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A ‘Promising’ Idea With Practical Problems

Income-share agreements are still rare, though they are becoming more common. Before they grow too fast, it is worth asking whether they are a real solution to our education debt problem – or a new problem in disguise.

An income-share agreement is a contract between a student and a school. The school agrees to provide education funding; in exchange, the student will pay the school a set percentage of his or her post-education salary for a given number of years. People have discussed this idea as a theory since the 1960s, but real-world income-share agreements in their current form are a recent phenomenon. Purdue University began offering them in 2016, and several other schools have since followed suit.

In an environment where educational debt has ballooned to $1.5 trillion in the United States, it is not hard to understand why students are looking for alternatives. But are income-share agreements the answer?

Only a handful of schools currently offer income-share agreements, so whether the idea catches on will likely depend on how these programs fare in the next few years. But many schools are paying attention. Tonio DeSorrento, chief executive of an organization called Vemo Education that helps schools design these agreements, told The Wall Street Journal that an increasing number of schools have expressed interest.

There are two main types of income-share agreements. In the first, the agreement is designed to make up the difference after a student takes out government-subsidized loans. In the other, the agreement funds the student’s entire education. In either approach, the student starts repaying the school once he or she leaves, though some programs offer a grace period before payments are due.

The idea is that these programs give schools an incentive to turn out graduates who are well-prepared to succeed in the work world. If alumni struggle, the school will earn less; if they do well, the school reaps a direct financial reward. In practice the programs are not necessarily this simple, but the broad-strokes version has drawn a fair amount of political support.

Think tanks and analysts from both sides of the aisle have expressed interest in the expanded use of income-share agreements. Supporters argue that, since many schools fund these programs primarily through partnerships with private investors, the agreements introduce a mechanism for the market to help sort out some of the problems in higher education funding. Over time, investors will concentrate on programs that turn out graduates well-suited for the labor market – at least in theory. The Education Department also announced in April that the administration is considering whether to establish a program through which the government could finance income-share agreements, though it is far too early to say whether this will happen or what such a program will look like if it does.

Despite growing optimism, I can see a few potential problems with the income-share agreement approach. A major one is adverse selection. Students who plan to embark on lucrative careers, such as STEM or business majors, often have access to better repayment terms. They are also the least likely to find an income-share agreement appealing. Ambitious students who hope to be the next Jeff Bezos are much more likely to want to pay off a traditional student loan than to promise away a slice of their future income, even if the program offers a repayment cap. Students who don’t expect to earn much, such as history or philosophy majors, may find the offer more appealing. But why would schools want them to?

By setting up a program where students may repay significantly more or less than the value of their tuition, schools are encouraging students to play the odds in a way that will undercut the school financially if their expectations are correct.

Those who support income-share agreements have argued that many potential problems simply require that administrators or lawmakers structure the programs carefully. Uniform consumer protection measures such as requiring grace periods after certain life events could give students greater peace of mind. Lawmakers could also establish caps for the percentage of income a program can charge or for the duration of payments.

There is no current legislative framework for income-share agreements, which means each school runs a unique program with its own terms and conditions. Lawmakers are reportedly working on setting legal standards, but for now, each of these contracts stands on its own. Since the agreements aren’t federally regulated, students will need to carefully review the percentage of future income they will owe, the period over which the agreement will apply and whether there is any cap on total payments. These terms vary widely. For example, the income percentage can be anything from less than 1% to around 15%, depending on the program. Some programs may go as high as 18%, according to Julie Margetta Morgan, a fellow at the Roosevelt Institute. Repayment terms vary from two to 10 years.

While regulation could help, I am skeptical of the argument that a properly structured program would fix every potential problem. To me, this sounds a lot like some of the rhetoric that has characterized the debate about American health care funding. There may be a perfect way to structure these programs on paper. But in the messy world where we actually live, there are a lot of factors that could make them fail for students, schools or both.

Some critics have also raised the idea of a moral hazard inherent in these programs. Students could, they suggest, enroll in an income-share agreements and then purposely take jobs where they earn much less than they otherwise would to minimize, or even eliminate, their payments. In essence, they would run out the clock on the repayment period and then begin their careers in earnest. But this does not strike me as terribly realistic for a variety of reasons. Purposely earning less early in a career has long-term consequences for earning power. And, depending on how the agreement is structured, earning less than a threshold may simply extend the payment period. While some people could go to great lengths to avoid their obligations – as some people already do with educational loans – I don’t view moral hazard as a major potential problem here.

Since income-share agreements are so new, critics’ concerns are largely about what might happen, rather than anything that already has. If Congress sets out a workable framework for these contracts, they could become more widespread. Or perhaps they will find their place as a niche option that is a good fit for a small handful of students.

If you are considering an income-share agreement for yourself or your child, approach with caution. As with any financial aid plan, it makes sense to exhaust scholarships and grants first, as well as any savings in a 529 plan or other funds earmarked for education. Federal student loans may also be a better option if they are available to you, since they offer features such as income-based repayment and public service loan forgiveness options.

As we have written in this space before, students should also consider whether attending a school that will require taking on a lot of debt – or, in the case of an income-share agreement, that requires promising away a large chunk of their future earnings – is really worth the cost. In some cases, it might be. But in many others, a more affordable school may offer an equally solid educational foundation at a more manageable price point.

Comparing the cost of a private loan to an income-share agreement is tricky. You are dealing with a variety of unknowns, not the least of which is the student’s future wages. While students pursuing a particular career may have a rough sense of what they can expect to earn, life rarely works out exactly as planned. A particular student may end up earning much more or much less than expected. Students should also bear in mind that interest payments on private or federal Plus loans are tax deductible up to $2,500, even if you do not itemize your tax return. Income-share agreement payments do not offer this tax benefit.

Individual students will need to thoughtfully evaluate their particular situation when deciding whether to enter an income-share agreement. But based on the variables in play, I am skeptical that income-share agreements will succeed as a widespread alternative to student loans. The problems of skyrocketing tuition and outsize educational debt are real, and they need to be addressed. But expecting students to mortgage their future earnings is not the way out.

Vice President and Chief Investment Officer Paul Jacobs, of our Atlanta office, contributed several chapters to our firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55, including Chapter 12, “Retirement Plans;” Chapter 15, “Investment Approaches and Philosophy;” and Chapter 19, “A Second Act: Starting a New Venture.”

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