Earlier this month, Florida Senator Marco Rubio proposed a piece of legislation that would offer an alternative to both federal and private student loans. Senate Bill 2230, Investing in Student Success Act of 2014, was introduced and referred to the Committee on Finance on April 9th and could offer many prospective students a loan-free way to get through college via private investor financing in exchange for a share of future income. Today we’ll take a look at how this would work, who it could benefit and some pros and cons of this proposal.
What the Legislation Proposes
S 2230 lays out the legal framework for income share agreements (ISA). This would be an agreement between the student and an investor where the investor pays for the student’s college and the student commits to pay a share of their future income for a specific period of time. At a minimum, the first $10,000 of income the student earns each year after graduation would be exempted from the income share and this would be adjusted annually based on changes to the Consumer Price Index (CPI).
The maximum income percentage allowed by law would be 15% and the maximum repayment period allowed would be 30 years. Contracts must also specify an early termination clause where the graduate sharing their income could “buy” their way out of the agreement prior to its natural conclusion. The legislation also specifies that the agreement could not be discharged under a bankruptcy petition. The amount paid under the agreement would be excluded from gross income for income tax purposes.
Would an ISA Impact Other Financial Aid?
The proposed law spells out that any payments the student receives from an income share agreement would not count as income or assets owned by the student or their family when calculating expected family contribution by the college. This is important because it would not cut into your opportunities to get free aid in the form of grants and scholarships from your college. The more free money you get, the less you would need to ask of your investor under your ISA.
What Are the Pros of Income Share Agreements?
While student loans are available to anyone despite their SATs, GPA or choice of major, investors will likely not offer money to students that do not show promise. They would inherently be a more risky investment. Instead, high value majors like STEM, nursing, law, engineering and business would garner more willing investors than those that do not promise high odds of employment and a good salary. An ISA would also ensure that the expense of school is proportional to future income.
Those that end up earning less would not be overburdened by paying an overwhelming share of their income. Also, if the graduate is struggling to find a job, their investor has (quite literally) a vested interest in the employment opportunities of the person they invested in and would be motivated to help them advance their career rather than lose out. This could also turn into a pay it forward mentality where graduates may invest in future generations of students in the same manner.
What Are the Cons of Income Share Agreements?
A student who ends up with unusually high earnings could pay more than they would have if they had taken out traditional student loans. This may be offset by language in the agreement that would allow a high earner to buy their way out of the ISA early. What may be a concern is that because having an ISA wouldn’t lessen other available financial aid, there is a potential for abuse. Conceivably, a student could take funds from both an ISA and federal student loans and pile on an unmanageable amount of debt.
Another con is that the terms may not be as advantageous as a federal loan under an Income Based or Pay As You Earn repayment plan, which offer 15% and 10% of income payments respectively (albeit with no income excluded from the calculation) and forgiveness after 25 and 20 years of payments respectively. Finally, taken to an extreme, this arrangement could be seen as tantamount to indentured servitude and that’s a concern, especially since the ISA can’t be discharged in bankruptcy.
You can read the full text of S 2230 Investing in Student Success Act at GovTrack by clicking here. We’ll keep you posted if this legislation gains any traction – according to GovTrack, statistically, this bill will not make it out of committee and has zero chance of becoming law. But what could change this is action by interested parties willing to push for this innovation. If you like the prospect of this bill, contact your Senator and tell them to get it up for a vote and to vote yes. To learn more about how ISAs could change higher education finance, check out this report by the American Enterprise Institute’s Center on Higher Education Reform.
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