It’s no secret that student loans are a problem, not only for those who bear their burden but for society as a whole. In early 2016, the amount of student loan debt in the United States was estimated at $1.3 trillion, and we can safely assume that number is higher today.
So, what do we do about this? The numbers aren’t going down. President Obama made student loan debt reform a focus of his last years in office, but he is no longer in office, and the new administration seems unlikely to continue these efforts. I am guessing, in fact, that President Trump will favor free market solutions to student loan issues.
As a former financial guy and now part of the higher education world, I tend to straddle both worlds with this question. On the one hand, I firmly believe in the power of the free market. On the other, I know that student loans aren’t going anywhere anytime soon. But I do think that we can reimagine how they are distributed and paid back.
There are a number of initiatives looming in terms of student loans, but the one I am most interested in is Income Share Agreements (ISAs).
The Student Loan Conundrum
Traditionally, student loans have worked like any other loan, such as a mortgage or a car payment. Students (and their parents) took out a fixed amount of money and then, after no longer being enrolled in school (whether through graduation or simply no longer attending school), paid a fixed monthly amount, including interest.
These loans were, usually, given through the government, although private companies also got into the game. Income-based repayment plans are popular, where the amount owed each month is derived based on how much that person makes. And for those people who choose certain careers, such as teaching in high-risk schools, loans will be forgiven after a certain amount of time.
The government argues that student loans are good social policy, because they support higher education and make access available to all. Free market advocates argue that student loans create an artificial market for higher education, because higher education institutions can raise tuition without regard for what the market actually can bear, since the government is there to take up the slack.
Defining Income Share Agreements
ISAs take a different approach. Instead of paying an amount based on how much was borrowed plus interest, ISAs offer students contracts where the ISA pays for the student’s education (or a portion of it) and then the student agrees to pay a percentage of future earnings for a specified time period. That percentage and time period are based on factors such as field of study and amount borrowed. Essentially, ISAs bet on future earnings outstripping the amount paid for education. This is not always the case, which is a risk ISAs take — they are not guaranteed to get back the amount they invested in students.
ISAs can be offered by different entities — banks, private companies, even the colleges themselves. Purdue University offers a “Back a Boiler – ISA Fund,” in which the Purdue Research Foundation offers ISAs to rising juniors and seniors. The program is experimental, but Purdue has high hopes it will prove popular.
There are a few benefits to ISAs, including:
Giving colleges “skin in the game.” Right now, students (and their co-guarantors) bear all the burden of student loans. Taxpayers, too, are on the hook for this money; the Obama administration failed to account for more than $100 billion in student loan write-offs from the Income-Driven Repayment and Non-Profit Loan Forgiveness programs. Colleges are able to accept this money, but if students drop out or receive an education that does not prepare them for the workforce, the college does not suffer financially at all. They’ve already been paid, and payment is not contingent upon quality of education. ISAs change that model and share the risk. With ISAs, colleges will want to offer programs that are tailored to the needs of the modern-day workforce because the better jobs students get after graduation, the more money ISAs will make back and the more likely ISAs are to pay more for the education. Having skin in the game will force colleges to rethink their educational model. I know that is something higher ed has traditionally resisted, but I believe the time has come to reimagine education.
Developing a virtuous cycle. Higher education currently has no strong incentive to lower costs, because the government has provided an open source of cash flow to these institutions via student loans. ISAs can help change that. Because ISAs are based on future earnings, students will prioritize things like cost, program quality and alumni outcomes when choosing their institution. Those schools that can find the sweet spot of offering quality at a lower cost will thrive under the new model of payment. ISAs will remove the artificial government backing that student loans provide and force schools to pay attention to what the market can actually sustain, creating a virtuous economic cycle that should, ultimately, lower costs.
Relieve taxpayer burden. Obama’s plans for student loan debt relief sound good to those who have the loans. And the plan was fine for colleges, which got paid regardless. But if those loans aren’t paid back, it’s the taxpayer who bears the burden. I don’t know what the new administration will do or not do about student loans, but I do know that ISAs remove the possibility of taxpayers losing out on loan repayment, because the government no longer takes the risk of default. And to my mind, that’s always a good thing.
Improved flexibility. Right now, student loans have to be paid back regardless of circumstance (up to and including bankruptcy or even death). ISAs offer more flexibility. The contracts signed are based on percentage of income and are for a fixed time period, so students can better plan their futures. And for those students who choose lower-paying professions, it can actually lower the expense of going to college, since they will be paying back a smaller amount of money (although the same percentage as those who go into more lucrative fields).
But no system is perfect, and I do have some concerns about ISAs.
Prioritizing profit. ISAs could potentially pick “winners” and “losers” in terms of what programs they prioritize. For example, it would make sense for ISAs to want to give people getting engineering, software development or business degrees more beneficial terms, because those are fields that are likely to yield higher salaries down the road. But that seems unfair to those professions that pay less but are still important, like teaching or human services. There would have to be safeguards in place to ensure that future earnings were only part of the matrix used to determine the terms of the contract.
The nature of the contracts. One of the issues with student loans, which is also an issue with ISAs, is that we are asking young people to make long-term decisions about their future without necessarily having all the facts. It can seem tempting to sign a contract that defers payment until after college, because many students assume they’ll get high-paying jobs right after college and will willingly take that risk. But does that do a disservice to those who might not be able to adequately understand what burden they are assuming for the future? Regulation likely would be needed to ensure that contracts were fair; if the housing crisis taught us anything, it’s that people are eternally optimistic about what the future will bring and will sign papers that are counter to their best interest without meaning to.
The state of the economy. ISAs only work if the economy is vibrant enough to give college graduates a path to career success. Otherwise, ISAs won’t earn back the money spent on the education, and the system will collapse. Although I believe that our economy will remain strong, I recognize that there is a lot of volatility in our system.
One thing I do know — our student loan system is broken and needs to be fixed. It needs to create solutions that organically allow the cost of a degree to be commensurate with the value of a degree. The best example of this currently is coding bootcamps, where students pay somewhere between $10,000 and $15,000 upfront, but almost always dramatically improve their salary within 180 days of graduation. The ROI is clear for coding bootcamps, and we need to make it clear for traditional degrees as well. While outcomes can be harder to measure, it’s something that higher education needs to start focusing on.