For College Financing, Consider an Income Share Agreement

A mortar board sits atop a stack of hundred-dollar bills.

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A college degree is an investment in the future. Yet, for many degree programs, the return on investment can be dismal. In our current college financing system, students get the same amount of federal loans no matter which program or school they select and irrespective of the salary they can expect to earn after graduation.

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Meanwhile, tuition has risen so dramatically that many graduates are left with crippling student loan debt that stops them from achieving important financial and life goals. According to a Bankrate survey, 59% of American adults are delaying milestones such as getting married, having children, buying a home and saving for retirement because of student loan debt. How did we get here?

Today’s college financing ignores value of a major

The current college financing environment completely ignores the ROI of each major. In any other industry, this wouldn’t be tolerated. Take the real estate industry, for example: When one takes out a mortgage, the loan is not only tied to the capacity of the borrower to repay the loan but also to the value of the underlying asset. But with student loans, the value of the degree isn’t considered at all.

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Take my personal example: I have three kids in college — two in business majors, one in a film major. Their tuition is almost the same, at $80,000 including room and board, and the parent PLUS loans I took out all have the same terms. How does this make sense?

College financing needs to change — and income share agreements (ISAs) are a step in the right direction. ISAs aren’t new. Milton Friedman introduced the concept of outcome-based financing to pay for tuition in 1955. An ISA is a contract that requires students to pay a fixed percentage of their future salary in exchange for funding their educational expenses today. Students are done making payments after a certain number of years (which is defined at signing of the agreement) regardless of whether their balance is paid in full. Both the repayment amount and the time to pay back are capped.

Moreover, ISAs ensure equal access to education funding because historical data like FICO scores and other socioeconomic factors aren’t relevant. Students from the same program receive the same terms.

The flexibility and affordability of ISAs set them apart from conventional student loans. Payments are paused if income falls below a certain level or in the case of unemployment. With ISAs, students cannot be stuck paying for college 20 or 30 years after graduation.

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As with any financial product, terms can vary depending on the funding provider. That is why students and their parents should look for ISA providers that communicate clearly their terms and ensure complete understanding of the agreement.

This is still a form of financing, and students should receive a standard set of disclosures, which is fundamental to protecting them. The term of the ISA should not exceed 10 years, and the circumstances and impact of payment pauses must be explicitly defined. Additionally, the effective APR should be capped at a reasonable rate, effectively ensuring no penalty for prepayment.

ISAs had a rocky start in the past

Some of the early originators of ISAs focused on for-profit coding programs, trade schools and other vocational programs and sometimes engaged in practices that were intentionally or unintentionally predatory. In 2023, proposed legislation was re-introduced to ensure that ISA providers are transparent and fair.

An ISA provider also entered into a consent order with the Consumer Financial Protection Bureau (CFPB). This settlement agreement laid out a series of disclosure requirements that ISA originators must follow that ensure that students are aware of how ISAs work, how much funding will cost, what early-repayment options are and what it means for their future.

Of course, ISAs aren’t a one-size-fits-all solution. Certain programs may not be approved for funding because of their ROI: An art major at one college could yield a better ROI than a science major at another college. Additionally, ISAs are gap funding, generally limited to amounts smaller than the entire cost of tuition, so other sources of funding are needed.

But ISAs make access to education more equitable and help students evaluate the career outcomes of the degree programs they choose, giving them a clear path to financial success, since students are not evaluated on their background or credit score, but on their degree programs.

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The student debt crisis won’t be solved by ISAs alone, but they are an important step toward making college financing more socially responsible and equitable. It is time to put education financing back in the hands of the private markets.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Dan Rubin is the founder and CEO of YELO Funding, a socially driven education fintech company on a mission to improve access to education by offering income-contingent financing to U.S. college students of all backgrounds. Mr. Rubin has 27 years of principal investing, investment banking, restructuring and operational experience, including roles as co-founding partner of YAD Capital, a private credit investment firm, private equity real estate investor at Halpern Real Estate Ventures and JEN Partners, investment banker at Lehman Brothers and turnaround consultant at Deloitte.