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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:
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. In addition, because they are available to students with virtually no assessment of the students’ ability to repay, federal loans likely exacerbate problems with overborrowing, putting students and taxpayers at risk and contributing to tuition inflation.
Federal student loans have become an essential component of student access to higher education. Still, for many students, federal loans are inadequate for their financing needs, and simply raising federal loan limits risks exacerbating issues with overborrowing and tuition inflation. Therefore, students need access to additional financing tools they can effectively pair with federal student loans to meet their higher education financing needs. ISAs are not currently a full substitute for federal student aid programs, but they can help correct some of the existing system’s shortcomings and improve student outcomes. As ISAs take root and expand, policymakers will have opportunities to think more expansively about their role in higher education finance.
Therefore, policymakers should take the following steps to facilitate the growth of ISAs as a new financing option for students:
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