Academic journal article AEI Paper & Studies

Investing in Value, Sharing Risk: Financing Higher Education through Income Share Agreements

Academic journal article AEI Paper & Studies

Investing in Value, Sharing Risk: Financing Higher Education through Income Share Agreements

Article excerpt

Executive Summary

Income Share Agreements (ISAs) are financial instruments for the private financing of higher education. With an ISA, an investor or other organization provides a student with financing for higher education in exchange for a percentage of the student's future income for a defined period of time after the student finishes school. Unlike a loan, there is no principal balance to repay with an ISA: depending on the level of success after school, the student may ultimately pay more or less than the amount financed.

ISAs are better suited for student financing than traditional student loans. Investing in higher education is risky, meaning the outcome of investing in students is highly uncertain. Loans are not ideal for financing an individual's education because they cap payments to the lender while forcing the student to bear too much risk. On the lender side, this means that the private student-loan lenders undersupply credit (even for students with good prospects) without some kind of government guaranty or subsidy. On the student side, traditional private student loans force students to bear significant risk of financial ruin if their educational investment does not pay off and they do not earn enough income to repay their debt with interest.

In capital markets, risky investments are typically funded with equity instruments where the investor shares in the profit (and the loss) of an investment. Borrowing from this payment structure (but without the ownership aspects of traditional equity instruments), an ISA has students pay more if they are successful in exchange for paying less if their educational investment does not pan out. This provides strong downside protections for students while making it easier for students of all backgrounds to obtain financing compared to the undersupply of credit that occurs with traditional private student loans.

In addition, because ISA investors earn a profit only when a student is successful, they offer students better terms for programs that are expected to be of high value and have strong incentives to support students both during school and after graduation. This process gives students strong signals about which programs and fields are most likely to help them be successful. It would also help stem tuition inflation and improve the efficiency of the higher education system by rewarding high-quality, low-cost programs.

In short, ISAs offer the following virtues:

* They make financing available to students of all backgrounds for worthwhile educational programs without requiring a government guaranty or subsidy.

* They offer students strong repayment protections similar to the income-based repayment option for federal student loans.

* They improve the efficiency of the higher education system by channeling students to high-quality, low-cost programs.

* They help students navigate to programs that will help them find a job and succeed in the workforce.

* Because no taxpayer dollars are put at risk, ISAs open a space for innovative educational providers who are currently shut out of the federal financial aid process through accreditation and other regulatory barriers.

* ISA investors have strong incentives to support the students they have funded during school--via advising, mentoring, and career counseling--as well as after graduation.

The federal student loan system was created decades ago as an attempt to address some of the failures with private student loans described above. Because federal loans are available with essentially no underwriting criteria, students of all backgrounds have access to the credit they need to go to school. And, more recently, programs such as income-based repayment provide students with strong protections against the downside risk of investing in higher education.

Nevertheless, federal student loans help undergraduate students only up to the Stafford loan limits, leaving many students with only private loans or Parent PLUS loans above those limits, both of which are highly problematic. …

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