Higher education finance is a topic of discussion and controversy because the way we fund higher education has changed dramatically in the past few generations. The average amount of debt owed by students has increased from around $12,000 in 1990 to around $30,000 in 2015, while wages have remained essentially flat.

When baby boomers and Gen Xers were going to college, fewer overall students attended; tuition was lower; states covered more of the costs; and student debt was not a major factor in most people’s lives. But a combination of many factors — diminishing funding from states; increasing importance of degrees for the job market; widening inequality; political trends that underscore individual liability; and others — have resulted in students having to shoulder more and more of the burden, in the form of student loans.

Under our current system, 44 million Americans have student debt, many of whom find themselves unable to repay. Balances grow with interest; repayment periods may stretch to encompass half of people’s lives. Colleges are not held accountable if their students can’t repay. Even if those with debt go bankrupt, student loans are not dischargeable in bankruptcy: you have to start paying again as soon as you have the money.

The many problems around higher education finance haven’t gone unnoticed by researchers and policymakers, and that’s where JFI’s work fits in: in our higher education finance initiative, we are looking both to scrutinize the extent of the problem, and develop solutions that take the risks away from students. Higher education finance shapes the human capital development system, which shapes our economy and our society — the risk and burden of this essential institution should not be unfairly placed on individual students.

Of all the money that students have to pay to finance their college educations — $429 billion in 2013-2014, according to Nate Johnson’s estimate, and rising — roughly a quarter comes from family support, a quarter comes from loans, and 19% comes from students’ jobs. 7.6% comes from Pell grants, which the federal government gives as support to low-income students.

Loans are crucial to this state of affairs: 69% of the class of 2018 took out some kind of student loan, and the average debt on graduation was $29,800 (to view these statistics and others click here).

The most common types of loans come from the federal government, and include federal direct subsidized loans and federal direct unsubsidized loans. But these loans frequently don’t cover the actual cost of college, which includes tuition and fees, of course, but also textbooks, food, housing, and more. Once students have used up all the federal loans they can get, where do they turn?

The federal government also offers Parent PLUS loans. Then there are private loans, and a variety of other ways to take on debt, like credit cards.

We’ve listed these on a spectrum from the relatively safe — if you must take on debt, federal direct loans are not especially hazardous (interest rates are currently set at 4.53%, and there are income-contingent repayment options that, while flawed, reduce some risk to students) — to the relatively risky — private loans often have very high interest rates (based on credit, and going all the way up to 13%) that keep students on the hook for repaying even long past when they’ve paid off the original amount they borrowed.

(Johnson’s 2017 report from the Understanding Higher Education Finance Project has a lot more detail about student finance and also about the ways that institutions fund themselves, including tuition, gifts, grants, and even university hospitals.)

An income share agreement (ISA) is an alternative to loans. With an ISA, a student agrees to pay a fixed percentage of their income to their educational institution for a defined length of time in exchange for a waiver of some or all of their tuition.

When you take out a loan, you owe an amount that (except in special cases) doesn’t depend on how well you do financially after graduation. The loan servicers don’t factor in whether you have a job — if you don’t pay, there will be penalties. When you take out an ISA, what you owe depends upon what you make — if post-graduation you have a low-paying job, you aren’t stuck paying huge bills.

In their public form, ISAs are effectively a grad tax: a tax that graduates pay in exchange for their education. For an example of this structure, see the HECS-HELP program in Australia.

The federal government offers income-driven repayment plans. An income-driven repayment (IDR) plan is a loan contract that allows students the flexibility to make payments proportional to their income. IDR plans cap monthly loan payments at a percentage of income that is meant to ease the burden of repayment on the student and make the process more manageable.

There are four types of IDR plans that you may have heard of: REPAYE, PAYE, IBR and ICR. These payment plans ask for payments of 10%, 15%, or 20% of your discretionary income, depending on the type of plan; in what period of time you enrolled; and other factors. Extensive information is available at studentloans.gov.

The concepts are similar, as they are both less risky for students and provide more flexibility than traditional loans. But there are a variety of differences, especially around what you can use them for, and around protections for students. IDR plans are repayment plans only for Stafford and Direct Loans offered by the federal government (not for Parent PLUS loans). ISAs are a financial product that has income-contingent repayment built into its basic structure.

IDR plans retain some aspects of loans, and ISAs do away with them entirely. If someone enrolls into an IBR plan (one of the kinds of IDR plans, as mentioned briefly in question 5), she will make payments as a percentage of her income, but still have a loan balance and interest, minus payments made under that plan. If she opts out of her plan, she must pay off a balance that comprises principal, interest, and any interest capitalized while on the IBR plan. Balances are forgiven after a set number of years, and the forgiven amount is taxable (this is a controversial element of these programs, as students may end up with a large, surprising tax bill at the end).

On the other hand, income share agreements are usually privately funded (by a school, a foundation, investors, or others). Under an ISA, there is no principal or interest. All payments are a percentage of annual income. After a set number of years, the contract terminates, and no more is owed — even if the original amount borrowed exceeds total repayment.

Finally, providers can build ISAs with a few other student-protecting options in the contracts, which we’ll address in the next question.

ISA contracts may contain a few technicalities that make a big difference in the lives of students.

One feature that most ISAs have is a threshold: if you make less than the threshold in a year, you don’t have to pay anything that year. (For example, if your ISA has a $20,000 threshold, and you only make $15,000 that year, you wouldn’t need to pay anything.)

Another feature is a cap: if you end up making millions, you won’t have to pay millions back; you’ll hit a limit on the total repayment amount.

Finally, ISAs may have term extensions — if you go to grad school, for example, you’ll probably spend several years making very little money, and so those years will be added on at the end of your ISA contract, so that you only pay when you can actually afford to do so.

ISAs are a new product offered currently to a very small number of students. There is no systematic, comprehensive reporting structure for outstanding ISAs that would allow anyone to say with any certainty how many ISAs there are, and what features they all have.

Further, ISAs are changing rapidly, with features being added, removed, or redefined all the time.

For instance, the bipartisan legislation in front of Congress that would enshrine those “mays” into actual requirements for certified ISAs is severely flawed, without a functional definition of usuriousness. Industry and regulation are both in their infancy.

Lastly, while there is significant and growing research on student debt and its impacts on students, graduates, and families (as well as the wider economy), there is limited research on ISAs.

When a school or investor puts money into ISAs, you might expect them to try to get everyone to major in high-earning fields like computer science and business. The idea is that the more the students earn, the more the investors get back.

This concern makes sense conceptually, but there are a few reasons why it likely won’t play out in actuality.

First, caps and other contract design decisions, as mentioned above, will prevent investors from making an excessively high return on students, which will diminish this motivation. The end goals determine the product, and the ISAs that we build and advocate for are not intentioned to find the next huge startup founders and get equity on their success, but to function more like insurance for students for whom the system fails: students who attend schools that don’t care about their outcomes; students who end up with way more debt than they can pay.

We also design pricing models with a modest return on investment, so that we can minimize the number of years and the percentage of income required of students. These are not meant to be a wild money-making venture, but to have broader benefits for the whole higher ed system.

Third, in this early phase of ISA market-building, we’d most recommend them as a substitute for Parent PLUS and private loans – not for federal direct loans. In general, it’s wise for students to take out their federal direct loans first, and add ISAs for other expenses they need to cover. The amounts that investors can expect to earn simply aren’t that large.

Fourth, even though data is publicly available on the highest-return majors, students still select a wide array of majors: financial outcome matters to students, but is only one of many elements that factor into the choice of major. Certainly, we want everyone to have lives that afford them flexibility, and since ISAs work best when most people make some kind of living, we’re comfortable with the fact that they encourage participation in the labor market. Art majors and English majors can make good livings and afford the lives that they want. The student debt crisis in this country isn’t a result of too many humanities majors: it’s the consequence of a system where predatory, low-quality colleges (like the for-profits) have little accountability; college costs have risen to the highest levels in history while public investment is at historical lows; lenders can take advantage of students; and servicers can make money even when students are struggling.

It is important here, as everywhere, to emphasize that understanding of ISAs is very limited, both by the small amount of research, and the small number of examples of ISA programs.

JFI’s current involvement with ISAs can be split into a few categories:

i) Modeling

JFI has constructed the most comprehensive ISA pricing and underwriting engine in existence — combining more than 20 public, private, and academic datasets to model a host of ISA structures, features, and terms. With our model, we are able to provide analytics to our partners and collaborators who are working on ISA pilot programs. Our higher ed analytics capacity runs the spectrum from academic research into sociology of student debt, to actual capital structuring.

Alongside our ISA pricing model, we’ve built a family of models for econometric research, to analyze the risk-adjusted returns to education and the returns to students of any given program. These models allow us to examine the equity and viability of particular financing programs and structures, as well as to give a broader analysis of the student debt landscape.

ii) Advising: We advise and consult with partners on how to structure ISA programs. We’ve worked with a range of partners from higher education institutions to college access organizations to governmental partnerships to foundations, including:

• Student Freedom Initiative
• Purdue
• Education Finance Institute
• Better Future Forward
• College Possible
• The Jack Kent Cooke Foundation
• Vaughn College of Aeronautics
• Lumni
• San Diego Workforce Partnership
• Laura and John Arnold Foundation
• Opportunity @ Work
• TheDream.Us
• Russell Sage Foundation

iii) Research: JFI researches theoretical and empirical implications of higher education finance, including returns to education, access, risk, and the forms and impacts of income-contingent financing. We have a number of different projects we’ll explain next.

Research projects include:

Borrowing Arrangements and Returns to College Education. This paper by director Sidhya Balakrishnan and senior fellow Barry Cynamon looks at how the way that you pay for college affects the value you get out of college. With their model, income-driven repayment plans and income share agreements lead to higher lifetime returns, compared to loans.

Millennial Student Debt. This research project, consisting of an interactive map and analysis, is being conducted by lead researcher Laura Beamer, senior fellow Marshall Steinbaum, and other staff. The goal is to expand the breadth of research into the US student debt crisis by examining student debt and costs of higher education in relation to an area’s labor market concentration and post-secondary institution density. Does having more local choice in higher education lead to higher or lower costs? Does it lead to more or less debt? When complete, the map will allow researchers, policymakers, and generalists the ability to see how student debt affects people by region, and how it interacts with other social factors.

Liquidity and Insurance in Student Loan Contracts: The Effects of Income-Driven Repayment on Borrower Outcomes. This paper by senior fellow Dan Herbst examines how IDR effects the welfare of borrowers — IDR enrollees tend, for example, to have higher credit scores, and are more likely to be homeowners, than those who pay with traditional loans.

Student Debt and Racial Wealth Inequality. This paper by senior fellow Marshall Steinbaum explains how cancellation of student debt in the US — proposed by Bernie Sanders and Elizabeth Warren in two slightly different iterations — is progressive, and will help remedy the racial wealth gap.

One way to think about whether college is worth it — and whether the financing of college is worth it — is what the payoff is, in terms of financial returns. It’s important to bear in mind that while our research does find that on average there is a college premium, 1) it’s less than discussed/proposed, 2) the range of results is wide and involves a lot of bad outcomes for graduates, and 3) no one has produced a good measure of the harm of debt. This is against the background of a widening premium between college and high school and wages that are overall stagnant.

We are currently developing a model that will help students decide whether college is worth it for them using a Monte Carlo simulation. Students will be able to input terms: if I’m going to pay X for school, then in order to all told have a Y lifetime return, I have to hit Z income.

There’s a growing body of research on returns to college, including excellent work by Doug Webber (for marginal students, and generally) and Cece Rouse (taking a historic view). Our researchers, Barry Cynamon and Sidhya Balakrishnan, develop this research by incorporating the risk from different forms of financing. They find that “the typical bachelor’s degree graduate worker earns $1.19 million in lifetime earnings, which is twice what the typical high school graduate earns,” but these earnings change based on the type of financing: loans are more detrimental to lifetime earnings than ISAs.

In our research, we’re especially interested in questions of what the return on college is for the marginal student, variously defined. Marginal students are important from the systematic perspective we adopt: what new students will enter school, in what new circumstances, with what new financing?

JFI strongly supports broad access to a liberal arts education. However, we believe that the financial returns to college are a crucial factor to consider when evaluating higher education finance and higher education finance policy.

Right now, there aren’t any organizations that will work with individual students to fund their educations with ISAs.

If you’d like an income share agreement, contact your college or university financial aid department and see if they’re exploring the idea. If you have loans from the US government, look into enrolling in income-driven repayment, which is similar (amounts change based on your ability to pay) and available to all.

You can find info on enrolling in income-driven repayment here.