Imagine you’re going into college and staring at a bill for $25,000 for tuition and assorted other fees for your first year of school.
You’ve got two ways to pay the bill. You can take out a combination of federal and private student loans, or … you can agree to pay to a lender a set portion of your earnings over a defined period of time.
The latter is called an income share agreement, a concept originally proposed by economist Milton Friedman in his 1955 essay, The Role of Government in Education. Under an ISA, an entity (could be an investor, a bank, or even an employer) would give a student the money to pay for a college or graduate education in exchange for a fixed percent of the student’s future income to be paid for a fixed period of time.
For an example of what an ISA looks like, here’s the one offered by a company called Upstart.
There’s been renewed interest in the ISA over the past few years, including Investing in Student Success Act of 2014, a bill to increase the use of ISAs.
Now here comes Pave, a company that offers an income sharing agreement as an alternative to the traditional student loan. According to its website the company makes lending decisions based not only on FICO score but also on, “alternative factors that might demonstrate financial responsibility and creditworthiness, like education, employment history, current job status and future potential.”
An income share agreement sounds like a great idea. The lender is more of a partner in the student’s future success. There’s an incentive for the lender to help the student get a good job because the higher the income, the better the lender’s return on investment. In situations where the school is the lender, bad job placement means the school has to do a better job of educating people in the first place because a failure to do so loses money for the school.
It’s great for the student as well, bringing income based repayment into the arena of private lending. Borrowers know that their payments won’t exceed a certain portion of their income, so they don’t have to worry about repayment quite as much as is currently the case with private student loans.
Looking at it that way, the ISA sounds fantastic for everyone involved.
But the income sharing agreement has some problems. If you can’t see them, consider that the economist who proposed the concept is the same one who is responsible for trickle down economics, an idea widely embraced in the 1980s and now just as widely vilified.
Who’s going to receive an ISA? Not the 18 year old undergraduate at a mid-level college who thinks she wants to be a math teacher at a public school. And definitely not a community college entrant who has yet to figure out what he wants to do with his life.
Instead, the ISA will be reserved for those who attend the top universities and opt for the major with the best employment options after graduation. People getting an MBA or other professional graduate degree will be more likely to have the earning record and career path that leads to the best job, so more money will go to them than to undergraduates.
Choosing a major based on return on investment is a great idea, right? After all, we don’t want a bunch of people getting degrees in Underwater Basket Weaving, do we?
But consider the long term impact of those decisions. Over time the market becomes flooded with computer science engineers and professionals from the top schools. Lesser schools, filled with the cast offs who can’t get better funding for their educational endeavors, struggle to attract the top talent. With graduates less likely to go into high paying fields, those schools suffer from a decline in alumni contributions.
At the same time, students from the best schools stop picking a course of study that includes English, history and philosophy because they know it’s not going to allow them to get the ISA. The inventory of teachers coming from excellent universities dries up, leaving universities with only those graduates who didn’t qualify for an ISA in the first place.
The rich get richer, the poor get poorer. And over a fairly short period of time, we as a society become dumber as the next generation becomes less likely to learn about history, philosophy, literature and similar fields.
First in your family to go to college? Recent immigrant? Slightly older student with some bad credit and employment history? Forget an income sharing agreement because you’re less likely to have the employment track record to please the lender. Instead, you’ll be left with the high cost private student loan, which will be even more expensive as banks recognize that they have more leverage than ever with those least able to get more attractive financing.
This isn’t to say that income sharing agreements are a bad idea – they’re a different way to approach the spiraling costs of higher education. But don’t buy into the idea that it’s a cure for what ails the world of higher education.
the income share agreement is an idea that’s more likely to work for graduate students in a field of study that’s in high demand.
For everyone else, it’s just another reminder of the growing divide between the haves and the have nots.