Students Need Investors, Not Lenders
College tuition rates are surging, and the three-year default rate on federal student loans is 11.8 percent. To combat this crisis, Sen. Marco Rubio is encouraging Americans to embrace alternatives to traditional student loans, including Income Share Agreements (ISAs).
Pioneered by Milton Friedman, ISAs allow students to sell "shares" in their post-graduation earnings instead of taking out loans. If widely adopted, they could be the long-sought answer to the student-loan crisis.
The current system encourages students to take out traditional loans and pay them back, with interest, after they've graduated.
With ISAs, by contrast, students agree to pay a portion of their income, for a fixed period of time, to their investors. Graduates earning less than expected might pay less than they received, while graduates earning more will pay extra.
Investors can be more discerning than traditional lenders. When brokering ISAs, they can adjust the length of the agreement and the percentage of income they will receive in order to fit the student's particular circumstances, such as their field of study and the university they plan to attend. This framework will advantage students majoring in lucrative fields, like finance or engineering, by allowing them to secure contracts that take into account their higher-than-average expected earnings.
For example, accounting majors — who, even early in their careers, can expect to earn about $10,000 a year more than the typical bachelor's degree holder of the same age — might be able to find an ISA requiring them to pay 10 percent of their income over five years. Art history majors, on the other hand, might be required to pay 15 percent of their income over eight years, due to their somewhat below-average expected earnings.
ISAs also minimize the risk of default. Graduates with ISAs won't be faced with an insurmountable financial obligation if their circumstances deteriorate. Instead, their immediate financial obligation will grow and shrink along with their income.
Unfortunately, a lack of basic protections for students — such as sensible limitations on the percentage of income that can be legally owed — and regulatory clarity for investors prevent the spread of ISAs. This is why Senator Rubio and Rep. Tom Petri, R.-Wis., introduced the Investing in Student Success Act. The act, if passed, would not spend any taxpayer dollars or remove existing aid programs. It would simply create a legal framework for students and lenders to safely enter into ISAs.
A few trade schools training web developers, and a lone non-profit in California, are already using ISAs. But this is just a small taste of what could be possible if a bill like the Investing in Student Success Act is passed.
As outstanding student-loan debt continues to soar, so does the need for feasible alternatives. Income Share Agreements deserve the attention of both students and taxpayers.
Michael Shindler is a Young Voices Advocate and a writing fellow at America's Future Foundation.
