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New Kind of Student Loan Gains Major Support. Is There a Downside? New Kind of Student Loan Gains Major Support. Is There a Downside?
(8 days later)
Q: When is a student loan not a student loan?Q: When is a student loan not a student loan?
A: When it’s an “income-share agreement,” a new financial instrument being promoted by Education Secretary Betsy DeVos.A: When it’s an “income-share agreement,” a new financial instrument being promoted by Education Secretary Betsy DeVos.
With total outstanding student loan balances at $1.6 trillion and rising, politicians are looking for solutions. Senators Bernie Sanders and Elizabeth Warren have proposed forgiving much or all existing debt while making public colleges and universities tuition-free. President Trump is said to be searching for his own loan plan.With total outstanding student loan balances at $1.6 trillion and rising, politicians are looking for solutions. Senators Bernie Sanders and Elizabeth Warren have proposed forgiving much or all existing debt while making public colleges and universities tuition-free. President Trump is said to be searching for his own loan plan.
This month at a national conference of college financial aid administrators, the Department of Education proposed an alternative: income-share agreements, a private-sector financial product that is increasingly popular among education start-ups in Silicon Valley.This month at a national conference of college financial aid administrators, the Department of Education proposed an alternative: income-share agreements, a private-sector financial product that is increasingly popular among education start-ups in Silicon Valley.
The vast majority of regular student loans are issued by the federal government. After graduating, students are obligated to pay back the principal and accruing interest. If they don’t, their wages can be garnished, credit damaged, and loans turned over to a collection agency.The vast majority of regular student loans are issued by the federal government. After graduating, students are obligated to pay back the principal and accruing interest. If they don’t, their wages can be garnished, credit damaged, and loans turned over to a collection agency.
Loan repayment is a huge and growing problem. One study projects that nearly 40 percent of students who borrowed in the mid-2000s will eventually default.Loan repayment is a huge and growing problem. One study projects that nearly 40 percent of students who borrowed in the mid-2000s will eventually default.
Income-share agreements look a lot like loans, at first. In both cases, a bank gives students a certain amount of money to pay tuition, fees and other college expenses. Like a loan, it is a legally binding contract that obligates students to make monthly payments until their obligation is fulfilled.Income-share agreements look a lot like loans, at first. In both cases, a bank gives students a certain amount of money to pay tuition, fees and other college expenses. Like a loan, it is a legally binding contract that obligates students to make monthly payments until their obligation is fulfilled.
The difference is in the repayment. Loan payments are typically driven by principal and interest. Income-share agreements payments are driven by income and time. Students agree to pay a certain percentage of their earnings for a fixed period. If they make more, they pay more. If they make less, they pay less. Students with high earnings could end up paying back the equivalent of a loan with a high interest rate. Students with meager earnings could pay back less than the original principal.The difference is in the repayment. Loan payments are typically driven by principal and interest. Income-share agreements payments are driven by income and time. Students agree to pay a certain percentage of their earnings for a fixed period. If they make more, they pay more. If they make less, they pay less. Students with high earnings could end up paying back the equivalent of a loan with a high interest rate. Students with meager earnings could pay back less than the original principal.
In that sense, an income-share agreement is like a loan with a built-in insurance policy. Students forgo some of the potential upside of making a lot of money after graduation in order to eliminate some of the downside of making little or no money instead. Regular federal student loans have a similar provision, allowing students to limit their payments to a percentage of their income.In that sense, an income-share agreement is like a loan with a built-in insurance policy. Students forgo some of the potential upside of making a lot of money after graduation in order to eliminate some of the downside of making little or no money instead. Regular federal student loans have a similar provision, allowing students to limit their payments to a percentage of their income.
Income-share agreements are often used by “coding boot camps,” private-sector companies ineligible for federal student loans. Boot camps offer short-term training in high-demand skills like software engineering and data science. At Flatiron School, for example, students can opt to pay 10 percent of their gross income for 48 months after graduating, through such an agreement. If their annualized income falls below $40,000 in a given month, they owe zero — but that won’t count as one of the 48 months. The most they can pay, in total, is 150 percent of Flatiron’s upfront tuition fees.Income-share agreements are often used by “coding boot camps,” private-sector companies ineligible for federal student loans. Boot camps offer short-term training in high-demand skills like software engineering and data science. At Flatiron School, for example, students can opt to pay 10 percent of their gross income for 48 months after graduating, through such an agreement. If their annualized income falls below $40,000 in a given month, they owe zero — but that won’t count as one of the 48 months. The most they can pay, in total, is 150 percent of Flatiron’s upfront tuition fees.
Traditional colleges and universities are also experimenting with this financing, most prominently Purdue. The Purdue program adjusts the payment terms depending on students’ academic majors, because some fields are more lucrative than others. A computer science major who graduates next spring with a $10,000 income-share agreement would owe 2.32 percent of income for 88 months, around seven years. A philosophy major would owe 4.01 percent for 116 months, or nearly 10 years. Philosophy majors pay a higher percentage for longer because their expected income is less.Traditional colleges and universities are also experimenting with this financing, most prominently Purdue. The Purdue program adjusts the payment terms depending on students’ academic majors, because some fields are more lucrative than others. A computer science major who graduates next spring with a $10,000 income-share agreement would owe 2.32 percent of income for 88 months, around seven years. A philosophy major would owe 4.01 percent for 116 months, or nearly 10 years. Philosophy majors pay a higher percentage for longer because their expected income is less.
Proponents note that colleges have a financial stake in the success of students whose education is funded this way, something that is not the case with regular student loans. With very few exceptions, it doesn’t matter how many of a given college’s graduates default on traditional loans. Colleges are paid up front. With income-share agreements, colleges make less if their graduates make less and more if they make more.Proponents note that colleges have a financial stake in the success of students whose education is funded this way, something that is not the case with regular student loans. With very few exceptions, it doesn’t matter how many of a given college’s graduates default on traditional loans. Colleges are paid up front. With income-share agreements, colleges make less if their graduates make less and more if they make more.
Legislation has been introduced in Congress that would solidify the legal standing of the agreements and set limits on their terms. At the financial aid convention this month, Department of Education officials announced an experimental initiative that, if expanded, could eventually increase their use by orders of magnitude. The program would give students the option of converting their regular student loans into income-share agreements. Colleges would pay the federal government back and effectively become the bank, taking on the upside and downside risk.Legislation has been introduced in Congress that would solidify the legal standing of the agreements and set limits on their terms. At the financial aid convention this month, Department of Education officials announced an experimental initiative that, if expanded, could eventually increase their use by orders of magnitude. The program would give students the option of converting their regular student loans into income-share agreements. Colleges would pay the federal government back and effectively become the bank, taking on the upside and downside risk.
With these agreements growing in popularity and political support, potentially affecting millions of college students, it’s worth asking what could go wrong.With these agreements growing in popularity and political support, potentially affecting millions of college students, it’s worth asking what could go wrong.
Many of the current ones have terms that appear to be reasonable, or at least comparable to private education loans. But the first version of a new financial product can be very different from the 10th or 100th — especially when the goal is to put your best foot forward to get federal approval and federal funds.Many of the current ones have terms that appear to be reasonable, or at least comparable to private education loans. But the first version of a new financial product can be very different from the 10th or 100th — especially when the goal is to put your best foot forward to get federal approval and federal funds.
The model legislation, sponsored by the Republican senators Todd Young and Marco Rubio and the Democratic senators Mark Warner and Chris Coons, would allow banks and colleges to set terms that are vastly more onerous than what Flatiron, Purdue and others are offering today. Payments of 7.5 percent of income could last for as long as 30 years, and months where people don’t earn enough to owe money wouldn’t count as a payment, even though banks could still charge a separate fee. This could effectively extend an income-share agreement for someone’s entire working life. Payments as high as 20 percent could last longer than a decade.The model legislation, sponsored by the Republican senators Todd Young and Marco Rubio and the Democratic senators Mark Warner and Chris Coons, would allow banks and colleges to set terms that are vastly more onerous than what Flatiron, Purdue and others are offering today. Payments of 7.5 percent of income could last for as long as 30 years, and months where people don’t earn enough to owe money wouldn’t count as a payment, even though banks could still charge a separate fee. This could effectively extend an income-share agreement for someone’s entire working life. Payments as high as 20 percent could last longer than a decade.
Repayment is also more complicated than with a regular student loan, because students have to regularly provide tax returns, payroll stubs or other evidence of how much money they earn. Failure to provide that information in a way that meets the exact terms of the agreement could throw the contract into default, converting it into a debt subject to collections, garnishment and all the rest. In other words, all of the problems the new loan products are supposed to avoid. Of course, the consumer protection provisions of existing student loan programs have troubles of their own. Repayment is also more complicated than with a regular student loan, because students have to regularly provide tax returns, payroll stubs or other evidence of how much money they earn. Failure to provide that information in a way that meets the exact terms of the agreement could throw the contract into default, converting it into a debt subject to collections, garnishment and all the rest. In other words, all of the problems the new loan products are supposed to avoid. Of course, the consumer protection provisions of existing student loan programs have troubles of their own.
Purdue markets its income-share agreements as an alternative to private and parent-backed loans. That suggests that students using them will have already taken out the maximum available federal loans, which means they will have to pay a percentage of their income in addition to monthly payments on their regular debts. Although Purdue makes a point of asserting that its income-share agreement is “not a loan or other debt instrument,” the practical effect is to remove the ceiling on colleges’ ability to be paid by financial products that walk, talk and quack like students loans. The distinction between “debt” and “money you are obligated by force of law to pay” may have some legal meaning, but will most likely be lost on naïve students who have never borrowed money in their lives.Purdue markets its income-share agreements as an alternative to private and parent-backed loans. That suggests that students using them will have already taken out the maximum available federal loans, which means they will have to pay a percentage of their income in addition to monthly payments on their regular debts. Although Purdue makes a point of asserting that its income-share agreement is “not a loan or other debt instrument,” the practical effect is to remove the ceiling on colleges’ ability to be paid by financial products that walk, talk and quack like students loans. The distinction between “debt” and “money you are obligated by force of law to pay” may have some legal meaning, but will most likely be lost on naïve students who have never borrowed money in their lives.
While Purdue advertises it as a “potentially less expensive option” for college financing, the university does not plan to lose money on the program, which means that, by definition, it will not be less expensive for the average student. The private-sector providers also plan to turn a profit, which means students will pay more, on average, than they would have paid upfront.While Purdue advertises it as a “potentially less expensive option” for college financing, the university does not plan to lose money on the program, which means that, by definition, it will not be less expensive for the average student. The private-sector providers also plan to turn a profit, which means students will pay more, on average, than they would have paid upfront.
Giving colleges an incentive to enroll students in programs that lead to high-paying jobs may result in more well-designed programs. But it also gives colleges a reason to see people who need more academic support — or who don’t prioritize becoming rich — as “subprime children,” as the author Malcolm Harris put it in a New York Times Op-Ed.Giving colleges an incentive to enroll students in programs that lead to high-paying jobs may result in more well-designed programs. But it also gives colleges a reason to see people who need more academic support — or who don’t prioritize becoming rich — as “subprime children,” as the author Malcolm Harris put it in a New York Times Op-Ed.
For some students, income-share agreements may prove as useful as a loan, and possibly less anxiety-producing. But these agreements bring no new money to the challenge of making college affordable. They only shift the payment burden from some students to others. That won’t change the fact that nearly all students are paying more for college than ever before.For some students, income-share agreements may prove as useful as a loan, and possibly less anxiety-producing. But these agreements bring no new money to the challenge of making college affordable. They only shift the payment burden from some students to others. That won’t change the fact that nearly all students are paying more for college than ever before.
Kevin Carey directs the education policy program at New America. You can follow him on Twitter at @kevincarey1.Kevin Carey directs the education policy program at New America. You can follow him on Twitter at @kevincarey1.