Many students struggle with paying for a college education and want easier terms for repayment of student loans. Bernie Sanders has even promised tuition-free and debt-free college. Sounds a little crazy to me, but an idea I think sounds fascinating is what Alex Tabarrok discusses in “Venture Capital to Buy Equity in Purdue Students”. An income-share agreement (ISA) is an alternative to private student loans in which an investor funds a student’s education and in return receives a percentage of that student’s earnings for a certain number of years after graduation. This concept is not unheard of, there are some companies that will help pay for an employee’s education as long as the student/employee agrees to work for the company for a certain number of years. But this idea is different because any investor could calculate the risks and take on this investment.
The article points out that this type of funding could be expensive for students who underestimate their earning potentials. Tabarrok offers this insight:
“Being unlucky or uninformed is less damaging [to the student] with an income share agreement than with a traditional loan. Loans have the greatest burden when a student overestimates their potential earnings and is poorer than expected. Thus, the loan offers no relief when relief is most needed. In contrast, payments under an income share agreement fall when income falls. An ISA does cost more than a loan when a student underestimates their potential earnings but in this case the student is richer than expected and can easily bear the extra burden. Thus, ISAs offer income insurance.”
Based on that I wonder if investors would only want to invest in students with higher earning potentials, while this option would actually attract students with lower earning potentials. In a Washington Post article that Tabarrok references, an executive from Vemo Education (a financial services firm working with Purdue students on the experiment) says that such adverse selection can be avoided. “It’s easier to scale [the agreements] and meet both investors’ and students’ needs if you fund people in groups.” The article continues, “By pooling agreements, investors could hedge against graduates who might wind up with low earnings or lose their job.” Students could be grouped by field of study or other characteristics to be better compared to their peers. This is a fascinating idea to help what some call the student loan crisis.
The Washington Post article includes a brief discussion on potential government regulation that would inevitably follow and notes that Senator Marco Rubio and Representative Tom Petri have already introduced legislation to help facilitate the use of ISAs. There are a lot more details to work out, but it is an interesting discussion and an exciting prospect. I think it could help slowly remove the government from the student loan business. I’m interested to see what happens with the Purdue experiment.