The first experiment was a failure. In the 1970s, Yale University offered tuition to a group of students in exchange for a percentage of their future incomes. Adapting a 1955 idea by economist Milton Friedman to sell “human capital investments,” the university paid the students’ tuition. In return, the university hoped to recoup its investment by having the group collectively repay it as a share of each individual’s income.
It didn’t work out. Low-earners paid back at different rates than high-earners, leaving frustrated students holding the bag for others. It was, in the words of one higher-education policy expert, “an utter disaster.”
After lying nearly abandoned for 40 years, that former disaster has reemerged in a financing model called modern income-sharing arrangements (ISA), which aim to fix some of the earlier flaws posed by similar arrangements (students pay back their own commitments out of future earnings, for one thing). The model is attracting a new generation of startups, as well as investors, eager to bail out American students drowning in $1.3 trillion in student debt. The Brookings Institute estimates as much as 40% of students who entered college in the early 2000s may default on their loans by 2023, based on historical trends.
One of the first firms to enter the US market was the Chilean firm Lumni founded in 2002 (although it only came to the US in 2009) followed by 13th Avenue (2009), Cumulus Funding (2011), Upstart (2012), Pave (2012), and Vemo (2015). Not all are still signing ISAs, but current interest seems to be based on growing demand. Vemo’s co-founder and CEO Tonio DeSorrento says it has seen its ISA volumes triple year over year, and it credits major universities and training programs for getting on board after years of wariness. Purdue University, Lackawanna College in Pennsylvania, and New York’s Clarkson University all have ISA programs. Vocational schools such as the code bootcamp App Academy, MissionU, and tech apprenticeship Kenzie Academy are using them as well.
That’s just the beginning, says University Ventures co-founder Ryan Craig, who has invested in Vemo and college alternative MissionU. “I’d go as far as to say that in five years, any postsecondary education or training program that’s two years of length or less and that’s attempting to charge tuition will be seen as an anachronism,” writes Craig by email. “It will be a negative market signal to prospective students, who will wonder why they’re demanding tuition upfront rather than taking an income share (i.e., is this a scam?).”
Are income-sharing arrangements a good deal for students?
Robert Kelchen, an education researcher at Seton Hall University in New Jersey, believes it’s too early to say. “Not a lot of rigorous research evaluating ISA has been done because it’s so new,” Kelchen says. Only about 1,000 students have signed for ISAs at US colleges, based on Kelchen’s estimates (although more are enrolling through short-term coding “bootcamps” and vocational programs such as MissionU).
If ISAs work, the market is huge. The federal government already provides more than $200 billion (paywall) in grants, loans, and work-study assistance for students’ post-secondary education each year. Private lenders hand out about $8 billion in student loans annually, estimates the Consumer Financial Protection Bureau. Parents and family contribute still more.
Although not as favorable as most federally-subsidized loans (which offer income-adjusted repayment plans and loan forgiveness), ISAs essentially allow students to pay for today’s tuition out of their future earnings. Compared to private lending, one “of the riskiest ways to finance a college education,” reports The Institute for College Access & Success (PDF) due to their high interest rates (as high as 13.74%) and the lack of loan deferment or forgiveness, ISA may prove more attractive.
Theoretically, ISAs incentivize students to maximize their income while repaying investors who assume the bulk of students’ risk relative to private debt. Payments scale with earnings, so high-earners pay more of their income and the share progressively declines as income falls. The exact percentage depends on their course of study, earning potential, caliber of school and other factors, but terms of 10% of future income for 10 years or more for shorter periods are not uncommon. Below a certain threshold, students pay nothing, and an upper cap can ensure students will never pay back more than a fixed share of the initial value of their ISA.
Of course, the devil is in the details. Standards for ISA are still evolving. Bills making their way through Congress and state legislatures would impose some guidelines on the sector. For now, however, regulation is loose (paywall) and it’s unclear what consumer protection laws or regulatory jurisdiction apply.
But students are looking for options. Almost 60% of college graduates in the US carry student debt, and about 57% of Americans regard it as a major problem, reports the Harvard Kennedy School of Government. Yet many are not even confident their college educations are still the golden ticket they once were. A 2017 survey of 32,000 college students revealed only one-third felt prepared to enter the job market, while only half said their major will lead to a good job.
Investors are betting that turning those students’ tuition into what amounts to an equity investment, rather than debt, is a business opportunity. For students who see college as a road to a well-paying a job, Vemo’s DeSorrento argues, “ISAs are the best way to charge for this value proposition.”
ISAs may not be acccesible to everyone. Investors could just back future high-earners at prestigious schools, rather than granting access to students still climbing the economic ladder. Today’s loan underwriting criteria certainly favors the former. A 2015 study by the American Institutes for Research found just 7% (about 272,500 students) of students entering American universities were likely to receive an ISA, under current lending criteria, and no more than 5% of first-time, lower income students. Even loosening the criteria would likely only qualify about 14% of all students, estimate researchers who looked at credit scores, majors, academic achievement, education plans and employment history as possible criteria. “Recent history suggests firms that offer ISAs, or have offered ISAs in the past but now offer only loans, have largely focused on students who are high-ability, who attend prestigious universities, and who pursue lucrative fields of study,” the report states.
Two developments may rewrite those criteria, and expand the pools. ISAs are growing more popular at two types of institutions for very different reasons. Four-year universities like Purdue are using them as a way to show their commitment to students as much as reduce their financial burden. The school’s program, Back a Boiler (an abbreviation of the nickname for the student body known as Boilermakers), is offering 175 students almost $2 million in ISA funding. Graduates with high income never pay more than 2.5 times their original ISA amount, while those earning less than $20,000 a year see their payments go to $0. Brian Edelman, chief operating officer for the Purdue Research Foundation, wants to scale up the program with institutional investor money once its track record is solid. “We would like to see a whole market at scale for ISAs,” he told the financial site NerdWallet.
Programs like these, backed by university endowments, and managed by private companies, may favor inclusion over profits. “It’s still too early to tell, but I think this will be the model,” says Kelchen. “More colleges may try to adopt this to offer credit to students and convey that they believe in their students.”
The second path is affordable vocational training. MissionU, a one-year training program in data analytics and business intelligence, offers students a blended online (80%) and in-person curriculum (20%), and work experience. It charges no tuition. After graduates earn at least $50,000, they pay back 15% of their income for the first three years.
C0-founder Adam Braun says the program aligns its incentives with that of students since the school only gets paid based on their success. “MissionU is entirely judged on outcomes of students,” says Braun. The school, founded in 2016, had 5,000 applicants for 25 spots last year, and claims its graduates will eventually outcompete any bachelor degree holders on the job market. “We think our core competition is the traditional university,” says Braun.
The promise of debt-free graduation is key to luring students away from colleges. Braun estimates that today’s ISA market of $50 to $150 million should “increase exponentially” to billions of dollars over the next 5 years.
But first, programs like MissionU will need to prove they can deliver. It will take several years before students know if these programs can fulfill their promise of delivering a quality education, as well as an affordable one, without going out of business.
Just as important for ISAs will be students knowing about them. A 2017 American Enterprise Institute study of 400 college and high school students and parents found just 7% of students and 5% of parents even knew ISAs existed.