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IT'S PAYBACK TIME

Are income share agreements a solution to the student debt crisis?

AP Photo/Joerg Sarbach
Debt-free education.
Published Last updated This article is more than 2 years old.

As a filmmaker, Claire Gregowicz would often talk with friends about the importance of building out a brand and gaining marketable skills in today’s competitive job market. “That’s what everybody is looking for these days,” she laments.

So she was intrigued when one of those friends alerted her to a digital marketing credential by UC San Diego Extension, an online research university, and the San Diego Workforce Partnership. In addition to finding the skills she wanted to learn, what attracted her was that she would not have to pay for the course upfront.

“It sounded too good to be true,” she says.

Gregowicz applied, and is now part of a cohort of around 80 students enrolled in a new income share agreement, or ISA, offered by UCSD Extension. Instead of paying her fees at the outset, Gregowicz will pay a percentage of her earnings to the school for a set period of time after graduating. If she lands a job making above $40,000 after graduating this spring, she will pay 8% of her salary for up to 60 months. The payment is capped at $11,700 or 1.8 times the cost of the $6,500 program.

Landing a highly paid job could mean fewer payments. But if her income drops below $40,000 annually, the payments are paused. In this way, ISAs can offer students much more manageable repayment terms after graduating than typical student loans, although the terms, such as the cap on repayments and time spent repaying, vary depending on the program.

Gregowicz, 41, never went to college. After high school, she got a medical administrative certificate; she’s had odd jobs from a costume designer to working for a family cleaning service over the past decade until becoming a filmmaker. “I worked really hard not to take on any debt that I didn’t need,” she says.

As a mother of four, Gregowicz says the security of knowing her payments could be paused if she didn’t get a high enough paying job was a “big deal.” She encouraged her 21-year-old son to also apply to UCSD Extension’s first cohort. Now, they will be embarking on the experiment together.

Market forces are pushing universities to think up creative ways to help students finance their education. Already popular abroad, ISAs are increasingly being offered in the US, where student loan debt, at $1.6 trillion, has become a political flashpoint. Around 40 US colleges and universities currently offer ISAs, in addition to dozens of coding bootcamps and vocational schools. A number of private firms have entered the market to back ISAs, manage them for schools, or offer them to students directly.

It’s a large-scale social experiment to see whether ISAs are viable in the long-run, and if they can provide a promising alternative to the crushing student debt hobbling the US financial system.

How ISAs work

Unlike traditional student loans, ISAs act as equity, with investors taking a stake in the student’s future income. Risk is shifted from the student to the ISA provider; graduates who fail to land a decent-paying job will pay back less than the total cost of their tuition.

When the goal of education is hireability, an ISA can help align the incentives of a school with its students. When students don’t do well, the first loss would accrue to the university and any co-investors. When students do well, the school will be more economically successful, explains Daniel Pianko, managing director at education investment firm University Ventures.

For Pianko, this is a convincing argument that “ISAs are the right progressive answer to the cost of college.”

But as with most contracts, the liability can be financed in multiple ways. The risks lie in the terms and the incentives they create for the various parties involved.

Just under 10,000 students in the US have funded at least part of their education through an ISA, covering $10,000 to $20,000 with it, estimates Charles Trafton of FlowPoint Education Management, which creates and invests in ISAs. Silicon Valley’s Lambda School is the most prolific, followed by Purdue University, which has funded over 1,200 contracts.

Countries such as Hungary, New Zealand, England, Wales, South Africa, South Korea, and Australia have established models of using post-graduation earnings to pay for college. Australia has long been seen as a model for a generous student loan program; it created an income-contingent program in 1989 to complement a plan to charge tuition at public universities, and a majority of students used it due in part to its subsidized terms.

Currently, ISAs are tiny compared to the size of the US student loan market. A majority of student loan debt—an estimated 92%—is in the form of government-subsidized loans, while the rest is owned by private lenders. While the US government has established income-driven payment plans since 2007, they are often seen as overly complicated. (There are four different versions with slightly different terms.)

Some experts, like Jason Delisle, a resident fellow at the American Enterprise Institute who focuses on higher education financing, believe that ISAs could help streamline those programs—or even replace the federal loan program completely.

Delisle says that the current federal loan system offers generous benefits such as income-based driven repayments and loan forgiveness terms to all borrowers. But the issue, he says, is that these benefits tend to “flow to high-income borrowers.”

With an ISA, the distribution is reversed—you may pay more if you earn a high income, but you don’t get dinged if you earn less than the income threshold you’ve agreed to. In other words, the distribution of money becomes more targeted on the borrower’s post-college outcomes.

So far, the US government has not expressed much interest in ISAs. But it has embraced the principle that how much a student pays should be based on what they earn. According to recent estimates from the Congressional Budget Office, 45% of all outstanding federal student loan borrowers were being repaid through income-driven loans. Those enrolled tend to have larger loan balances, as many who fall in this category are pursuing advanced degrees.

Progressive or predatory?

USCD Extension’s ISA program is the brainchild of assistant dean of research affairs Josh Shapiro, in conjunction with San Diego Workforce Partnership’s COO Andy Hall. The program is targeted at underrepresented individuals, and includes support services, such as transportation, childcare, mentorship, and job preparation.

Students are enrolled in technology-focused programs, including front end development, java programming, digital marketing, and business intelligence analysis, with the goal of creating a more diverse pipeline for the white, male-dominated tech industry. Their courses are structured to be shorter and more “intensive” than a non-ISA program.

They are also more expensive—almost double what it would cost for a student not participating in an ISA program. That’s in part to fund the support services provided and the fact that the first cohort would pay nothing upfront, but also to help UCSD eventually create an evergreen pool of capital without the help of outside investors, and be self-sustaining by 2025.  (The program has received $3.5 million in funding from backers like nonprofit Strada, Google, and the James Irvine Foundation.) Shapiro says students are shown a breakdown of the numbers before they enroll.

ISAs have increasingly attracted the attention of investors for their potential returns. At a conference on alternative funding to education in San Francisco last March, Shapiro says he was approached by a number of venture capital firms offering to back UCSD’s ISA program.

The VC approaches—including one offer in the range of $40 million—made Shapiro feel uncomfortable, because the funds felt like too much of an “unknown commodity.” One firm’s proposed ISA model shifted dramatically in terms of payback period and percentage payback. Another provided a “targeted list of individuals who would likely have a good payback,” which went against the university’s ethos of providing accessible education.

The relationship between schools offering ISAs and their co-investors has raised concerns in some cases. Lambda School, a popular coding bootcamp, has recently come under fire for the way it has packaged and financed its ISAs, for example, as well as its curriculum and job placement statistics.

Mark Kantrowitz, a student loans expert at SavingsForCollege.com, says federal regulation is needed to keep out bad actors that would use ISAs to exploit borrowers with predatory terms. He says if investors in ISAs don’t make enough profit because borrowers don’t land good jobs, they may increase the percentage rates. Congress is currently considering a bipartisan bill that imposes a regulatory framework on income share agreements.

In such a nascent field, there’s also potential to overstate numbers or inaccurately market programs. Massachusetts senator Elizabeth Warren, responding to a potential ISA experiment by the US Department of Education, believes they share the same potential pitfalls as private student loans “with the added danger of deceptive rhetoric and marketing that obscure their true nature.”

While proponents often say having an income threshold will lower risks, Warren argues that there is no evidence that these thresholds protect students from having to make payments they cannot afford. And she objects to terms in Purdue’s ISA suggesting that defaulting would require paying two and a half times the original amount the student “borrows.”

In response, Mary-Claire Cartwright, Purdue Research Foundation’s vice president for information technology, reiterates that payments vary based on earned income, and that the 2.5 amount is a maximum, regardless of earned income. “The most prevalent reasons people default are because they are either employed with a lower income or become unemployed,” she says. “If someone becomes unemployed, they would have no ISA payment to make, and no accruing interest, until they find employment. Again, contrast this with a loan, in which the balance would still be accruing interest and monthly payments would still be expected, regardless of an individual’s salary or employment status.”

Who are ISAs good for?

With these concerns in mind, ISAs may still appeal to students who worry that they might be unemployed or earn a low salary after graduating and don’t want to take on a lot of debt. (The fact that ISAs might attract risk-averse students has actually made them less attractive to some investors, according to the Financial Times.)

The more certain you are about having a good job, the less value an ISA actually has, explains Doug Webber, an associate professor at Temple University, who focuses on labor economics and the economics of higher education. He says ISAs can be thought of as a type of insurance.

“If you know the bad outcome is not going to happen, then you don’t want to buy insurance,” he says. “If you’re worried about the bad outcome, that’s when you want to buy insurance.”

ISAs also hold potential for students on the margins of the student loan market. For instance, Colorado Mountain College offers ISAs to undocumented students who are not eligible to receive federal aid. And their availability could help students make better financial decisions. That’s the experience of Courtney McBeth, special assistant to the University of Utah’s president, who says discussing ISAs with students also affords her the opportunity to make students more aware of federal aid options, scholarships, and grants.

Tonio DeSorrento, co-founder of Vemo, which designs ISA programs, says ISAs may also encourage students to pursue higher education. Research shows that students who avoid loans may not invest in postsecondary education, or will forego college completely.

But not all students would benefit from an ISA. If a student earns a high income after graduation, they may pay more to the fund than they would have with conventional debt.

In addition, ISAs won’t cover all college costs. Universities offering ISAs say that students should exhaust federally subsidized options before considering ISA as an option.

Community payback

In the coming years, universities may work on a larger scale with capital providers to create the market for income-shared agreements. That could dramatically lower the cost of funding for ISAs, and create additional funding options for students and families, says Pianko. The market potential is huge, with private student loans totaling $125 billion in 2019.

But, as of now, there isn’t enough historical data for large institutional investors to start providing capital at scale. Purdue, which began offering ISAs in 2016, is starting to raise capital from private investors. Pianko says his firm is talking to “dozens of universities” about financing their ISA once they get past the pilot phase.

“The real incentive here is that over time the financial markets will help students and parents pick their school,” he says.

Shapiro hopes UCSD’s program will help increase transparency into how students benefit from ISAs, says Shapiro. He says he plans to make his first batch of data public—the number of students in the program, how many dropped out, how many graduated, how many got a job and at what salary range. Ongoing data will help them track student retention and success, allowing them refine the program.

“We hope our pilot in San Diego begins to elucidate how ISAs can be part of the solution to the student debt crisis,” says Shapiro. “We know that a rapidly changing labor market, the growing costs of education, and student debt make it clear that financial reform is needed in higher education.”

The fact that UCSD is not taking in private investors has also created a powerful marketing message: students are paying the money back to the community, not VCs or banks.

This message has resonated with Gregowicz, who will be graduating in the spring.

“This goes back into a program that’s going to take kids like my son or people like me,” she says. “I want to get the biggest paying job I can. I want to pay you the cap on what I can, so it doesn’t only just help me, I help other people with that.”