Who Would Use Income Share Agreements to Pay for College?

This post first appeared at the Brookings Institution’s Brown Center Chalkboard blog.

In response to concerns over the rising price of college and increasing amounts of student loan debt, the Obama Administration has worked to expand income-based repayment programs for those with federal student loans. In late 2015 or early 2016, the U.S. Department of Education will likely allow students with any federal loans to enroll in a more-generous version of income-based repayment that would cap monthly payments at 10 percent of discretionary income (i.e., earnings above 150 percent of the federal poverty line) for 20 years for undergraduate students and 25 years for graduate students, with any remaining balances forgiven by the federal government.

Although this new version of income-based repayment has the potential to benefit up to six million Americans with student loan debt, concerns have been raised about this more generous program. First, the price tag is estimated at $15.3 billion over 10 years, or roughly 5 percent of forecasted Pell Grant expenditures during this period. Second, graduate students, who are more likely to have six-figure student loan debt and enroll in income-based repayment programs at higher rates, will see more benefits than undergraduate students with smaller amounts of debt but worse career options. Finally, as more students enroll in income-based repayment plans, colleges have fewer reasons to control costs due to students’ ability to access credit.

An interesting alternative to federal student loans that has emerged in recent years has the potential to shift the financial risk of paying for college away from the federal government and students, instead placing the risk in the private sector. Income share agreements (ISA) function somewhat similarly to income-based repayment plans, as students pledge to pay a predetermined percentage of their annual income in exchange for funds to pay for college. However, unlike federal income-based repayment plans, the percentage of income and the length of the repayment period are negotiated between a private investor and the student instead of being the same across all students. Students who major in economically desirable fields, such as engineering and business, at top colleges are likely to get better repayment terms than students majoring in less-profitable but socially important fields, such as education and nursing, at more typical colleges.

Given the current generosity of income-based repayment programs—and the likelihood that the federal government loses money on many students today—I have to wonder how many students would use ISAs once potential legal issues around their operation in the United States are resolved. Students in less-lucrative fields or those who plan to work in public service careers are unlikely to get better terms from the private sector than the federal government. These students would be likely to continue using federal student loans, although it is possible that ISAs could partially replace Parent PLUS loans as a financing source should parents not want to take out loans for their children when ISAs are available.

This leaves two groups of students who are likely to be interested in ISAs. The first group is those students who are either attending colleges that do not offer their students federal loans (primarily for-profit colleges and community colleges), or those attending short-term training programs such as coding ‘boot camps’ that do not currently qualify for federal student aid. Something in the neighborhood of two million students attend these colleges and programs, which results in a fairly sizable market. However, all of these programs tend to be relatively inexpensive, meaning that the per-student profit for an ISA provider will be fairly small.

The group of students who would be more lucrative for ISA providers would be those students enrolled in profitable degree programs at traditional undergraduate and graduate institutions. Because these programs tend to be expensive, the contract would need to be designed so the provider could make a profit on a large initial investment. However, students could lock in paying a lower percentage of their income than what they would expect to pay under income-based repayment if their expected earnings are high enough.

But students with high expected incomes may stay away from ISAs because they may expect to pay more in an ISA than under the standard federal repayment plan (a fixed monthly payment over 10 years). It would be difficult for ISA providers to undercut the federal government’s price in today’s environment of reasonably low interest rates, but it could be possible for students who have the highest likelihood of graduating and making a large salary because of the relatively low risk these students represent to a provider. Additionally, the presence of post-graduation private loan refinancing options such as Earnest and SoFi give successful graduates a way to lower their loan payments without giving up a share of their income.

Income share agreements have the potential to create another option for students looking to pay for college while seeking assurances they will not be overwhelmed by future payments. However, given the current generosity of federal income-based repayment programs and the likely hesitation of those who expect six-figure salaries to sign away a percentage of their income for years to come, the market for these programs may be somewhat limited. However, the federal government should encourage the development of private ISA providers in order to give students as many options as possible to finance their education while setting reasonable parameters for their operation that protect students from fraud and abuse.

Trends in Federal Student Loan and Pell Grant Awards

The U.S. Department of Education’s Office of Federal Student Aid released its newest quarterly update on federal student loan and Pell Grant awards on Friday, and the data (through the end of the 2014-15 academic year) are nothing short of stunning. As shown in the table below, federal student loan volume dropped by nearly $11 billion in 2014-15 to $89.4 billion, the lowest level since before the federal government ended the old bank-based lending program in 2010. Total Pell Grant awards also declined in 2014-15 to $30.3 billion, more than $5 billion below 2010-11 levels. (For more on trends in Pell awards over the last two decades, see my recent post on the topic.)

aid

What could explain such sharp drops in student loan and Pell Grant dollars? Four factors could be at work:

(1) As America slowly continues to climb out of the Great Recession, more students and families may be earning enough money not to qualify for Pell Grants or need to borrow as much in student loans. Unemployment rates are down sharply since 2010, but median real household income has been nearly flat—so this is probably a minor contributing factor.

(2) Americans may be less willing to borrow for college than they were a few years ago, leading to less student loan debt. I’m more concerned about undergraduate students underborrowing for college than overborrowing, particularly as students react to stories about other people’s (atypical) debt loads and concerns about their financial strength. But this is difficult to prove empirically given current data.

(3) Part of the decline in total Pell awards is likely due to changes in the FAFSA formula that reduced the number of students automatically receiving the maximum Pell Grant in 2012-13 and beyond. But this would not explain continued declines in Pell dollars received.

(4) The most likely explanation to me is decreased enrollment due to an improved labor market inducing some individuals to work instead of attend college combined with the collapse of some of the large for-profit college chains. The most up-to-date data from the National Student Clearinghouse (which is available well ahead of federal estimates) show that enrollment has declined at degree-granting colleges each of the past three years, with the largest declines taking place at community colleges and in the for-profit sector. Lower enrollment, particularly among adult students, leads to fewer students taking out loans and receiving Pell Grants.

As the economy continues to slowly strengthen and the for-profit sector continues to sort itself out, I would expect enrollment (and the number of students receiving Pell Grants) to very slowly increase over the next several years. Future trends in student loan debt are less clear. Given the explosion of students enrolling in income-based repayment programs, students (particularly in graduate programs) might have less of an incentive to keep loan amounts in check. Yet, to this point, there doesn’t seem to be a boom in graduate school loans across the board. It would be worth looking at particular colleges with large programs in fields that are especially likely to qualify for Public Service Loan Forgiveness to see if loan amounts there are up by large amounts.

To Reduce Debt, Give Students More Information to Make Wise College Choice Decisions

This article was originally published at The Conversation.

Higher education has gotten a lot of attention during the early stages of the 2016 presidential campaign. All three major candidates for the Democratic nomination – former New York Senator Hillary Clinton, former Maryland Governor Martin O’Malley and Vermont Senator Bernie Sanders – have proposed different plans to reduce or eliminate student loan debt at public colleges.

However, the price tags of these plans (at least $350 billion over 10 years for Clinton’s proposal) will make free college highly unlikely. Republicans, including leading presidential candidates, have already made their opposition quite clear.

But student loan debt is unlikely to go away anytime soon. What is important for now is that students and their families get better information about tuition costs and college outcomes so they can make more informed decisions, especially as the investments are so large.

What colleges will reveal

Although colleges are required to submit data on hundreds of items to the federal government each year, only a few measures that are currently available are important to most students and their families:

First, colleges must report graduation rates for first-time, full-time students. This does a good job reflecting the outcomes at selective colleges, where most students go full-time.

But full-time students make up only a small percentage of students at some colleges, and data on the graduation rates of part-time students will not be available until 2017.

The price tag of Hillary Clinton’s college plan is too steep.
Marc Nozell, CC BY

Colleges must also report net prices (the cost of attendance less all grant aid received) by different family income brackets. The cost of attendance (defined as tuition and fees, room and board, books and supplies, and other living expenses such as transportation and laundry) and the resulting net price are important measures of affordability.

Because financial aid packages can vary across colleges with similar sticker prices, net prices are important to give students an idea of what they might expect to pay.

Colleges that offer their students federal loans must report the percentage of students who defaulted on their loans within three years of leaving college. This measure reflects whether students are able to make enough money to repay their loans. Colleges must also report average student loan debt burdens, so students can see what their future payments might look like.

In addition, vocationally oriented programs must report debt and earnings metrics under new federal “gainful employment” regulations. This provides students in technical fields a clear idea of what they might expect to make.

The Obama administration has promised that additional information on student outcomes will be made available “later this summer”, although they have not said what will be made available.

What don’t we know?

Despite the availability of information on some key outcomes, more can still be done to help students make wise decisions about which college to attend.

Below are some example of outcomes that would be helpful for students and their families to know about.

Although enormous gaps in college completion rates exist by family income, students and their families cannot currently access data on the graduation rates of low-income students receiving federal Pell Grants. (The federal government is purchasing data from the National Student Clearinghouse to fix this going forward.)

Colleges are required to report the percentage of minority students and the percentage of students receiving Pell Grants, but nothing is known about the percentage of first-generation students.

This is of particular interest given the key policy goal of improving access to American higher education; without this information, it is harder to tell which colleges are engines of social mobility.

Students need to have more information.
Lynda Kuit, CC BY-ND

Private-sector organizations such as PayScale and LinkedIn work to fill this gap, but they can only provide a limited amount of information.

How could we know more?

The data needed to answer many of the questions above are already held by the federal government, but in multiple databases that are not allowed to communicate with each other.

The greatest barrier to better information from the federal government is due to a provision included in the 2008 reauthorization of the Higher Education Act which banned the federal government from creating a “student unit record” data system that would link financial aid, enrollment and employment outcomes for students receiving federal financial aid dollars. This ban was put in place in part due to concerns over data privacy, and in part due to an intense lobbying effort from private nonprofit colleges.

States, in contrast, are allowed to have unit record data systems, and a few of them make detailed information available to anyone at the click of a mouse.

For example, Virginia makes a host of student loan debt information available in a series of convenient tables and graphics.

Senator Rubio has teamed with Democratic Senators Ron Wyden of Oregon and Mark Warner of Virginia to introduce legislation overturning the ban on unit record data, although no action has yet been taken in Congress.

A bipartisan push to make more information available to students and their families has the potential to help students make better decisions.

But getting data is only one part of the challenge. The other is getting that into the hands of students at the right time. For that, it is important for the federal government to work with college access organizations and guidance counselors.

Students should be able to access this information as they begin considering attending college. Although additional information may not allow a student to graduate debt-free, it will help him or her to make a more informed decision about where to attend college and if the price tag is worth paying.

The Conversation

Read the original article.

Comments on Senator Clinton’s Higher Education Proposal

Hillary Clinton’s presidential campaign released her framework for higher education reform at midnight on Monday morning (see details here and here). The plan, officially listed at a cost of $350 billion over ten years, would move closer to the idea of debt-free public college, require states to increase their spending on public higher education, and potentially embrace some accountability reforms with bipartisan appeal. Below are some of my first-take comments on Sen. Clinton’s proposal, as I look forward to seeing complete details. (I didn’t get an embargoed copy in advance.)

  • This proposal feels like a direct reaction to pressure that Sen. Clinton was facing from the political Left. Both of her main rivals, independent Senator Bernie Sanders of Vermont and former Maryland Governor Martin O’Malley, have supported versions of debt-free public college plans. This has zero chance of passing Congress as is, particularly as the House of Representatives is likely to stay in Republican hands through 2020 and the proposal would be paid for by additional taxes on wealthy Americans.
  • I’m highly skeptical of the $350 billion price tag, or at least when it’s phrased as just being $35 billion per year (roughly equal to federal Pell Grant spending). New federal programs take several years to phase in, meaning that most of the expenses are in later years. (President Obama’s free community college proposal is similar.) Once this plan is fully in place, I’d expect the price tag to be closer to $70 billion per year. All politicians like to massage the ten-year budget window used for cost estimates, and Sen. Clinton is no different.
  • Unlike some other “free college” proposals, Sen. Clinton’s proposal brings at least some private nonprofit colleges to the table by potentially making some of their students eligible for additional aid. This is a politically smart move, as the private nonprofit lobby is strong and many colleges in this sector do good work for students. But as noted in Inside Higher Ed this morning, the leadership of the private college lobby is concerned about any proposals that direct relatively less money to private colleges—as it could affect some institutions’ ability to survive.
  • This plan includes a federal/state partnership, which is typical for Democratic higher education proposals (and a good way to keep the price tag down somewhat). However, as suggested by Medicaid, many Republican governors may not take up the extra funds in exchange for having to assume additional responsibilities. For that reason, Sen. Clinton’s proposal to allow public colleges in those states to bypass the state governments to work directly with the federal government is politically brilliant. But states probably won’t be happy.
  • Much of the price tag will go to reduce interest rates on student loans, both for current students and to allow former students to refinance their loans. This is a big deal for the Elizabeth Warren faction of the Democratic Party—the folks who really make their voices heard in primary elections. But this money will do little to improve access and completion rates, in part because much of the money goes to students after they have left college and because income-based repayment plans make interest rates less relevant. Additionally, students who tried to avoid debt as much as possible (many from lower-income families) won’t benefit as much and may be upset by the subsidies going to higher-income borrowers. I wrote about this in my previous post.
  • There are bipartisan pieces in this plan, including accreditation reform, better consumer information, and risk-sharing for student loans. If Sen. Clinton becomes the nominee, look for her to pivot to the center and highlight some of these proposals.
  • The Clinton staff are claiming this proposal will help bring down the cost of providing a college education, in addition to the price that students pay. I just can’t help but be skeptical when suggested cost-saving areas include administration and technology. Colleges have been facing pressure to tighten their belts for years from states (and many have actually done so), so I don’t think the federal government will be any more successful. But it makes for a good soundbite.

The three main Democratic candidates have now laid out their higher education agendas. Hopefully, the Republican field (which, with the exception of Sen. Marco Rubio, have been fairly quiet on the issue) will follow suit.

Why “Debt-Free” College Will Upset Some Students

In a major higher education policy proposal, former Senator and current Democratic presidential frontrunner Hillary Clinton recently announced plans for higher education reforms that come close to debt-free college by increasing grant aid to students and reducing interest rates on current loans. She is following in the footsteps of the other two main candidates for the Democratic nomination—Vermont independent senator Bernie Sanders and former Maryland governor Martin O’Malley—both of whom have called for some sort of debt-free higher education option.

Putting aside the substantial cost to federal taxpayers ($350 billion over 10 years) and state governments (unknown at this point) for a while, any plan for student loan reforms or debt-free college should make those who know the burden of student loan debt happy. Right? Perhaps not so much. A somewhat similar example comes out of Seattle, where credit card processor Gravity Payments announced earlier this year that its employees would be paid a minimum of $70,000 per year. Again, this is an idea that sounds great—essentially double the wages received by lower-level employees and get an outpouring of good publicity. However, although Gravity signed up a number of new customers, the company has faced some unexpected opposition.

As detailed in a recent New York Times article, Gravity lost a number of existing customers over fears that increasing wages would result in higher future charges, even though the CEO cut his salary to partially pay for the wage increases. That doesn’t really have a corollary to higher education, but the other key point in the article does. Gravity lost two employees making over $70,000 per year as a result of the wage increase for everyone else, as they did not feel valued in a company that paid lower-skilled workers similar amounts to what they earned.

This raises an important point—whenever a program such as a dramatically higher wage floor, student loan reforms that reduce borrowing costs, or debt free college is introduced, at least some similar people who do not qualify for the new program are likely to be upset. Consider the case of a student who just finished repaying $15,000 in student loans by making additional payments in order to become debt-free as soon as possible. She may have sacrificed by working additional hours while in college, attending a less-selective college, and forgoing buying a newer, more reliable car. If the terms on student loan debt change in a way that essentially reward a student who borrowed $35,000 in order to not work in college and enjoy a slightly higher standard of living, it’s reasonable to expect the student with less debt to be upset. (Let’s also not forget the group of lower-income students who are debt-averse and will do anything not to borrow for college. They wouldn’t benefit from any student loan reforms.)

A move to debt-free college works in a similar way, as students who go to college after such a program is instituted get to benefit, while students who attended a few years earlier get nothing. This is happening to some extent in states like Tennessee, where all students can go to a community college tuition-free, and there is no constitutional amendment saying that life must be fair for all. But when plans for debt-free college and reducing student loan burdens get introduced, let’s not forget that some people will get upset because they perceive themselves as getting the short end of the stick. And when presidential campaigns try to build up support, they should do everything they can to make this group happy.