Income Sharing Agreements Could Help Fix the Student Loan Crisis
A novel funding concept is sweeping the college education funding system by storm. Income Sharing Agreements (ISAs) are a financial vehicle in which a student receives a fixed amount of money to pay for their college tuition and in exchange agrees to pay back a percentage of their income for a fixed number years following graduation. Indeed, ISAs are an alternative to the traditional student loan system which has created $1.2 trillion in U.S. college student debt, forced many young adults into bankruptcy and has marred the credit ratings of many individuals for life. The ISA idea is already beginning to take hold as number of entrepreneurs have entered the space to create organizations such as Upstart and Lumni which fund student college educations under ISAs.
To give a sense of how widespread the student loan endemic is and how important it is to come up with meaningful solutions, the $1.2 trillion college student debt burden is spread among 37 million borrowers, 5.4 million of whom have already defaulted. Unlike traditional Sallie Mae government loans or private student loans, ISAs would not create any student debt that immediately starts accruing interest after graduation. Instead the ISA would entitle an investor to a small percentage of the future stream of a student's cash flows across many years following college.
In short, ISA investors are betting on the long-term success of their students rather than the short-term ability of students to meet their student debt obligations. Investors only make money on ISAs if students are successfully employed post-college and that's the risk the investors take. If the students do very well financially after college, they will end up paying more than they would have in tuition. If they are less successful, they may end up paying a lot less, but without the mechanism of default under the traditional student loan system.
The Income Sharing Agreement (ISA) idea was originally proposed by Milton Friedman, in his 1955 essay titled, "The Role of Government in Education." In essence, Friedman argued that college education should be funded through an "equity investment" rather than debt.
ISAs have already been launched in several pilot programs, demonstrating substantial potential for growth. Upstart, an ISA start-up which matches students and investors, has won high-profile backing from Google Ventures and has launched a pilot with a several hand-picked students and investors. Lumni, a similar ISA start-up co-founded in 2002 by Vanderbilt economist Miguel Palacios and entrepreneur Felipe Vergara, has funded nearly 5,000 students in five countries.
Some have argued that for income-share agreements to go mainstream, they need more legal and regulatory clarity. This spurred Sen. Marco Rubio (R-FL) and Rep. Tom Petri (R-WI) to introduce legislation that would 'broaden the use' of ISAs. For Rubio, student debt is personal since when he was sworn into office in January 2011, he owed more than $100,000 in student loans. He also is driven by the belief that the $1.2 trillion student loan industry is a drag on the economy.
Some proponents have acknowledged that ISAs may not help the majority of students but rather focus on students pursuing STEM (Science, Technology, Engineering, and Math) careers. They contend that ISAs will provide an incentive for students to pursue degrees that have a high success rate with post-collegiate employment (such as STEM fields) rather than continue to fund students in fields that ultimately do not lead to jobs.
In sum, there is a lot of hope that ISAs will act as a mechanism that will help reduce overall student debt, especially given ISAs are one of the few plausible solutions being introduced.