STUDENTS are betting on their long-term incomes, with investment firms now covering the cost of their degrees, in return for a percentage of their future salaries.
In the US, student debt is now so out of control, that it totals $US1.2 trillion — more than the GDPs of Australia, New Zealand, and Ireland combined.
That huge figure is weighing down a generation, potentially preventing people from enjoying higher education.
But a new approach to student debt is taking hold in the country, allowing investment firms to pay for the tertiary degrees of young people in exchange for a percentage of their future income. Known as Income Share Agreements (ISA), the idea effectively creates a share market for future members of the workforce for companies to bet on.
If students earn more than expected when they enter the workforce, they pay back more. If they earn less, they pay back less.
Companies are even producing algorithms to predict student potential in an attempt to earn a return for investors.
Elida Gonzalez, 23, of California recently signed up with a company called 13th Avenue Funding to get a loan of $US15,000. Now she’s on the hook for five per cent of her income for the first 15 years of her employment. If she turns out to be wildly successful, she will pay back much more than if she went with a traditional loan.
She is studying with hopes of becoming a physician’s assistant and could end up paying back $60,000 for the $15,000 loan, reports the Wall Street Journal — something which she says she is “willing” to do.
“Equity is always more expensive than debt”, Chris Brycki, founder and CEO of Sydney investment firm StockSpot told news.com.au.
He’s taken an interest in the emerging market of ISAs in the US and views them as the free-market solution to the burdensome system of student loans in the country.
Unlike Australia’s HECS system which provides loans on non commercial terms that don’t incur interest, in the US, student loans have some of the toughest conditions imposed on them and are becoming crippling for a generation of unemployed graduates.
Mr Brycki believes young people who “back themselves” to be successful in the workplace will stick with the traditional student loans while others who are less confident will be more inclined to seek out the ISA option.
From an investor’s point of view, this could be a problem. These pools of ISA loans are only attractive if they have a good diversity of students, he said.
For instance, those undertaking a liberal arts degree might be more inclined to sign up for an ISA while those studying to enter high demand and well paid industries such as engineering will stick with a regular loan.
“Everyone jokes in Australia that if you do an arts degree then you won’t have to pay back your HECS,” he said. A similar sentiment in the US could almost undermine the scheme or create extortionate terms for the investment loan.
As Andrew Davis, the founder of Educational Equity in Chicago, which offers income-share agreements put it:
“If you start a new medical-insurance business you don’t go looking for the sickest people to insure.”
There is also uncertainty as to the time frame the loans will be repaid. Most ISAs have a repayments threshold — similar to Australia’s HECS system — that means graduates won’t have to make a payment until they earn at least $US18,000 a year. The median wage in the US per person is $US26,695.
That being said, Mr Brycki believes “the market works out pretty quickly what the risk is.” The returns for investors “won’t be astronomical” he said. Unless of course they strike gold with the next Mark Zuckerberg.
ISAs are seen by many as a way of tackling (or at least transferring) the burgeoning student debt in the company which has grown to alarming proportions in recent years. Student debt has surged in the past decade to represent the second largest form of debt in the country. It has trebled in that time to reach $US1.2 trillion.
However the idea of commodifying someone’s future employment prospects is seen by some as somewhat predatory and critics of the idea say it’s taking the education system in the wrong direction.
“It feels icky to me,” David Bergeron, a former Obama White House education adviser, told the Wall Street Journal.
A feeling that was echoed by Kevin Roose of New York Magazine who said these programs amount to making low income students “indenture themselves to patrons in the investor class.”
Others however champion the ISA market for offering the opportunity of higher education to those who would otherwise struggle to access university.
“This concept is quite innovative in its approach to financing college,” Wisconsin Republican Tom Petri said in a release. “These plans would help all students get the financing they need — including students from disadvantaged backgrounds — but without the anxiety that comes with traditional loans.”
While many companies such as Upstart, Pave, and Lumni are getting in on the action, they have faced plenty of challenges because at the moment the market exists in a legal wilderness.
Earlier in the year senator Marco Rubio and Tom Petri introduced legislation that seeks to formally define their terms. The legislation in currently pending in Congress and should provide the much needed legal framework for the emerging market. The bill outlines details such as the maximum length a contract can last (30 years) and the cap on income a fund seeker can owe (15 per cent).
Meanwhile these companies are developing elaborate algorithms that use data points like education, standardised test scores, credit history, and job offers to ensure investors get a return on their bet.
However the stringent due diligence of these loans will likely nullify the purported virtue of providing a university path way for under privileged students.
“It would defeat the whole purpose,” Mr Brycki told news.com.au. “It would become a last resort” for those student who amount to a risky investment.
However while the kinks continue to be worked out, the popularity of the idea is gaining momentum.
Indiana’s Purdue University (one of the biggest schools in the country’s mid west) is the latest institution to endorse the model and is currently soliciting a firm to establish an ISA fund.
“This no-debt, low-risk option is another way we can help keep our school within financial reach of all qualified students,” Purdue University President Mitch Daniels said in a statement this month.
With the skyrocketing cost of certain degrees in the county, it’s certainly not a sure thing for investors but Mr Daniels said a Purdue University student is a “a very sound investment.”