Purdue is the first American university to experiment with ISAs in more than 40 years, and if successful, could mainstream a novel alternative to private student loans.
The exact terms of the agreements will vary by student, but school officials say the length and percentage will be competitive with private student loans. The standard repayment period will be nine years or less, a shorter amount of time than most education loans. Payments will kick in six months after students leave school. Depending on a student’s professional earnings after graduation, the money repaid on the agreement could be higher or lower than the amount provided.
All of the money students pay back will be used to replenish the fund for future investments. Purdue tapped Vemo Education, a Reston-based financial services firm, as well as nonprofits 13th Avenue Funding and the Jain Family Institute, to flesh out the terms of the agreements. The school has hosted information sessions and created a website to help families understand the differences between ISAs and loans.
“Back a Boiler is designed for students who have economic need beyond what they can get from grants, subsidized federal loans,” said Brian Edelman, chief operating officer at Purdue. “At Purdue, we have thousands of students who fit that profile. But this is not for everyone.”
Income shares do not function like traditional debt in that there is no explicit principal balance or interest. Purdue created an online comparison tool that lets students plug in their major, credit hours and expected graduation date to analyze repayment terms based on projected earnings.
A history major, for instance, with a $10,000 ISA would be expected to pay 3.72 percent of his salary for nine years, according to the comparison tool. The income share would be fixed, even though the calculation assumes an anticipated starting salary of $34,000 that would grow an average $1,590 a year the first 12 years out of school.
At the end of nine years, that history major would have paid back $14,265 on the ISA. If that same student were to get a $10,000 bank loan at 9 percent interest without a co-signer, it would cost $16,684 to repay the debt in a standard 10-year term, according to the tool; the ISA in that case would give the student a savings of more than $2,400.
Most private lenders require students to have a co-signer, so it is entirely likely a borrower would get a lower interest rate that could make the loan cheaper than the income share. But if that history student earns less than expected in those same nine years, he would be responsible for a smaller payout on the ISA. Banks would expect full repayment of the loan regardless of the borrower’s earnings.
By the same calculation, an ISA could become an expensive gamble: A student who agrees to pay five percent of their income for five years on a $10,000 agreement could pay more than on a standard loan if, after graduation, they land a higher-paying job than expected.
At Purdue, students in high-earning fields — economics or engineering, for examples — would pay a lower percentage of their income for a shorter period than those with lower earning potential. Purdue also has put a cap in place that prevents students from paying more than 2.5 times the amount of money they received, Edelman said.
“That’s still a fairly high cap,” said Robert Kelchen, a higher education professor at Seton Hall University.
The biggest drawback to the program, he said, is for students who may earn a lot of money coming out school. Given the expanding market of companies, like SoFi and Commonbond, that refinance student loans for high-income borrowers, engineering majors could be better off with traditional debt. Kelchen said Purdue’s program is a “good replacement” for private student debt and federal Parent Plus loans, which carry high interest rates and offer none of the consumer protections of federal student loans.
A month away from graduation, Mike Young, a senior studying engineering at Purdue, no longer has to worry about paying for the next semester, but he and his friends have been talking about the university’s new experiment.
“The thing that makes this attractive is it would be a little bit easier than the traditional structure of taking a loan from a bank,” Young said. “With a bank, you owe a certain amount of money no matter what happens. Whereas with this agreement, if your degree doesn’t end up getting you the job that you want, you’ve got options. You’re not stuck with debt that’s going to be impossible to pay off.”
Income shares are in many ways uncharted territory, even though they have existed for decades. Economist Milton Friedman proposed the idea in the 1950s, and a handful of Latin American countries use the agreements. Yet they have been slow to catch on in the United States. Yale University experimented with group income shares in the 1970s, but that attempt failed because students often had to cover much more than their share.
A handful of small companies and nonprofits, including 13th Avenue, have piloted programs or offered contracts on a limited basis, but the market is in its infancy and the legal and regulatory framework for income shares remains a bit nebulous.
Sen. Marco Rubio (R-Fla.) and Rep. Tom Petri (R-Wis.) introduced legislation in 2014 to create a legal framework for ISAs that set the maximum length of a contract at 30 years, capped income-based payments at 15 percent and stated that the agreements are not loans. The bill stalled in committee but brought attention to the nascent market.
The agreements aren’t exactly loans, so it’s unclear whether they’d be subject to laws like the Fair Credit Reporting Act. It would be up to policymakers and regulators like the Consumer Financial Protection Bureau to determine which consumer laws would be applicable to an income agreement.
CFPB officials would not discuss Purdue’s program, but said the bureau is closely monitoring income-share agreements.
“It is important that consumers know upfront the costs and risks of financial products,” said Seth Frotman, the student loan ombudsman at the CFPB. “Income-sharing agreements … can create challenges for borrowers trying to navigate their repayment options. These borrowers also lose out on important federal protections such as those built into income-driven repayment plans.”
Purdue structured its income shares to function like other forms of unsecured consumer debt, but with an added protection that is incredibly difficult to obtain with student loans: bankruptcy discharge.
Edelman said the foundation put other protections in place to account for hardship, including no required payments for graduates who earn less than $20,000 a year. If someone is making above that amount but does not make payments, the foundation will pursue that person through debt collection, he said.
Purdue is offering five years of deferment for those who go on to attend graduate school as well as those who exit the job market to care for an ailing parent, raise a child or volunteer.
“If this experiment works, you could see colleges using this as a recruitment tool, saying we’ll help you finance your education without taking out expensive private loans,” Kelchen said. “If enough large universities end up doing this, then the question is will there be a market for the truly private ISAs out there? Then the question is how much better will the terms be at Purdue versus some of these private companies.”
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