Can Income Sharing Agreements (ISAs) Fix the Student Loan Crisis?
January 22, 2015

The national student loan debt is worth $1.2 trillion. Approximately 37 million borrowers have a share in this debt, of which 5.4 million have already defaulted. These numbers alone give an idea of the widespread reach of the student loan endemic.

As the volume of student loan debt continues to rise, not many meaningful solutions have emerged to arrest this upward incline. However, in recent times, a new concept has emerged in the college education funding system i.e. Income Sharing Agreements (ISAs). ISAs might well present a viable alternative to the conventional student loan system that has little to offer in terms of easing the ever-increasing burden of student loan debt.

What are Income Sharing Agreements (ISAs)?

Milton Friedman bears the credit for originally proposing the concept of ISAs in his essay of 1955 titled, “The Role of Government in Education.” In the essay, Friedman proposed the funding of college education through equity investments rather than via debt.

More recently, Jon Hartley mentions that ISAs are a credible alternative to the traditional student loan system. The traditional student loan system does little else for many students other than driving them into bankruptcy or marring their credit ratings for life.

Sallie Mae government loans or private student loans typically start accruing interest once the student graduates. This results in the accumulation of debt for the borrower. In contrast, ISAs are financial agreements whereby students receive a fixed amount of money for paying for college tuition. In return, they agree to repay a percentage of their income for a specific number of years following graduation.

The Risks and Benefits Associated with ISAs

Therefore, an ISA does not result in the accumulation of a debt burden for the student. Instead, it entitles an investor to receive a minor percentage of the student’s cash flows in the future for a specified number of years, once the student graduates. As a result, it sidesteps entirely the short-term ability of the student to repay the student loan. Rather, it focuses solely on the long-term success of the student.

However, an ISA is not exactly free of risks. An investor will only make money on the ISA if the student gains employment after college. In an ideal world, a successful student will do well financially after college. In this scenario, the student will repay the investor a sum that is higher than what the student paid for tuition.

On the other hand, if the student does not do well financially, the student will probably end up paying a much lesser amount. In addition, the ISA ensures that the student does not end up with the tag of a defaulter, as routinely happens in similar situations in the traditional student loan system.

The key benefits of ISAs lies in the fact that ISAs:

  • Are available to all students, regardless of income or wealth
  • Offer better options in terms of higher education programs by ensuring that students enroll in high quality, low cost programs
  • Provide job security to graduates
  • Offer better support structures to students including advising, mentoring and career counseling
  • Eliminate student debt and student loan default and,Eliminate risks to taxpayers

ISAs in the College Education Funding System in Recent Times

Hartley mentions that the concept of ISAs is beginning to gain widespread acceptance as various entrepreneurs have entered the college education funding space in recent times. These entrepreneurs create ISA organizations that fund college educations under ISAs. Several pilot programs have already launched ISAs, thereby highlighting the immense growth potential these agreements have.

Hartley cites the example of Upstart, an ISA start-up that matches students and investors, has launched a pilot with several handpicked students and investors. Recently, it secured the backing of Google Ventures as well, thereby highlighting its potential worth.

Similarly, Vanderbilt economist Miguel Palacios and entrepreneur Felipe Vergara co-founded Lumni, a similar ISA start-up, in 2002. Today, Lumni has funded nearly 5,000 students in five countries.

Yet, Hartley writes, this growing phenomenon has also raised several concerns. For example, ISAs will require additional legal and regulatory clarity before they can become a sizeable part of the mainstream.

Similarly, another emerging concern is that ISAs are worthwhile for students pursuing Science, Technology, Engineering and Math (STEM) careers, but not for the majority of the students. As a result, the ISAs will focus on students pursuing STEM careers because they offer a higher success rate in terms of post-collegiate employment, rather than funding students in fields that are not as lucrative or successful.

Senate Introduces Bill Aiming to Simplify Student Aid

While ISAs are not a part of the mainstream yet, millions of students are preparing to complete the Free Application for Federal Student Aid (FAFSA). Completing the FAFSA enables a vast majority of the students to access the hundreds of billions of dollars in college grants and loans. It is worth mentioning that for many families, the FAFSA is often the only way to obtain federal college aid.

However, the cumbersome form often makes it difficult for many people to access this aid. As a result, fewer people apply and enroll for federal college aid each year. According to this analysis:

  • US high school graduates left unused over $2.9 billion in free federal grant money by not completing the FAFSA in the last academic year
  • Approximately 47 percent of all 2013 high school graduates did not complete the FAFSA that could have enabled them to earn Pell Grant money they would not have needed to repay
  • High school graduates in California lost over $396 million in Pell Grant dollars by not completing the FAFSA

Bridget Terry Long and Kristin Conklin report a development that did not get the attention it merited. Sen. Lamar Alexander, R-Tenn., introduced bipartisan legislation aiming to simplify student aid, within hours of the opening of the 114th Congress. The Senate bill aims to provide a simpler, more transparent financial aid system that has fewer barriers to innovation.

The bill could help students obtain a better understanding of the amount of federal college aid that they could expect to receive, unlike the present system where students only figure out the amount of aid they could get once colleges admit them. It could also simplify the framework by which the system evaluates the aid given to students by focusing solely on critical variables like the adjusted gross income and the number of individuals in the family.

A simplified form could also help states and colleges identify the students most in need of college aid. It could also ensure that mentors and counselors focus on helping students enroll in courses that they can complete on time, rather than spending their time helping students complete the FAFSA.

Members of both parties openly embraced and encapsulated the features mentioned in the Senate bill in last week’s Senate legislation. At present, the bill appears to be a more practical legislative solution that will address the immediate challenges students face when they apply for financial aid.

However, as students look for ways to pay for college, ISAs are becoming increasingly popular. Today, many people are viewing ISAs as a plausible means for arresting the ever-increasing levels of student debt. Given the lack of other viable alternatives, ISAs might just be a worthwhile solution that helps students pay for college, whilst avoiding other, more dubious alternatives.