We Should Replace Federal Student Loans With Income Share Agreements

The federal student loan system on which many students rely to pay for their education has been the product of patchwork legislation. Right now, there is around $1.6 trillion worth of outstanding loans currently owed in the United States. Student loans are the second highest source of household debt after mortgages. As options such as free college and student loan forgiveness become more prominent in national politics, it’s clear that policymakers are looking for a solution. Some are even making it the center of their political agenda for the upcoming presidential election. One solution being considered by legislators—although less well known—is Income Share Agreements, or ISAs. 

The current federal student loan program has many problems. There are dozens of options available to students—PAYE, RePAYE, accelerated, graduated, and income-based repayment, to name a few. And each option has its own specifics. This makes it very difficult for people to evaluate which program would be best for them because they have to understand all available options first. Income-based repayment, introduced in 2009, was initially projected to cost taxpayers $1 billion per annum, but now they are expected to cost over $14 billion each year. Further, the Department of Education has failed to perform adequate oversight over federal student loans, resulting in a number of people being provided poor quality service by loan servicers. This was according to a recent report by the Office of the Inspector General at the department, outlining many of the failures in the department’s student loan administration.

Income Share Agreements as a Solution

Income Share Agreements, or ISAs, allow students to raise the money they need to pay for their education in exchange for a percentage of their future income. Students who borrow money through an ISA only need to pay when they earn over a certain amount each month, and those who are very successful will only make payments up to a cap limit, designed to protect against disproportionate payments. ISAs are not a debt, and offer student-friendly, flexible financing terms that account for individual circumstances, job changes, and align the incentives of schools and students.

Income Share Agreements have been experimented with for decades—the first known experiment at Yale in the 1970s—but have recently gained traction in the bootcamp and college spaces. Lambda School, a nine-month coding bootcamp which provides students with a comprehensive education in areas like UX design and full stack web development, offers ISAs to their students. Students who attend Lambda School can pay 17 percent of their salary for two years through an ISA, but only if they get a job that pays more than $50,000 per year. Payments are capped at $30,000, which means that high-earning students will never pay back more than is proportionate to the value provided by the student’s education. Bootcamps such as Thinkful and General Assembly and colleges like Purdue University and Lackawanna College are also experimenting with ISAs.

These programs have demonstrated the potential of ISAs, both economically, and as a way to increase access to education. Because ISAs are not a debt-based security, people with poor credit backgrounds, those who cannot find a co-signatory, or people who are averse to debt, are able to attend school, which they may not have been able to do with debt. Perhaps the real promise in ISAs is not just in educational institutions, but as a replacement for the federal student loan system.

How a Federal Income Share Agreement Program Would Work

A recent paper by the Manhattan Institute outlines an idea of replacing the entire federal student loan system with an Income Share Agreement plan. Under this plan, students would agree to pay one percent of their income for every $10,000 they borrow from the federal government—the maximum a student could borrow would be $50,000—and payments would be made until the ISA expires after 25 years, or the payment cap has been reached. This would be a viable alternative to the federal student loan program and would perhaps reduce the amount of outstanding student debt in the US.

Eliminate Old Programs

Replacing the federal student loan system with ISAs would eliminate old programs and simplify the system for both borrowers and the government. There are dozens of repayment plans available, and the federal government often does not replace old programs, but rather develop new plans and keeps the old programs. A federal ISA would mean that borrowers would only have to learn about one option when financing their education, which would make it easier for them to understand whether borrowing money to pay for their education is best for them. If payment terms were simpler, students would be less likely to make mistakes in repayment. Student debt, for example, has a default rate of 11.4 percent, in part due to the complexity of making payments.

Logistics

Further, the reduced logistics involved in terms of maintenance—the federal government would no longer have to manage dozens of plans—may make it easier for the Education Department to provide more comprehensive oversight, and thus protect borrowers. A federal ISA program would mean the government could stop contracting loan servicing companies to process applications, inform borrowers of repayment plans available, and ensure payments are made. The IRS could take over student loan remittance by calculating how much is owed as a percentage of each person’s tax returns who has an outstanding federal ISA. Outsourcing student loan administration costs taxpayers around $3 billion per year and requires a lot of time from the Department of Education. Indeed, a federal ISA would require a new type of administration, but because there would only be one program to manage, the burden would be significantly reduced.

The Manhattan Institute paper also outlines how an Income Share Agreement program could mitigate increasing interest and negative amortization—a period where the balance of your loan is more than the initial amount borrowed. IBR still accrues interest over time, and even if people make consistent payments, their student loan can still appreciate in value. However, with an ISA, no interest would be accrued, and students would only make payments when they are earning over a certain amount. This means that balances would never grow higher than the initial amount borrowed, and even if a student cannot make a payment, their ISA would still continue without imposing any penalties. This works because ISAs are income-based, so high earners may pay back a little more than they initially borrowed, which is capped at a certain amount. Therefore, the high earners will subsidize the losses from the lower earners, which would allow the program to operate perpetually.

Flexibility for Students

A federal ISA program would also provide students with more flexibility in their payments. ISAs have a minimum income threshold, which means that if you are earning under a certain amount, you will not be required to make payments. So, if you become unemployed or get a low-earning job, you will not make payments until you succeed. A federal ISA program would reduce the financial burden of making consistent monthly payments that people have in student debt and perhaps reduce the mental burden imposed on students. 48 percent of borrowers in 2018, according to the National Financial Capability Study, were concerned about paying back their student loans, and a survey by Gradifi found that 80 percent of working professionals cited student loan debt as a source of “significant” or “very significant” stress. Federal ISAs would provide better payment terms, and ensure that if people cannot pay, they will not accrue interest or face a penalty.

Other Benefits of a Federal Income Share Agreement Program

There are a few other benefits to a federal ISA program. Students enrolled in an ISA-based repayment plan would likely pay less than what they do through income-based repayment and other repayment options. A federal ISA would leverage lower income-share percentages to increase flexibility for borrowers. Current federal income-based options range from 10 percent to 20 percent. An ISA would waive payments when students are not earning over a certain amount. In addition, a federal program would also make it easier for colleges to provide access to student financing education, as they would only have to advise students on one option. For the overall market, a federal ISA program would also reduce the need for schools to start their own ISA funds, and would allow students attending any college to use an ISA to pay for their education.

Student Financing Legislative Landscape

Replacing federal student loans with an Income Share Agreement program is an ambitious idea. Lawmakers have been contemplating plans to reform higher education financing for years, and many ideas, such as income-based repayment, have continued to show flaws and contribute toward the increased amount of student debt in the US. ISAs may be more difficult to sell because they are not as attractive as other options available, and perhaps have a higher barrier for understanding. Moving to a federal ISA program does not sound as attractive as free college or loan forgiveness, two ideas being spearheaded by prospective presidential candidates. That is the nature of politics, however, and even if an ISA program were to pass, there are still many things that could go wrong—oversight could be limited, terms could become unfavorable, and more—as we have seen with prior student debt legislation.

In July, the ISA Student Protection Act was proposed by Senators Todd Young (R-Ind.), Marco Rubio (R-Fla.), Mark Warner (D-Va.) ,and Chris Coons (D-Del.), which aims to regulate ISAs. This income share agreement legislation creates a set of standard consumer disclosures and borrower protections and creates a clear definition of ISAs under the law. While this is not a federal ISA program, it does demonstrate increased interest from both parties toward exploring ISAs. Diane Auer Jones, principal deputy under secretary at the Education Department, announced in April that the department was “thinking about how we can use the federal programs to do an experiment with income-share agreements”. A pilot program would be a good place to start and perhaps pave the way for full federal ISA programs in the future. Although, this plan did receive criticism from Sen. Elizabeth Warren and other Congressional Democrats, so the status of this program is unclear.

The State of Income Share Agreements

ISAs are still a very new concept, and policymakers are still navigating these documents. There has been no comprehensive Income Share Agreement legislation passed yet; however, they present a reasonable alternative to student loans that would provide students with more flexible fundraising terms and help expand coverage to education financing to more people. ISAs have been successfully implemented in colleges and bootcamps around the country, and more data is starting to become available about how they should be structured to ensure students are offered the most favorable terms possible. There are many hurdles to overcome before a federal program would be introduced, but seeing more reports and interest in a federal pilot program is a good start.