Young woman saving for her education, photo by andresr/Getty Images

commentary

(The RAND Blog)

June 5, 2019

Income Share Agreements: What's Risky, What's Promising, and What We Still Need to Know

Photo by andresr/Getty Images

by Melanie A. Zaber and Kathryn Edwards

This commentary is part of a series on issues relevant to congressional efforts to reauthorize the Higher Education Act.

While policymakers debate options to address college affordability and the nation's mounting student loan debt, an alternative education financing model has been gaining ground in a handful of schools and state legislatures—the income share agreement (ISA).

In theory, an ISA allows a prospective postsecondary student to figuratively put him or herself on a stock market of sorts, selling shares of future income in exchange for tuition payments. In theory, investors could consider many elements indicating risk—like major, high school grades, and test scores—and fund students with the best prospects. In practice, ISAs are offered by educational institutions, not investors. Current repayment terms vary only by a student's field of study and school, and the realized cost of an ISA-funded education depends on the student's financial success. In this setup, students agree to pay back a percentage of their salary to their lender: their university, college, or other institution of higher education.

Like an insurance policy, this agreement reduces financial risks for students, but that reduction comes at a cost—graduates who excel will pay comparatively higher effective interest rates.

While income share agreement terms vary from institution to institution, they are all based on the same premise: the more income a graduate makes, the more they will pay back.

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To date, ISAs are available from a number of four-year schools as well as accelerated degree programs, certificate programs, and even coding bootcamps. Some institutions use them as a last resort for those who have exhausted other aid options; others offer them for special populations. While ISA terms vary from institution to institution, they are all based on the same premise: the more income a graduate makes, the more they will pay back.

By way of example, let's consider how an undergraduate economics major graduating in 2022 might fare under Purdue University's “Back a Boiler” ISA program. In the ISA contract, she would promise 4.46 percent of her income for 8.3 years in exchange for $10,000 (about one year of in-state tuition). After graduation, the total amount she pays back depends on what she earns.

We can compare three scenarios: one with the average starting salary of an economics graduate, $41,000, one with higher pay, perhaps at an analytics or investment firm, $55,000, and one with lower pay, say at a Starbucks, $17,000.

In the first scenario, with average wage growth, she would pay back about $2,600 more under an ISA than under a traditional, subsidized federal student loan (at 5.5% interest), but about $2,200 less than under a private loan (at 9.7% interest). In the second scenario, again with average wage growth, she would pay back $8,300 more with an ISA than with a federally-subsidized loan and $4,000 more than with a private loan. In a third scenario, she pays nothing until her earnings climb above $20,000, but as long as she works full-time, her payment clock keeps ticking. If her earnings stay below $20,000 for 8.3 years, her obligation will end with no payments.

The bottom line for schools providing ISAs depends on student repayment—and thus employment—outcomes, giving them extra incentive to help their graduates secure well-paying jobs. Indeed, some ISA-granting institutions have added additional supports, such as an ISA-funded living stipend, wraparound services, and specialized career counseling.

ISAs can increase the flexibility of higher education finance. Many students require more aid than the subsidized federal student loan maximum, but if they lack a credit-worthy cosigner, finding affordable financing can be a challenge. Similarly, students and their families can experience a financial shock while in school that changes their ability to finance a loan. ISAs in which terms are based only on major, not on socioeconomic standing, have the potential to improve college access and persistence, enabling students to maintain their graduation timelines.

ISAs may also shift incentives for students and graduates. As ISA repayment percentages and periods typically differ across fields of study, ISA-funded students might select majors with better payment terms. Job-searching graduates, without a fixed loan repayment, could opt for jobs with better opportunity for intellectual growth or life satisfaction, rather than the highest pay. ISA payment deferment policies could even change who temporarily exits the labor market to attend graduate school or care for children.

To date, there is currently very little regulation of ISAs. For example, there are no universal standards for maximum repayment amounts or periods or credit bureau reporting requirements, and their eligibility for federal loan forgiveness and hardship discharge programs remain unclear. This could change soon: Legislators in California and Washington state have introduced bills to create an ISA pilot program. At the federal level, the Kids to College Act aims to develop a legal framework for ISAs, and last month, a representative of the federal Department of Education said the agency was considering support for ISAs.

So, do ISAs work? Despite this increasing interest in ISAs, there has been little research on their effects on the outcomes, choices, and incentives we have discussed. As Purdue's first ISA cohorts make their way through the labor market, initial insights into repayment rates, job placement, and frequency of deferment will become available. The sustainability of ISAs is similarly unproven: a number of ISA-funded coding bootcamp programs have shuttered.

The effects of the alternative are clear: Student loan debt has been cited as an explanation for declining marriage, childbearing, and homeownership rates. Only time—and more research—will tell if ISAs are an improvement over loans, and for which students.


Melanie Zaber and Kathryn Edwards are associate economists at the nonprofit, nonpartisan RAND Corporation.

Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.