With the nation’s student-debt load at $1.5 trillion and growing, presidential candidates, higher education leaders, borrower advocates are looking for ways to slow its climb.
Amid this backdrop, an idea first proposed in the 1950s is being hailed by industry, philanthropists and some higher-education leaders as a partial solution to our student-loan problem.
But to consumer advocates and even U.S. Senator and Democratic presidential candidate Elizabeth Warren, this same idea runs the risk of discriminating against women and students of color, and tying students to a financial product that’s designed to provide a return to investors at their expense.
Instead of taking on a traditional loan to finance their education, students pledge to give a portion of their future income to a funder to cover the cost.
Nobel Prize-winning economist and free-market proponent, Milton Friedman, originally pitched this financial tool, known as an income-share agreement, in 1955: Instead of taking on a traditional loan to finance their education, students pledge to give a portion of their future income to a funder to cover the cost.
The ISA concept started capturing headlines in earnest around 2016, when Purdue University, a public college in Indiana, indicated it would launch its own ISA program. Since then, a handful of other traditional, four-year colleges have created their own ISA programs, ISAs have become almost a standard offering to students looking to finance coding bootcamps, which don’t qualify for federal financial aid, and several companies have cropped up to help colleges manage their ISA programs or find investors.
When Charles Trafton, the president and co-founder of edly, which helps connect schools to interested accredited investors, started working on the idea for his company four years ago, there were only three schools offering ISAs. Today there are about 40 schools, he says, and he estimates that number will climb to 100 by the end of the year.
Proponents of ISAs tout the arrangements as a way to hold schools accountable, since they’re on the hook if their students don’t make enough money to repay the funds. (Not all schools that offer ISAs are currently working with investors and, even the ones that do are typically funded only partially by investments.) In addition, they provide students with a financing option that aligns more with their ability to actually repay the funds and without the overhang of a balance that comes with traditional student debt, supporters say.
But many aspects of ISAs that supporters see as a feature — for example, the potential to adjust the terms of the agreement based on the student’s school or major and that the arrangements don’t look like a traditional student loan — critics see as a bug.
‘It’s just a symptom of how bad college affordability and the student-debt crisis has gotten.’
Consumer advocates worry that setting terms by major and school, which correlate relatively strongly with race and gender, could open up the door to discriminatory lending.
And by framing ISAs as something other than credit with an interest rate or balance, critics say the terms can be confusing, making them difficult to compare to other financing options. In addition, they worry that the industry is trying to get lawmakers to define ISAs in such a way that would allow them to avoid regulations that protect consumers from things like discriminatory lending and usury.
“It’s just a symptom of how bad college affordability and the student-debt crisis has gotten,” Julie Margetta Morgan, a fellow at the Roosevelt Institute, a progressive think tank, who has written skeptically of ISAs said of the debate raging over them. “ISAs seem like an appealing solution when they’re pitched as an interest-free, debt-free way of going to college.”
But, she adds, critics are quick to remind students that ISAs are effectively another form of student loan.
Here’s a look inside the burgeoning industry and the battle brewing over its future:
Consumer advocates worry
Some consumer advocates like Joanna Darcus, a staff attorney at the National Consumer Law Center, worry that the proliferation of ISAs is more about creating an attractive product for investors than helping students afford college.
As Darcus sees it, “ISAs are a resurgence of the private market seeking a larger share of higher education finance,” after years of diminished participation in the wake of the Great Recession. “A lot of the same players in the private loan market are also present in the ISA market.”
Indeed, some of the backers of ISAs are a who’s who of organizations that have created challenges for student-loan borrowers over the past several years.
For example, the website incomeshareagreements.org, which advocates for ISAs, is run by Goal Structured Solutions. That company has acted as an administrator of National Collegiate Student Loan Trusts, a group of trusts that between 2001 and 2007 bought and securitized private student loans and sold notes secured by those loans to investors, according to the Consumer Financial Protection Bureau.
National Collegiate aggressively pursued the debts when borrowers defaulted on the loans, filing a rash of lawsuits over the past several years. But it turns out they may not have had a right to sue; in 2017, National Collegiate settled with the CFPB over claims they were suing borrowers to collect on debts that they couldn’t prove they owned.
‘We’re unclear about the problem or issue that ISAs are intending to solve and whether they’re targeted to solve the problems that they built.’
“We’re unclear about the problem or issue that ISAs are intending to solve and whether they’re targeted to solve the problems they built,” Darcus said.
She, and other consumer advocates also worry about the way that ISA proponents are framing the agreements. By describing them as something other than debt, ISA supporters are misleading borrowers and making it more difficult for students and families to compare their terms to other financing products, Darcus said.
And it’s possible for students to wind up paying more than they would under a traditional loan, according to an analysis by Mark Kantrowitz, the publisher of Savingforcollege.com.
Assuming an ISA charges students 0.4% of their income for every $1,000 borrowed — a rate that Kantrowitz says is typical based on his review of publicly available ISA terms — and that the term lasts 10 years, a borrower earning $50,000 a year and paying back $30,000 would yield a total payment of $65,698.33, or 1.7 times the amount paid with a traditional student loan with a 5% interest rate. That’s an equivalent to an interest rate of 18.4%, Kantrowitz found.
Consumer advocates like Darcus are also concerned that ISA supporters’ push for regulation is actually an effort to define ISAs differently from other products that would exempt them from existing consumer protection regulations.
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Last month, a bipartisan coalition of lawmakers introduced a bill aimed at regulating ISAs — a development ISA advocates have been clamoring for, for years. The proposal places some guardrails around the contracts, including a minimum income threshold at which funders can collect payments.
It caps the legal percentage of income a funder can collect at 20% and the maximum repayment period at 30 years. In addition, ISAs would be dischargeable in bankruptcy, which sets them apart from traditional student loans.
But the proposal also exempts ISAs from certain laws on the books, including state usury laws, by preempting them (essentially that means that this federal law would take precedent over existing state laws that regulate financial products). The bill also preempts state laws surrounding lenders’ ability to pull a payment directly from a borrower’s paycheck and state laws surrounding prepayment penalties.
‘They’re asking for an escape valve from the ways we normally regulate products just like these.’
“They’re asking for an escape valve from the ways we normally regulate products just like these,” Darcus said of ISA advocates.
In addition, the bill proposes to exempt qualified ISAs that vary based on major, college and other categories from the anti-discrimination provision of the Equal Credit Opportunity Act — which bans discrimination in lending on the basis of race, sex, religion, marital status and other factors.
Adam Levitin, a professor at Georgetown University’s law school, called that exemption “outrageous” and “an open license for discriminatory financing.”
When lenders use educational criteria to underwrite financing products, majors and schools with higher earning prospects tend to get better terms. An overwhelming amount of data also indicates that these majors and colleges are likely to be whiter, wealthier and more male than colleges and fields where graduates earn less.
In other words, consumer advocates worry that groups protected by the ECOA will be less likely to get credit and to pay more for it when they do if educational data is used as underwriting criteria.
A new asset class
ISA advocates see the use of educational criteria as more inclusive and much more predictive of a student’s ability to repay than a traditional credit score.
“We’re really trying to increase accessibility, increase affordability,” Trafton said. His company, which works to connect investors with schools interested in offering ISAs, requires participating schools to put up some of their own money in the ISA deals. Because the schools have skin in the game, “the system creates the incentives where the school can increase the quality of education,” Trafton said.
At edly, Trafton and his team are looking to turn ISAs into a new asset class somewhere in between debt and equity, he said. Basically, they do this by analyzing the terms of a school’s ISA as well other data, including graduation rate and graduates’ earnings to offer investors an expected yield.
Schools pay a fee to post their ISAs on edly’s platform, where accredited investors can view all of this information and decide where to put their money. Chris Riccardi, the chief executive officer of edly and part of the team creating the new asset class, was a former Merrill Lynch BAC, -0.37% banker who reportedly helped popularize collateralized debt obligations, a structured credit product that played a role in the financial crisis.
Riccardi’s expertise “has been invaluable to create ISAs in a form that are investable by not only accredited investors, but also the largest institutional investors,” Trafton wrote in an email.
‘Every one of these schools very much desires third-party capital to fund these programs.’
“Every one of these schools very much desires third-party capital to fund these programs,” Trafton said in an interview. At the same time, he added, “investors have an overwhelming appetite for these.”
The level of returns expected by investors interested in backing ISAs varies, Trafton said. Some are essentially donors and are willing to accept no or minimal returns; others view ISAs as an impact investment, so they’re looking for below-market returns. On edly’s platform, investors are looking for a return somewhere between debt and equity.
Other investors have sought venture capital-type returns, which can be at least 20% per year, Trafton said. Because that level of return is expensive to schools, it’s been a barrier to adoption, he said.
From a substitute for loans to a substitute for scholarships
Jason Delisle, a resident fellow at the American Enterprise Institute, a conservative think tank, has watched the conversation surrounding ISAs for years. He said he’s surprised at how the concept has evolved to be centered mostly around schools instead of private investors.
When Delisle first started hearing ISAs discussed seriously in policy and higher-education circles around 2012, the idea was that private investors would back students expecting some kind of return. But these days, many of the more prominent ISA programs are actually run by colleges.
‘The school wants to lose money, they just want to lose less than they would on a scholarship.’
Often the schools cap the amount of money a student will pay back, typically at around double or 250% the amount a student receives. But at least one school caps the funds a student is required to pay back at the amount of money they received.
In this scenario, an ISA allows a college to stretch its financial-aid budget further than if they were just handing out a traditional scholarship, Delisle said. With ISAs, they plan to get the money paid back, as long as the student has a decent salary after graduating. But since the amount paid back is capped at the amount the school handed out, they’re not actually profiting off the ISA.
Schools see ISAs as a tool to boost competition
Indeed, at Colorado Mountain College, an open-access public college system with 11 campuses across north-central Colorado, that’s how the program works. That school’s ISA, which they call Fund Suenos, provides money to students who are eligible for in-state tuition at the school, and who are authorized to work, but can’t access federal financial aid.
Colorado Mountain College’s ISA is funded completely through philanthropy and students can only borrow up to $3,000 per year through the program. After graduating, students earning at least $30,000 pay 4% of their income for a maximum of five years.
Most of the students they expect to take advantage of the program are recipients of Deferred Action for Childhood Arrivals program (better known as DREAMERs), or young people who were brought to the U.S. illegally before they turned 16.
‘We give them a greater opportunity to take advantage of their own human capital faster.’
This group is eligible to receive work permits in the U.S. and, in Colorado, they can receive in-state tuition, but because they couldn’t access federal financial aid, many struggled to afford to attend school full-time, said Matt Gianneschi, chief operating officer at the school.
That’s a problem not only for them, but also for employers, who are desperate for workers in a state where the unemployment rate is hovering around 3%, Gianneschi said. The idea behind Fund Suenos is to provide students who can’t get federal grants or loans with financing that will allow them to work less while in school, which improves their chances of graduating.
“We give them a greater opportunity to take advantage of their own human capital faster,” he said.
At the University of Utah, officials also view ISAs as a way to mitigate challenges students face completing college, said Courtney McBeth, a special assistant to the president there, who helped design the school’s ISA program. As part of a strategic plan to increase the school’s completion rate, officials discovered that students’ debt aversion and financial challenges were getting in the way of them finishing school, McBeth said.
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As students had maxed out their financing options in their first few years of college, they hesitated to take on debt to complete their degrees, McBeth said. Instead, they would lighten their course load and only take the classes they could afford out of pocket — often a class here or there — slowing down the time to completion, or in some cases stopping out all together.
(The influence in the state of the Church of Latter-day Saints, which historically encourages their members to avoid excessive debt, may contribute to students’ hesitancy towards taking on excess debt, McBeth said).
To address that challenge, the school launched its own ISA pilot. Through the program, which right now is limited to seniors, students can borrow up to $10,000 and the amount they pay back is capped at double the amount borrowed. After graduating, students earning $20,000 per year or more pay 2.85% of their income for up to 10 years and seven months, varying depending on their major and how much they take out.
In order to take advantage of the ISA, students are required to meet with a financial-aid counselor who has expertise in the program to make sure they understand the terms and that they’ve exhausted their federal aid and grant options as well as other scholarships, McBeth said.
The program is funded through a combination of university and donor funds as well as investments from family foundations.
“We haven’t guaranteed any sort of return,” McBeth said. “These are donors. They give a lot of scholarship money to the university and this is a new type of way to give a scholarship that creates an evergreen fund that will continue to regenerate and help future students.”
More than just traditional colleges are interested in ISAs
But it’s not just traditional colleges experimenting with ISAs. One nonprofit, Better Future Forward, offers ISAs to low-income students who are clients of certain community organizations that aim to increase college access and success.
Students can borrow up to $35,000 through the program and will pay back anywhere between 3.5% and 10% of their income for a maximum of 20 years. They’re only required to make payments if they’re earning at least $30,000 — a threshold that will adjust with inflation.
Kevin James, the founder of Better Future Forward, said the product is meant to provide financing to low-income students who may need more funds after they’ve exhausted their access to federal student loans. The ISA program keeps them and their families from signing up for private student loans, which can have few protections and high interest rates for families with limited or poor credit. It also allows students to avoid working excessively while in school.
In addition, by partnering with community organizations, Better Future Forward insures that students have the academic and other support necessary to make it through school and ultimately on to a career that will allow them to pay the money back, James said.
“We’re trying to complete the other half of the puzzle on the financial side,” he said.
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At Lambda School, which offers full-time nine-month courses and part-time 18-month courses in topics like data science, iOS AAPL, -2.12% development and web development, students aren’t asked to pay anything upfront. Instead, they can use an ISA offered by the school to pay for their courses.
Austen Allred, the chief executive officer of Lambda, said the school turned to an ISA strategy after realizing that many students were struggling to come up with enough money to shell out for the courses at the start (the school isn’t eligible for federal financial aid, so students can’t use federal loans to attend).
“For us, the key is that if a student doesn’t get hired they don’t pay anything,” he said. In addition, “the incentives of the school are aligned with the incentives of the student.”
Under the terms of Lambda’s ISA, students earning at least $50,000 per year, pay 17% of their gross income every month after graduation for two years. Graduates pay a maximum of $30,000 to the school. Students earning $90,000 or more per year would hit that cap.
In the future, Lambda may offer students the choice to pay back a large percentage of their income for a short period of time or a smaller percentage of their income for a longer period of time, Allred said.
The school is also planning on expanding its course offerings to areas that would prepare students for jobs in other in-demand fields, like health care, Allred said. “We want to train everybody for every high-paying job out there.”
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