A lot of changes to student loan lending are afoot, or at least in the planning stages. These include a proposed total revamp of the student loan servicing system, the recent pilot launch of a financial aid debit card and, last but not least, a discussion of adding income-share agreements (ISAs) to federal student aid.
ISAs allow students to receive funds for their education in exchange for a portion of their future paycheck (if they earn one), generally for a set period of time after the student is making some set minimum level of income.
Education Deputy Under Secretary Diane Auer Jones said this past spring that her department was exploring ways to “experiment with” ISAs. So although nothing’s been announced yet, a publicly-funded ISA could be on the way. Here’s what that could look like…
Debate flares over creating government-run income share agreements
First, ISAs don’t seek to forecast a college freshman’s “capacity” for debt repayment. Unlike loans, they don’t require repayment for students who remain unemployed after leaving school.
Secondly, ISAs shift the financial risk from students and taxpayers to the colleges and universities that provide the education. If schools only get repaid when a graduate earns sufficient income, the reasoning goes, then they’ll work hard to better prepare their students for the workforce.
“ISAs are financial products, drafted by lawyers, often structured to provide an attractive return on the investment of funders or private investors,” Sen. Elizabeth Warren (D-Mass.) and other senators wrote in a June 4 letter addressed to DeVos. “They carry many common pitfalls of traditional private student loans — with the added danger of deceptive rhetoric and marketing that obscure their true nature.”
What could a federal ISA look like?
Warren and her colleagues pointed to existing, privately-financed income share agreements in their criticism. But according to Manhattan Institute scholar Jason Delisle, a government-run ISA could have safeguards — similar to those of federal student loans — that would make them a better deal for students.
Here’s how Delise’s proposed ISA would work:
- Students could access up to $50,000 for their college or postgraduate school costs.
- For every $10,000 they receive for their education, they agree to repay 1% of their future income for the first 25 years after leaving school or until they repay 1.75 times the amount they originally received.
- Payments would be submitted through income-tax withholding, cutting loan servicers out of the equation.
“Linking payments to income and withholding the payments from a borrower’s paychecks also ensure that the borrower’s payments always track their income in real-time,” Delisle wrote. “Borrowers in financial distress due to low or no income will automatically owe nothing on their debts.”
This federal ISA program, at least as Delisle imagines it, could beat the traditional federal student loan in other ways:
- You wouldn’t have to annually recertify your income (as you currently do with income-driven repayment on federal loans).
- You would never have to allocate more than 5% of your total income to education debt payments (compared to income-driven repayment, which calls for 10% to 20% of disposable income).
- You wouldn’t have to watch a balance increase because of accruing interest.
Unlike Purdue University’s pioneering ISA program, which varies repayment costs depending upon students’ choice of major, Delisle’s solution is one-size-fits-all. That leaves questions as to whether your preferred career path would make you a better or worse fit for ISAs.
It’s one pitch in a debate that’s sure to see more, but Delisle stressed that his federal ISA takes a targeted approach: “It strips the existing loan program down to its core components: universal access to capital, income-based payments, and a safety net.”
Federal ISAs likely won’t replace federal loans anytime soon
It’s unclear what we’ll see first: a mass federal student loan forgiveness program or a new federal ISA that supplants or supplements future loans.
For her part, Education Deputy Under Secretary Jones said creating such a novel ISA program requires “very careful thinking and consideration.”
For instance, she wondered, whether two-year schools would turn away students who aren’t (yet) serious about pursuing a degree, as these students might be perceived as “bad investments” for ISAs.
“A risk-sharing model [that’s] not well designed could really harm community colleges,” Jones said. “We don’t want them to become uber-selective institutions.”
Instead, the Education Department may first spend some time reviewing the successes and failures of private and college-run ISA programs already in place. It might then work with other schools on a trial program. How that fares would determine whether a federal ISA ever makes it to a university near you.