David Bowie Reinvented Student Loans
The National Center for Education Statistics has predicted that over the next 10 years full time enrollment in a higher education university will only increase by 2%, a stark contradiction to just 20 years ago when full time enrollment was up by 45%. So what happened? Have universities reached capacity, or is there a bigger, more psychological change that has occurred within the student population?
Actual and projected undergraduate enrollment in degree-granting post-secondary institutions, by sex: Fall 2000 through 2028 (The National Center for Education Statistics).
Many have suggested that the “bubble” we found ourselves in over a decade ago, when there was a major influx of students enrolling in four-year universities, is coming to an end. Part of the reasoning for this phenomenon is explained by the rapid increase of debt students have accumulated, which has surpassed $1.5 trillion. Even though there are many options for taking out loans to pay for higher education, the fact that one will be in debt for the next twenty-something years can be disenchanting.
However, it is because of this very disenchantment that the private sector is trying to rebrand the student loan industry in the form of income share agreements (ISAs). Instead of paying a flat fee every month (that you may or may not be able to afford) back to your bank or the government to repay your loans, income share agreements, which are financed through your school, will take a percentage of your income once a month for a set amount of years. This novel way of repaying student loans seems preferable to traditional student loans because the rate at which you pay back is proportional to your income, and not based on an agreement made as a twenty-two year old estimating their future income while still finishing their GE’s. In a time when young adults are doing their best to make ends meet, not having to worry about coming up with the money for student loan payments at the end of the month does sound appealing.
The key differences ISAs promote between themselves and traditional student loans are the fact that they do not have interest rates, there are a set number of years you are obligated to pay back, regardless of whether that amount is less than the amount you borrowed, and you are seen as an investment opportunity rather than just another poor college student. All of these characteristics sound too good to be true. The question must be posed then: why are ISAs just gaining popularity now, in 2019, when student loans have been around for what seems like forever?
To answer this question, we look to rock legend, David Bowie. In 1997, David Bowie wanted to buy back the rights to his material and his intellectual property. To do so would cost a whopping $55 million. Because he did not have $55 million lying around, David Bowie approached Prudential Insurance Company with an offer. The contract set in place between the rockstar and the investment company came with the terms that in exchange for $55 million, investors would take a cut of David Bowie’s royalties year after year.
This deal became known as Bowie Bonds, and received renowned attention for being a new way of investing in the music industry. Instead of investing in capital, some tangible input that would eventually add value to the final product, companies would invest in people and their intellectual property, essentially investing in their human capital. This idea inspired Miguel Palacios to apply the same principles to the student loan industry, thus creating what we today know as Income Share Agreements.
Mr. Palacios thought that the way the student loan industry was structured forced students to either go into a major that would likely result in a high paying career, or skip out on college altogether because if students weren’t able to get high paying jobs after graduation, they would not be able to pay back their loans. Mr. Palacios wanted to change a student’s perspective on paying back their loans. Instead of stressing about how one would come up with the money to pay back the loans, the “how” was integrated into the ISA structure; at the end of the month, the loan provider would take a percent of one’s income, and use that share as payment for the loan.
For people who already have taken out the max capacity of government provided aid, ISAs offer a new and perhaps better way to pay for school. However, there are other factors to consider when deciding if ISAs are the right option for one’s situation.
While ISAs do have the potential to be comparable to traditional student loans, in that one could possibly pay as much or even less than if they had chosen to take out the latter, there is also the risk of paying much more than the initial amount borrowed.
This graph from Financial Planning shows the potential payback amount given the principal balance contrasted between Student Loans and Income Share Agreements.
Purdue University is one of the first major four-year universities to implement ISAs in the United States. The school emphasizes that ISAs are not a “loan or other debt instrument,” but is rather the school’s investment in that student becoming successful. An example the Purdue website gives in favor of ISAs is stated as follows: you’re a rising senior Economics major with an ISA of $10,000. Based on your anticipated salary in that field upon graduation, you pay 3.11% of your $49,000 salary for 100 months. At the end of the contract, you would have paid back $15,036, and fulfilled the terms of your ISA (Back a Boiler Program Overview, Purdue). What this example assumes is that the economics major described above will not receive any raises or promotions over that ten-year period, meaning his rate would stay constant.
At Purdue, the cap at which the university can no longer accept shares of students’ income is maxed out at 2.5 times the principal amount. Given the previous example, if $10,000 was borrowed, this would mean Purdue could take up to $30,000 of the economics graduate’s income if they received enough raises or promotions to be awarded that kind of salary. While this does not inherently mean the economics graduate will be paying more than double what they borrowed based on their income, it is a risk they must consider before signing up for an ISA.
ISAs certainly pose higher risks for those who are uncertain of their future income earnings, or for those who are hesitant to devote a portion of their income every month to their school with no options like refinancing or forbearance, which are offered by student loan providers. However, for students who are confident in their income potential, and are willing and able to pay off their debts as soon as possible, there are other models that might work.
Even though the Lambda School is less than two years old, and so the results of their ISA structure are yet to be determined, the current model seems promising given their population is composed entirely of students going into computer and data science fields, whose average income after graduation starts at about $70,000. The ISA layout at Lambda begins collecting income shares once an alumnus has started earning $50,000 or more, and they will only take 17% of one’s income a month for two years. If an alumnus is not making $50,000 right after they finish the Lambda program, there is a five year maximum set in place wherein the school has up to five years to hopefully collect on their investment, otherwise the contract lapses. This means that students could potentially pay nothing for their education at Lamda if they are not making at least $50,000. Another appeal to the program is that the school will only collect up to $30,000 in income shares before the contract ends, meaning that if an alumnus is making $100,000 after they finish the program, they will only be obligated to pay for 21 months since they will have met the $30,000 cap before they meet the 24 month cap.
It is important to note that Lambda School does not offer a degree, but focuses more on streamlining computer science experience and knowledge through their classes. However, because Lamda classes only last six months for full time students, $30,000 might be a bit steep for six months of education. Although if someone is starting at a $100,000 is salary, $30,000 might be a bargain.
Income Share Agreements offer an interesting solution to the student debt crisis in the United States. It seems clear that ISAs will benefit some students more than others, and may be more successful in specialized schools like Lambda that are practically guaranteed high returns on investment; whereas a school like Purdue might struggle collecting on an English major graduate. Moreover, ISAs could potentially benefit students if they’re forced to compete with traditional student loan providers for the right to fund a student’s education. It seems too early to tell how beneficial ISAs will be in the student loan market, but if one thing is for sure, it is that something needs to be done to appeal to young adults distressed about the current student debt crisis.
