During COVID-19, making the case for a controversial alternative to student loans

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May 13, 2020

Uncertainty around the magnitude of the pandemic’s effects on institutions, students, and their families has prompted Congress to continue pursuing solutions to the student debt crisis beyond the relief offered by the CARES Act. Proposals for the next stimulus package include forgiving $30,000 of debt for borrowers (including those left out of the CARES Act), canceling the student debt of frontline healthcare workers specifically, and revisiting legislation that expands Pell Grant eligibility to cover high-quality and rigorous short-term job training programs.

As Congress is repeatedly reminded, and as millions of borrowers wish they could forget, traditional higher education’s financing model is proving increasingly inadequate, especially when failures to offer promised relief flare up. And while it’s hard to imagine any financing system handily absorbing the effects of a pandemic like COVID-19, there wouldn’t be as unmanageable an inferno if the system wasn’t on fire to begin with. 

Yet, amidst all this uncertainty there is a growing consensus that Congress, employers, and postsecondary programs will need to dramatically scale up efforts to get people back into the workforce when the time is right. The solution may require adding—and appropriately regulating—alternative financing tools such as income share agreements, or ISAs, to address the needs of those for whom existing solutions aren’t working.

1. ISAs shift financial risk away from students 

By quickly suspending student loan payments and lowering interest rates to zero percent, Congress staved off what would have been a massive wave of defaults—even before the pandemic, one million borrowers defaulted each year—by essentially mimicking a key component of ISAs: their built-in downside insurance. 

In traditional student loan programs, colleges and universities that do a poor job of supporting learners through to graduation or leave their graduates ill-equipped to earn a living wage bear virtually no financial risk for those poor outcomes. That risk falls squarely and relentlessly on the borrower’s shoulders, with fixed monthly payments regardless of income and a system that renders it extremely difficult to discharge the loans in bankruptcy. ISAs shift some of that risk to schools and investors—entities with much greater capacity to bear it. For graduates who experience poor outcomes in the labor market—a number that has spiked as several industries experience unprecedented levels of unemployment— their ISA payments fall commensurately with their salaries or drop to zero if their income falls below a minimum threshold. 

Thankfully, a polarized Congress and White House were able to come together to provide many borrowers with temporary relief from their student loan payments. Going forward, the built-in downside insurance mechanism of ISAs could provide that relief regardless of political climate, protecting students from paying for educational experiences that may not pay off until the labor market recovers and freeing up policymakers to sort out the allocation of stimulus and relief funds elsewhere. 

2. ISAs can align program incentives with student outcomes

ISAs have the potential to create financial incentive alignment between education providers, capital providers, and learners. Unlike the student loan system, wherein schools earn the same amount of tuition revenue regardless of whether a student does well or poorly after graduation, well-designed ISAs tie the school’s fate to that of its graduates, incentivizing schools to teach workforce-relevant skills, provide support to improve retention and completion, and help students navigate the job market. Where the current student loan system promotes access to admission, ISAs could promote access to socioeconomic mobility. 

Part of this, in practice, revolves around increased transparency for students regarding different programs’ return on investment. As institutions collect tuition revenue for individual programs through ISA payments, they will better recognize where they add more or less economic value. Whether these schools respond by adjusting terms for individual programs, financing higher-ROI programs at more favorable terms, for example, or by changing their programmatic offerings altogether, their ISAs could serve as a signal of value and an additional data point around institutional and program quality for learners, employers, and regulators. 

This incentive alignment potential can hold even in more complex financing scenarios. In a scenario in which an outside investor originates the ISA, advancing funds to schools such that their profit formulas aren’t as immediately impacted, schools will still need to establish processes that optimize for student outcomes. Investors are unlikely to channel funds to schools that lose them money. That said, the ISA market could use more widespread innovation in designing ISAs and financing structures that maximize schools’ skin in the game, ensuring that this financing model truly aligns incentives. 

3. ISAs increase access for students

Many ISA programs, like Colorado Mountain College’s Fund Sueños, are designed to increase access for students. Fund Sueños aims to help students who fall under the category of Deferred Action for Childhood Arrivals (DACA) finance their college education. Given their undocumented status, these students can’t access Title IV funding, the current model for federal financial aid found in the Higher Education Act (HEA) that includes federal loans, grants, and work-study programs.

Another access-increasing implementation involves alternative providers focused on preparing learners for the digital economy, like coding bootcamps. These providers, many of which could prove valuable in rapidly getting millions of unemployed individuals back into the workforce and thus bolstering a staggering economy, are also ineligible for Title IV funding. As Congress considers the support it will offer to upskill and reskill the labor market,  it could revisit legislation erecting basic guardrails around ISAs, spurring growth in the workforce-aligned training programs that use them while protecting learners.

A step toward getting student debt under control

ISAs are by no means a silver bullet solution to the student debt crisis, nor should they be the only financing mechanism for all postsecondary programs. However, had more borrowers benefited from lower-risk financing options while pursuing their education prior to the pandemic, perhaps the current inferno would be more manageable. 

As legislation ramps up to focus on stabilizing both students’ and businesses’ futures, this may be the perfect time for Congress to consider the much-needed regulatory framework for ISAs to realize their full potential. Legal assurances of student protections and clarity around issues like tax treatment and dischargeability in bankruptcy are crucial to the ISA market, and arguably to a robust recovery of the American economy as well.

As a research fellow on the Christensen Institute's higher education team, Richard helps investigate novel business models in postsecondary education, professional development, and lifelong learning.