Graphic done by Mario Arasakumar
By: Noah Blaff, Comm '20
Harvard, Yale, Princeton. The mere mention of these institutions conjures up prim, polished images of centuries-old campuses engulfed in ivy, grooming the next generation of prodigies to propel the world forward. The higher education system in the United States is seen as a beacon of hope and revered as the intellectual breeding ground for innovation. While this network of academic institutions is an incredible accomplishment, a sordid underbelly is often neglected – a student debt epidemic that is crippling millions of Americans.
Over 44 million Americans are currently struggling to pay off an aggregated $1.5 trillion in student debt. Astoundingly, student-debt is now the second highest consumer debt category, trailing only property mortgages. The ~$37,000 average graduate indebtedness is considerably more damning given the astronomically high cost of living in the U.S., coupled with a dearth of job prospects for students in myriad disciplines.
As post-secondary accreditation has become necessary for virtually all employment, recent graduates are drowning in debt as new students nervously seek a life raft. Delinquency in paying back loans can derail post-university life and restrict students for decades following graduation. One alternative being used to combat this epidemic is Income Sharing Agreements, or ISAs, which provide scholastic funding for a percentage of future income.
Milton Friedman, one of classical liberalism’s founding fathers, opined on the potential benefits of funding higher education costs through equity investments in a 1955 essay entitled The Role of Government in Education. In this publication, he posited that investors could effectively fund an individual’s education for a share of future income. With this hypothesized financial instrument, a lender could receive much more than through alternative (conventional) loans while providing lenient financing options for students. Though Friedman did not live long enough to witness the full effect of student debt spiraling out of control, his sentiment persists through ISAs.
What is an ISA?
Conventional ISAs, still in their infancy, are structured along similar guidelines to Friedman’s proposal. First, each has a system that takes inputs – such as anticipated degree, expected graduation date, and principal amount required – to provide terms for the agreement. These terms include an income repayment amount (a payback percentage of your income), and the term (the number of months over which the repayment will occur). Lastly, conditions are embedded into the agreement; while these differ depending on the offering entity, they remain similar. These most commonly consist of a maximum payment amount over the term – 1.5x the principal loan amount, for example – as well as a threshold of income, below which, the student is not required to repay any amount.
Currently, there are only three ISA Service Providers – Vemo, Lumni, and Edly – that provide ISAs to students across any college. However, in recent years, a myriad of universities has developed their own ISA-funded programs including Purdue, MIT, Harvard, and even Columbia University. The success or failure of funding from these prominent programs will determine the ubiquity, or lack thereof, that the ISA movement will garner. These pilot programs are the first form of modern ISA implementation, although similar ideas have hitherto been toyed with.
ISA antecedents have gained about as much traction as zeppelins did post-Hindenburg.The first notable form of equity investments in post-secondary financing was in the 1970s, when Yale applied the concept to an entire academic cohort. This venture is regarded as a failure due to asymmetrical repayments – some students contributed more than their fair share as peers failed to attain equally lucrative employment. More recently, in 2013, Oregon legislators passed Pay It Forward, a publicly-funded campaign in which students attend school for free and contribute a proportion of their income to fund future students’ scholastic needs. Unfortunately, these campaigns have yielded little success and failed to bring awareness to conventional ISAs.
Additionally, ISAs have failed to gain recognition due to muddled understanding of their place within America’s regulatory framework. Currently, they are legal in the United States and must adhere to the same regulations as any financial instrument. In July, a bipartisan bill was introduced on the Senate floor that legitimizes ISAs through the classification of their legality, and codification of conditions imbedded within the contracts. This includes exemptions for students earning less than 200% of the poverty line from making payments, restricting repayment obligations at 20% of income, and granting the Consumer Financial Protection Bureau oversight of ISAs. Democratic Senator Chris Coons of Delaware suggested this legislation allows ISA supporters to “proceed safely and with more government oversight.” This endorsement and coverage validate ISAs and provides a forum for proponents and opponents to converse further.
Be it Resolved…
Proponents of ISAs would argue that it allows students to engage in efficient capital allocation, provides a form of insurance, lowers job search costs, and aligns incentives. First, students are often faced with the dilemma of deciding between an institution’s reputation and its cost. ISAs offer more attractive terms (lower repayment percentage and duration) for students enrolled in high-quality programs that boast competitive employment rates. Therefore, students are less likely to choose a cheaper, substandard program out of financial constraint – benefiting both students and investors. A common example would be students that resort to community college education over state colleges, upon being accepted into both, purely based on financial constraints.
ISAs also excise the financial noose enveloping a student’s bank account. Since a student must only pay a percentage of future income, they have no financial burden should they be incapable of repayment. If they were to get fired, for example, and had no income to pay, their financial obligation would be precisely $0. Ultimately, students generally pay a premium for this insurance that the instrument provides.
Lastly, ISAs allow graduates to engage in meaningful job searches that are more thorough and preserve the longevity of income. In a Princeton paper, Justin Weidner argues that graduates with traditional debt feel pressured to hastily enter the labour market, and therefore, spend less time considering career paths that will be lucrative, fulfilling, and sustainable. After all, without looming repayments, one can find a suitable occupation that maximizes enjoyment and employs the full skillset that graduates have to offer.
On the contrary, opponents cite concerns that this contract is indentured servitude under the false guise of mutual benefit. Individuals arguing this will often compare the structure of ISAs to indentured servants that would work for a given number of years to earn economic resources. However, ISA advocates would assert that there is no forcefulness through the agreement – the graduate has the option to approach his or her life with absolute autonomy. Further, users of this financing alternative are no more ‘owned’ than students who use traditional loans are through strict payback requirements.
Opposition would also mention the externalities – unintended consequences – associated with ISAs. Take, for example, a high school student interested in pursuing psychology. This student (not comfortable with taking a private loan) may notice that they can only afford state university using an ISA, and given the terms attached, would require a more lucrative degree to lead a preferred lifestyle. The logic asserts that eventually, society will suffer a lack of talent in fields that aren’t lucrative, but still provide value to society.
Discriminatory practices, such as offering inferior terms to certain students based on myriad factors, is another concern that ISA adversaries have. While there have been no reported cases of this, legislative codification should address this concern.
Lastly, in a society struggling with elitism, people worry that elite institutions will further monopolize the market and local colleges, which provide invaluable opportunities to millions of Americans, will vanish.
Comparing ISAs to Traditional Loans
While ISAs represent a novel concept that provides downside protection for more financially cautious individuals, in strictly financial terms, it rarely represents the least expensive funding option. With these agreements, students will often end up paying back more than with traditional loans. The deciding factors tend to surround risk appetite and employment assumptions.
Take John, for example. John is entering studies at Purdue University, conveniently the institution currently leading the charge in providing ISA options to its students. He is studying sociology and expects to earn an average amount upon graduation. With Purdue’s ISA calculation tool, he is given the following terms on $10,000 of funding: 4.01% of future income paid for just over nine years following graduation.
For John, an average individual in a liberal arts discipline, this is likely the most favourable financing option available. If all goes as expected, he would payback a total of ~$14,950 throughout the nearly ten years following graduation. Comparing this to a Parent PLUS loan, one where parents engage in a federal loan to fund their child’s education, it would save John approximately $800 while guaranteeing financial freedom from indebtedness. Further, for students – like John – whose parents have adverse credit and do not qualify for the PLUS loan, private (Stafford) loans available through the federal government would have an even higher net payback amount (~$17,100). For John, funding education through an ISA is a no-brainer.
On the contrary, Melissa, who is an extraordinary college student studying finance – with hopes of pursuing highly lucrative employment – would not be an ideal candidate to benefit from an ISA. Upon graduating, she will be earning (let’s say) $80,000 and her net ISA payback will total ~$23,000 compared to PLUS and private loan paybacks of ~$15,700 and ~$17,000, respectively. Generally, one pays more for the safety that ISAs inherently offer.
It seems odd that through traditional financing, post-secondary institutions have little incentive to support individuals after graduation. While ISAs are an ingenious option to address the debt crisis for millions of American students facing uncertainty, it is not for everyone. At the end of the day, ISAs are the same as every capitalist venture, an idea with the sole intent of generating cash flow for investors. However, Friedman famously lamented that, “one of the great mistakes is to judge policies and programs by their intentions rather than their results.” Income Sharing Agreements have benefits that far outweigh any malevolent intentions which opponents may cite and can provide freedom, a truly American construct, to the next generation of fearful pupils.