getty
Income-share agreements (ISAs) are growing in popularity as an alternative to student loans. The model – in which students pay back the cost of their education as a share of their income, with no balance or interest rate – is a better way to pay for college, since it offers students more protection if their degrees don’t pay off.
While ISAs are a promising innovation, all innovations have pitfalls. In a recent essay with Sheila Bair published by Social Finance, I explore how governments should design consumer protection rules for ISAs. Strong disclosure rules, combined with less prescriptive regulation in other areas, will enable the model to expand and thrive.
Why we need consumer protections for ISAs
Good consumer protection rules should shield students from unscrupulous providers, but also allow serious ones to operate without too many constraints. The need for safeguards designed with ISAs in mind is growing. As the model expands, state and federal regulators are imposing more scrutiny on ISAs using laws designed for traditional loans.
But existing rules, such as usury laws that regulate interest rates, don’t make sense for ISAs (which don’t have interest rates). This leads to some odd outcomes: California’s regulation of ISAs using outdated rules forced one ISA provider to remove a critical benefit for low-income students.
New consumer protections are important not just to protect students, but also to define the proper scope of regulators’ power. Greater regulatory certainty will encourage more investors to back ISAs, allowing the model to expand.
Since ISAs are an alternative to traditional student loans, the bar is on the ground when it comes to consumer protection. If a student defaults on her federal loans, the government can charge fees of up to 25% of her outstanding balance. It can seize her wages, tax refunds, and Social Security benefits. Her college can obscure the fact that she’s taking on debt. For this reason, many students end up borrowing more from the federal government than they think—and get a shock when that first bill arrives in the mail.
ISA critics often want to hold the model to the unattainable standard of perfection. But the proper comparison is traditional student loans, which are a consumer-protection nightmare. Nevertheless, we can and should hold ISAs to a higher standard to differentiate them from the much-reviled federal loan program.
The right way to protect students
There’s a bipartisan bill to do just that: the ISA Consumer Protection Act. The bill directs the Consumer Financial Protection Bureau (CFPB) to design standardized disclosure forms for ISAs and grants the agency oversight authority. The proposal also sets statutory limits on the terms that ISA providers can offer: for example, it caps the share of income students repay at 20%.
Robust disclosure rules are the most important aspect of the proposal. Again, the bar is on the ground, since colleges sometimes don’t even properly disclose that their students are taking on loans! But since ISAs are somewhat more complex financial products than loans, their terms should be crystal-clear to students. A standardized disclosure form, as is the norm with home mortgages, will allow students to easily understand and compare terms.
The ISA Consumer Protection Act also sets limitations on these terms. For instance, the share of income repaid can’t go above 20% and the obligation cannot last longer than 30 years. Notably, these limits are well outside current market norms. The ISA offered at Purdue University, for example, usually lasts less than 10 years. Traditional colleges typically have income-share rates in the single digits.
Setting hard limits on terms has the admirable aim of protecting students from predatory ISA providers, but it also may give an implicit stamp of government approval to ISAs with onerous terms. We don’t want 30-year ISAs to become common in a market currently dominated by ISAs of less than 10 years. Moreover, universal limitations do not make sense in an extremely diverse market for postsecondary education. A 25-year ISA term would be unthinkable for a 16-week coding bootcamp, but it might be appropriate for a medical degree.
Instead of hard limits, legislators could create a “safe harbor” range for terms that is closer to existing market norms. ISAs that fall inside these parameters would be subject to much less regulatory scrutiny (though disclosure rules would still apply). Providers could still offer ISAs with terms outside the safe harbor, but the CFPB would have more power to bring enforcement actions against them.
But the best disinfectant is always sunlight: regulators’ most important role is to ensure that students fully understand the product and the terms providers are offering. That clarity is unfortunately lacking in traditional student loans. ISAs represent a major improvement in the way we finance higher education. They should be an improvement in the consumer protection arena as well.
