The Future of Paying for College: Recruiting Investors to Pay Your Tuition?

November 16th 2014

Adam Rotstein

If it seems like we've been posting a lot about student loan debt in America, it's because it's an emerging economic crisis that will not disappear until we seriously reevaluate our flawed system.  To begin this conversation, we have been highlighting superior models of education in other countries.

Click here to learn how Germany just made college free, for instance. 

One particular alternative to the status quo is the possibility of Income Share Agreements (ISAs), which allow students to sell "stock" in themselves, or a specific share of their future earnings to investors. Sound crazy? Well, the system was first invented by Milton Friedman in 1954 and began as a mere footnote to one of his academic studies. But ISAs have resurfaced in 2014 in response to the staggering number of loan defaults among student borrowers. The system, to its proponents, is a viable alternative because it only requires students to pay back a portion of what they are earning at any given time after they graduate. If a student is making very little money, he or she is only expected to pay a small amount. Likewise, if the student is very successful, he or she would have to pay more money to their investors. It essentially allows students to repay their debt in proportion to their earnings 

Miguel Palacios, assistant professor of finance at Vanderbilt University, created a startup in 2002 that offers ISAs to students, which he claims has the potential to revolutionize higher education. Palacios maintains that ISAs are more liberating than student loans because, "You have the same freedoms, but you don't have the same worries."  In many ways, it is analogous to taxing the 1% more on their income. ISAs allow students access to their earnings while providing insurance against bad financial outcomes. This could be a total game changer for low-income students who are worried about the risk of taking out student loans in an uncertain job market. 

There are several other issues around the concept of ISAs. Some view ISAs as exploitative in the case of very successful borrowers. Others note that it could be used as a free pass because technically, if the student can subsist without an income, he or she wouldn't have to pay back any of their lenders. Still, some especially driven students might prefer to take federal loans instead because they will at least know exactly how much they will have to pay back. Many driven students might feel like their ISA could haunt them well into their lucrative careers. Palacios counters these concerns by explaining that each student gets a tailored contract of differing lengths. Basically, a student studying something less profitable will have a longer period of repayment. But what about those students who say they will become investment bankers and then choose to study French literature? Clearly, all the kinks have not been worked out.

This past spring, the Marco Rubio and Tom Petri introduced a bill that, if passed, would set some ground rules concerning ISAs. It would cap the percentage of income at 15%, make the maximum repayment period 30 years, and exempt all persons who earn less than $10,000 a year. Palacios' company, Lumni, pledged to fund 10,000 students by the year 2020. For better or for worse, ISA's may become a real thing soon.

What do you think?