Income Sharing Agreements (ISAs) are gaining popularity as an alternative to student loans. The model – in which students repay the cost of their studies as a share of their income, with no pay or interest rates – is a better way to pay for college, as it offers students more protection if their degrees are not profitable. .
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. Strict disclosure rules, combined with less prescriptive regulation in other areas, will allow the model to grow and thrive.
Why we need consumer protections for ISAs
Good consumer protection rules must protect students from unscrupulous providers, but also allow more serious ones to operate without too many constraints. The need for guarantees designed with ISA standards in mind is increasing. As the model develops, state and federal regulators impose more scrutiny on ISAs using laws designed for traditional lending.
But existing rules, such as usury laws that regulate interest rates, don’t make sense for ISAs (which don’t have an interest rate). This leads to the bizarre results: California ISA regulations using outdated rules forced an ISA provider to remove an essential benefit for low-income students.
The new consumer protections are important not only to protect students, but also to define the appropriate extent of the power of regulators. Greater regulatory certainty will encourage more investors to support 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 does not repay their federal loans, the government can charge fees of up to 25% of their outstanding balance. He can garnish his salary, tax refunds and social security benefits. Her college may hide the fact that she is in debt. Because of this, many students end up borrowing more from the federal government than they realize and are shocked when their first bill arrives in the mail.
Critics of the ISA often want to keep the model at an unattainable level of perfection. But the right comparison is traditional student loans, which are a consumer protection nightmare. Nonetheless, we can and should demand that ISAs meet higher standards to differentiate them from the much maligned federal loan program.
The Right Way to Protect Students
There is 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 power. The proposal also sets statutory limits on the terms ISA providers can offer: for example, it caps the portion of income that students repay at 20%.
The most important aspect of the proposal is strong disclosure rules. Again, the bar is on the ground, as colleges sometimes don’t even properly disclose that their students are taking out loans! But since ISAs are a bit more complex financial products than loans, their terms should be clear to students. A standardized disclosure form, as is the standard for residential mortgages, will allow students to easily understand and compare terms.
The ISA Consumer Protection Act also sets limits on these terms. For example, the part of the income repaid cannot exceed 20% and the obligation cannot last more than 30 years. In particular, these limits are well outside the current market standards. The ISA offered at Purdue University, for example, typically lasts less than 10 years. Traditional colleges typically have single digit revenue sharing rates.
Setting strict limits on conditions has the admirable goal of protecting students from predatory ISA providers, but it can also give an implicit seal of government approval to ISAs with onerous conditions. We don’t want 30-year ISAs to become commonplace in a market currently dominated by less than 10-year ISAs. Furthermore, universal limitations do not make sense in an extremely diverse post-secondary education market. 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, lawmakers could create a “safe harbor” range for terms closer to existing market standards. ISAs that fall within these parameters would be subject to much less stringent regulatory oversight (although disclosure rules would still apply). Suppliers could still offer ISAs with conditions outside the safe harbor, but the CFPB would have more power to take enforcement action against them.
But the best disinfectant is always sunlight: the most important role of regulators is to ensure that students fully understand the product and the conditions offered by the suppliers. This clarity is unfortunately lacking in traditional student loans. ISAs represent a major improvement in the way we finance higher education. They should also constitute an improvement in the area of consumer protection.