Nov. 14, 2013
Here’s a thought: Let’s have college educations that are less reliant on public subsidies, won’t require an increase in taxes, and allow students to leave school with less debt. Sounds fantastical, right? A financial vehicle to make this happen does in fact exist, but it is not without controversy. We call them Income Share Agreements, or ISAs, and the concept is rather simple: An investor gives a student some money to pay for school and the student agrees to pay back a percentage of his income for a certain period of years.
But first, let’s hear from the public intellectuals. In the New Yorker, James Surowiecki said that these contracts offer “more flexibility” than student loans. Kevin Roose of New York Magazine fired back, calling it indentured servitude.
Next, let’s ignore the public intellectuals, because a number of startup organizations—both for-profit and nonprofit—are moving ahead and offering these products (they are sometimes referred to as human capital contracts) now.
So, forward ho, but to where, exactly? Is this slavery or freedom?
The student can use the investor’s money to pay for school and then go about his life however he pleases.
The argument for freedom is persuasive. The student can use the investor’s money to pay for school and then go about his life however he pleases. The investor cannot force him into one career or another (that’s illegal). Nor can the investor force him to work harder or earn more money, and neither party can change the initial terms of the agreement later on. The borrower will probably try to find a fulfilling and high-paying career, but he can do whatever he wants. If he makes no money, he owes nothing, and when the time period is up, there is no further obligation.
Of course, if you enter into a contractual obligation in which one person gives up money now in return for the other person paying back money later, there will always be some truth to a metaphor involving shackles. You owe a debt; you are obligated to do your best to fulfill the terms of the contract. That’s life. The question then becomes, what do I want that contract to look like?
Let’s break down the numbers, starting with the private market. It’s about 10-15 percent of all outstanding student debt (the rest is from the federal government). Still, that’s somewhere around $150 billion and it is heavily concentrated among undergraduates. And when it comes to financing higher education, private loans are AWFUL. Worse than Miley Cyrus at the VMAs. Really bad. The rates are high, the terms are inflexible, and you almost certainly need someone with good credit (probably your parents) to co-sign the loan with you, putting them on the hook as well. It’s much harder to discharge them in bankruptcy than almost any type of debt. But the big problem is that you are borrowing against your future income, which happens to be unknown, and you have no asset to fall back on if your educational investment doesn’t pan out. In terms of shackles, this agreement is atrocious. If you took out a loan for a car, but you eventually find the payments to be unaffordable, you can always sell the car (albeit at a loss). But you can’t sell your diploma and you can’t walk away from yourself and start over. So, for those arguing ISA’s are slavery, I ask: compared to what?
On a private student loan, my nominal monthly payment is fixed (sure, certainty is nice) but my income could change or go away altogether (making certainty just a monthly repetition of bad news). With an Income Share Agreement the converse is true: I don’t know what my nominal monthly payment will be over the entire term, or how much I will pay overall, but I do know that I will always be able to afford it. Which would you prefer? I’ll take the certainty from an Income Share Agreement.
Next, let’s compare ISAs to federal student loans. The federal student loan program offers a different income-indexed plan called Income-Based Repayment, or IBR (the Obama administration calls the more generous version of it “Pay As You Earn”). IBR allows borrowers to pay 10 or 15 percent of a portion of their adjusted gross income and any remaining balance is forgiven after 20 or 25 years.
The lending market really under threat from Income Share Agreements is the one for which students desperately want an alternative: private student loans.
But, we still have the nut to deal with, i.e. the principal of your loan, and it’s accruing interest while you’re slow-footing repayment. Of course, from a student’s perspective, the current IBR program is probably a better deal than most Income Share Agreements. You don’t have to pay much if you don’t earn much, but if you earn a lot, your total payments are capped. In short, both IBR and ISAs protect low-income graduates, but the federal government’s IBR protects high-income graduates too. That makes it an expensive program from the taxpayer’s perspective, of course, which is especially frustrating since it benefits high-income borrowers. The New America Foundation has shown that recent changes to the IBR program significantly reduce higher income borrowers’ payments and provide the largest benefits to borrowers who attended graduate and profession school, even if they earn high incomes after they graduate.
That point aside, the lending market really under threat from Income Share Agreements is the one for which students desperately want an alternative: private student loans. In a perfect world, everything would be free. I get it. Income Share Agreements can’t do much about that. But they are a nice alternative in a world where things cost money and private student loans are expensive and extremely risky.
It’s only a matter of time before people start skipping private student loans altogether and jump straight to ISAs to finance their education above and beyond federal loans. Instead of debt-burdening their lives, careers, and well-being, students will be free to decide what they want to do. If they do well, investors share in that reward.
It’s not perfect, but it sounds like a better world to me."