 2020, according to Edly — more safeguards will be necessary to protect the interests of both schools and students in these agreements. Policymakers are continuing to review the ISA Student Protection Act, and it is important to ensure that all contract terms are taken into account before any legislation is passed to ensure that the ISA market protects both students, and innovation in the space. There are three main terms that any further legislation will need to take into account to achieve this goal: setting adequate minimum income thresholds, payment caps, and creating standard disclosures and protections for students.
Minimum Income Thresholds
The minimum income threshold is a term included in every ISA that protects students from making payments when they are unable to do so. This ensures that if a student becomes unemployed or underemployed, they will not have to make payments toward their ISA until they are in a better position, or their ISA is forgiven. Minimum income thresholds are designed to limit the downside risk for students and also ensure that schools collect payments only when their students are successful. Higher income thresholds mean that the school will take on even more risk and will be further incentivized to help students command higher salaries after graduation. However, larger thresholds may also mean that schools need to wait longer to realize a return on their investment — it may take students months or years to earn over the minimum income threshold. On the other hand, low thresholds mean that the student will assume more risk, and may result in students making payments when they are underemployed.
Future ISA legislation should address the minimum income threshold and create a framework that ensures risk is balanced between the students and the schools. Minimum income thresholds in the market right now range from $20,000 — common in college-based ISA programs — to $60,000, which are offered in bootcamps. This amount depends on the projected earnings of a student in a certain field — a student who goes to a coding bootcamp is more likely to command a higher salary. Competition has ensured that minimum income thresholds are favorable for students but legal safeguards are necessary to ensure that schools continue to offer favorable terms. The ISA Student Protection Act would set the minimum income threshold for ISAs at 200 percent of the Federal Poverty Level — $25,980 in 2019. This number is in line with what most ISAs offer right now, and is the key to ensuring that the ISA market continues to prosper. Perhaps in the future cost-of-living could be taken into account, or a higher income threshold could be set to move more risk to schools, although the current proposed number would be a good start.
Student Protections and Borrower Disclosures
Student protections and borrower disclosures will be a necessary element in safeguarding ISAs. There is not a legal definition for ISAs as of yet, which means that there is more uncertainty in the market — many schools are hesitant to offer a financing method that is not fully governed. Therefore, legislation for ISAs should include a clear definition of the agreements, and also clarify what existing legislation designed to protect student borrowers will apply to ISAs. The ISA Student Protection Act would apply federal consumer protection laws such as the Equal Credit Opportunity Act — legislation designed to prevent against discrimination in lending — to ISAs, which would make it easier for ISA lenders to understand what legislation applies to their agreements. A clear legal definition and standard protections will ensure that students have legal recourse if their ISA lender operates in an unethical manner, and would therefore help assist in building more public confidence in these agreements.
Borrower disclosures will also be necessary to ensure students are aware of the terms to which they are agreeing, and their long-term ramifications. Student loans already have standard disclosure requirements, like any other financial instrument, which helps ensure that students fully understand their loans and when they are expected to make payments. Future ISA legislation should create a set of standard disclosure guidelines which all lenders must include in their ISA agreements, like those offered in the student debt industry. These guidelines would help ensure students are fully aware of the long-term consequences of taking out an ISA, and will know about their rights when entering into an ISA. Borrower disclosures may also need to go further than those offered in the student debt market, and include forecasts of expected payment outcomes if a student commands a certain salary. This is because the size of payments through an ISA will depend on the salary of a student. Schools should also be mandated to provide apples-for-apples comparisons to other loans and aid options, and provide students with basic information about the specifics of each option.
Income Share Agreements should also include strict guidelines surrounding payment caps. Payment caps limit the total amount that a student will pay by the end of their contact, which ensures that high-earners are not liable to pay a disproportionate amount of their income back to the school. Payment caps typically range between 1 times and 2.5 times the initial amount borrowed, depending on the goals of the school — some non-profit programs, for example, set a payment cap of 1 times the initial amount raised; for-profit programs typically have higher payment caps. Higher payment caps also help assist schools in developing sustainable programs that can fund themselves over time, which will allow them to issue new contracts as previous borrowers start to repay their ISAs. ISAs rely on cross-subsidization to ensure that low-earners do not have to pay back disproportionate amounts of money, and so setting reasonable payment caps will be important.
The ISA Student protection act limits the income share percentage at 20 percent and caps the contract length depending on the income share percentage that has been set. However, the legislation does not address maximum repayment caps. Limitations on payment caps will ensure that students are not exploited in these agreements, and will also allow investors to earn a good return without being unethical toward students. Some ISA providers are also experimenting with progressive payment caps which mean that the quicker a student makes payments, the lower their payment cap will be. Perhaps future legislation could institute a similar safeguard to ensure that students never pay back more than a reasonable amount.
Balancing Innovation and Legislation
There should also be a limit on how much the federal government gets involved with Income Share Agreements. While the idea for an ISA came from Milton Friedman in a 1955 paper, most modern-day ISA programs were founded within the last five years. Therefore, there is very little data available regarding the long-term viability of these contracts, and which terms offer the most favorable payment options for students years after graduating. At present, there is a lot of experimentation going on in the market, and the terms for ISAs often vary significantly depending on the school and the subject a student is studying.
For example, Purdue University only allows borrowers to take out an ISA starting in their sophomore year, and the income share percentage and term limit depends on the students’ major. The University of Utah only offers access to their ISA program to students in their final year, who will all pay a set percentage of their future income, irrespective of their major. Legislators should ensure that policy does not interfere with experiments in the market and provides innovators with enough room to test out new terms that may be more favorable for students and more economically viable for the school. As more data becomes available, stronger ISA legislation can be enacted that accounts for a variety of different experiments and their outcomes for students and schools.
The Promising Future of ISAs
Critics do have a few concerns about expanding access to ISAs, though. Senator Elizabeth Warren, among other Congressional Democrats, sent a letter earlier this year to the Secretary of Education, stating that ISAs combine the “common pitfalls of traditional private student loans” and are “exploitative” agreements. Warren and the other Democrats also sent letters to seven colleges offering ISAs requesting information about how students can pull out of the agreement, and how their ISA programs are structured. Other critics have cited concerns that ISAs may be less favorable than traditional student loans as successful borrowers may pay back slightly more in the agreement. However, strong legislation such as the ISA Student Protection Act will go a long way in ensuring that such concerns are mitigated and that students who decide to finance their education through an ISA are protected.
ISAs are not a full solution to the student debt crisis, but they may help offer more favorable financing terms to students and reduce the burden of debt on both students and the federal government. ISAs would help hold schools more accountable for their student outcomes, which should lead to an increase in the quality of education offered by schools using ISAs. ISAs would also allow students an alternative to traditional student loans, which would serve those who cannot access federal financial aid or who are unwilling to take out a loan. The federal government should still spend time considering other proposals such as expansions to Pell Grants — a type of financial aid for low-income borrowers — to help further tackle the student debt crisis. Despite concerns by critics and the lack of a solid track record, ISAs continue to show promise as an alternative method of student financing. Schools and colleges should be taking note.
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