This week a new bill establishing a regulatory framework for alternative college financing options was voted out of the House Business & Financial Services Committee. HB 1923, sponsored by Representatives Hans Zeiger (R-25th), Steve Bergquist (D-11th), Larry Haler (R-8th), Mark Hargrove (R-47th), Steve Kirby (D-29th), and Kevin Parker (R-6th) would create a mechanism whereby college students could avoid the risk of taking on debt by agreeing to pay investors fixed percentages of their future earnings. It’s modeled after federal legislation called the Student Success Act of 2014. If passed, the bill would define and outline regulations for Income Share Agreements (ISAs).
Student debt puts a strain on Washington State’s economy. 58 percent of Washington State students graduate with debt. Among them, the average debt load is over $24 thousand dollars. Student debt now surpasses all other major types of debt in 90+ day delinquency rates. Increased student debt negatively impacts new business formation and disrupts career trajectories.
Last year, three similar bills failed to pass the Washington legislature. Termed “Pay It Forward,” these bills would have used public funds to capitalize ISAs, whereas HB 1923 paves the way for private investors to offer these financial instruments.
So, What Are Income Share Agreements?
ISAs do not create debt. Unlike a loan, there is no principal balance to repay with an ISA. Instead, they entitle a private investor to a percentage of the student’s earnings over a fixed period of time. This means that the amount of the payments fluctuate with the student’s income, and that the student may ultimately pay more or less than the amount financed.
Under HB 1923, ISA payments could not exceed 15% of the student’s income, and the length of the contract would be capped at 30 years.
ISAs entered the national spotlight when a few start-ups (Upstart, Pave, and Lumni) began offering them to individuals and businesses. They are also offered by some of the increasingly popular accelerated coding programs, which train web developers in exchange for first-year income at a job, which is all but guaranteed at the time of graduation.
America’s students have amassed $1.2 trillion in student debt. Our current lending system, coupled with high tuition costs, is a deterrent for many students considering higher education, especially four-year degrees. The fear of graduating with unmanageable debt weighs heavily against the shaky promise of higher earnings. Furthermore, those who do take on large amounts of debt to finance their education are limited when it comes to career choice and risk taking.
In Washington, the situation isn’t getting any better. State spending on higher education has been decreasing since 2009 and tuition has skyrocketed. Not to mention, funding requirements mandated by the McCleary decision almost guarantee that any discussion about funding for education will revolve around K-12.
The fact that ISA payments go up when income is high and down when income is low amounts to an effective hedge for the risk associated with the educational investment. Many students are discouraged from pursuing degrees because of the risk of taking on debt, this helps insulate them from some of that risk, potentially encouraging them to pursue higher earning degrees.
One benefit of privately-backed ISAs is that they don’t require the state to make an investment. Using taxpayer dollars to implement income share agreements would compete for funding with programs like the State Need Grant, which is already severely underfunded.
A Private Sector Solution?
ISAs are indeed using private capital to help solve a public problem. But, the truth is that many students have already turned to the private sector for help paying for college. Unfortunately, current private sector financing for higher education is part of the problem.
Private student loans account for about 10-15 percent of all outstanding student debt, and it is heavily concentrated among undergraduates. Private student loans have a horrible reputation that is well-deserved. They boast exorbitantly high interest rates and low levels of transparency. Creating regulations for ISAs can prevent them from becoming a tool for predatory lending.
In order for ISAs to have a positive impact on higher education, they have to be regulated (which they would be under HB 1923), and they have to be structured in a way that makes them better options for students. More on that point later.
Doesn’t the Federal government offer income adjusted payments?
The federal government offers a few income adjusted repayment programs: Pay-As-You-Earn (PAYE), Income-Based-Repayment (IBR), and Income Contingent Repayment (ICR). These programs differ from Income Share Agreements in the following ways:
- To qualify for the federal programs a student must apply after graduating and demonstrate a Partial Financial Hardship, among other requirements.
- After 20-25 years of consistent payments, the remaining loan balance is forgiven, but it is taxed as income.
- Under PAYE, IBR or ICR, students are guaranteed to pay between 10 and 15 percent of their monthly income.
What are some common concerns about ISAs?
Some arguments against ISAs have less to do with whether or not they are viable, and more to do with ideological questions about the role of private capital in a public domain.
First, there is general opposition to market-based solutions for social problems. There are important functions of the government that should never be privatized, and uncertainty about the degree to which we should rely on market-based solutions pervades almost all political debates. The injection of private capital into areas like higher education causes some people to wonder if the government shirking its responsibilities.
These concerns are valid, but they don’t overshadow the fact that ISAs can be a part of an interim solution to higher education funding. To quote a recent analysis by the Brookings Institution: “ISAs may not be the silver bullet that will solve all of our collective concerns, but they should have a place in the landscape of services available in the heterogeneous market for higher education.”
Another concern about ISAs revolves around equity. Would ISAs really be available to everyone? Or would they be accessible to people who already have a significant advantages?
The answer is that ISAs would probably not be available to everyone, especially not at first. In their infancy, ISAs are likely to go to safe bets– students with high earning potential. The current selection process for ISAs narrows the pool quite a bit. Private companies use algorithms to predict each student’s future earning potential, taking into account things like standardized test scores and credit history. But, the potential of ISAs lies in their scale.
If ISAs are issued in large enough numbers, investors would be able to hedge the risk of entering into contracts with students who have lower earning potential and are more in need of alternative financing. Conventional private companies might not have a financial incentive to expand and diversify their ISA portfolios, but nonprofits and social enterprises might be good candidates.
There’s another category of complaints about ISAs that fail to persuade because they could just as easily apply to student loans. Some critics have likened ISAs to indentured servitude because students are committing to lengthy contracts. Others decry ISAs because of the fact that some students are signing up to payback more than the cost of tuition. Reality check: these unpleasant realities are more characteristic of traditional student loans than of ISAs.
ISAs Signal ROI, Generating Valuable Information for Students
Although data shows that earnings increase with educational attainment, there is a massive disparity between the earning potential of different degrees. Many degrees do not lead to employment (as evidenced by the persistently high youth unemployment in the United States), or they result in underemployment (over 40 percent of college graduates hold jobs that don’t require a degree).
ISAs that finance degrees with lower earning potential will probably come with higher payments and/or longer contracts. Differential pricing conveys valuable information to college-bound students about which programs offer them better employment and earning prospects. Thus, ISAs provide incentives for students to choose degrees with good ROI (many of these degrees are STEM degrees).
These incentives may also help align higher education with private sector demand, and mobilize untapped human capital in Washington. There are 25,000 unfilled jobs in Washington as a result of the job skills gap (growing to 50,000 by 2017), 80 percent of which are in high-skill STEM and health care roles.
If a market for ISAs takes hold, the differential pricing of ISAs will send powerful signals to students about the earning potential of different degrees. This in turn may put pressure educational institutions to better align program costs with market value.
Keep it Simple
The debate about ISAs often unearths some larger, much more complicated questions like How should we, as a society, fund higher education? and What is the purpose of higher education?
The debate over HB 1923 (and ISAs in Washington State) is better served by interrogating a more modest set of questions: Can ISAs help some students? and Should we define and regulate ISAs before they go mainstream?
The answer to both of these questions is Yes. When priced and regulated fairly, ISAs can provide students with a better alternative to student loans. Passing HB 1923 doesn’t mean that ISAs will suddenly become ubiquitous, but if they do start popping up in Washington, at least we will have a regulatory framework in place.
Like all market-based solutions, getting the price right will determine whether or not ISAs actually make good alternatives to student loans. Student demand and investor appetite will dictate whether private ISAs take hold, and, in order to conjure sufficient demand, investors will need to offer ISAs at competitive rates. Competitive options for financing higher education will serve the interests of students and the larger economy.