The recession caused by COVID-19 will sink incomes and, if historical trends hold, may spur more people to return to school when they are out of work and opportunity costs are lower (though this effect may be delayed, given the unique challenges of the pandemic). With families now having fewer resources to pay for school, and colleges likely facing state funding cuts—particularly if Congress does not step in—and other significant losses in revenue, more students than ever may have no choice but to turn to debt to finance their education.
In this context, a crop of lenders are offering a different type of private student loan, called an income-share agreement (ISA), and marketing themselves as an alternative to debt. Similar to historical pushes behind “novel” products in the small-dollar lending space, the ISA industry is calling for new regulations that would define ISAs outside of existing consumer law and regulation. But this familiar call in the small-dollar lending space has begun to run into the reality that many state regulators seem to have no problem applying current state laws regulating credit to their products. This, in turn, means that we can expect the pursuit of the oft-utilized strategy of calling for new regulations will intensify.
Background on ISA Loans
ISA loans allow borrowers to pay back the principal based on a share of their income after they leave school. Although terms vary, most ISAs have a minimum income threshold, above which they require repayment calculated as a percentage of income (and below which no payment is due); a cap on the total amount that a borrower must repay, usually set as a multiple of the original amount borrowed; and a timeframe over which the borrower is required to repay. The design provides some income protections, but it is the details in these terms that really drive whether the loan will be more costly or less costly than other types of private student loans.
The ISA industry loudly claims that these products are “not loans,” but rather a novel financing mechanism. However, such claims have been made before in consumer finance particularly with products that rely on future wages for repayment, and when lenders wish to avoid usury interest rate caps stated in law and other consumer protections.
The Old Claims of “It’s Not a Loan”
Small-dollar lenders have, throughout history, argued that their particular form of credit was not a loan, and thus not covered by existing laws; at the same time, these lenders would fight for new regulations and legislation that would allow them to securely sidestep usury caps and to access the future wages of lendees as directly as possible—just like today’s ISA loan providers.
For these “salary buyers” (essentially, loan sharks) of the early 1900s, this meant that when trying to avoid a charge of usury, a lender would claim that a transaction was not a loan but a salary purchase, or a “chose in action”—the borrower’s legal right to use his wages. The claim by lenders was that the borrower was selling intangible property rights. Salary buyers would also maneuver questionable usage of jurisdiction to claim that loans originated in states with fewer usury restrictions, and also obtain a “wage assignment,” meaning that the lender could go directly to the employer to obtain repayment (much like today’s ISA contracts that require automatic payment withdrawal from approved bank accounts). When those practices were challenged, industry focused on building a new regulatory framework to legitimize its products.
A few decades later, the strategy became a pattern. When purchasing household items on credit grew in popularity through the mid-century, installment loan providers avoided usury caps for many years by hiding under the “time–price” doctrine, which stated that the difference between the cash amount provided the borrower and the price of an item sold on “time” was not interest on a loan. Installment loan providers in the retail industry similarly often tried to rely on wage assignments, even if they had the option to repossess the chattel. When courts began to question the time–price doctrine and states began cracking down on these loans, it spurred lenders’ efforts to legitimize their products through state retail installment sales acts that allowed them to avoid existing, general usury caps. (Some of those laws were also later weakened even further over time.)
Another variation on this theme was rent-to-own products, which lenders also claimed were exempt from state credit and usury laws as well as federal laws. Rent-to-own lenders attempted to rename their loans as leases. Ultimately, a series of court cases with less than favorable results once again spurred lenders to make efforts to secure protective legislation; today, nearly every state has an industry-crafted law to remove consumer protections from applying to the rent-to-own industry, allowing high fees and even exposing consumers who cannot make payments (primarily already vulnerable consumers) to criminal penalties.
Yet another form of this ruse existed in the “deferred presentment” offerings at check cashing stores that gained steam in the 1980s, as lenders also claimed not-a-loan status for their products—which became harder to argue when they became known as payday loans. In the 1990s, lobbyists for the industry got to work (successfully) building safe harbors that, amongst other things, exempted products from usury caps, for their payday loan products in states across the country.
As federal and state efforts to regulate ISAs move forward, this history is instructive: the push for new regulation in small-dollar lending space played out again and again, as the industry made the case that their new product was inherently different, and, buoyed by fear of bad court precedent or enforcement of existing laws, pushed for industry-friendly legal reform looking for greater legitimacy and protection.
Regulators Weigh In on ISAs
Like their historical counterparts in small-dollar lending, the ISA loan industry has, for several years, attempted to carve out a new regulatory structure for these loans, claiming that their products are not loans and not debt. Doing so provides an avenue to remove existing credit restrictions, and, in particular, would extricate these products from the age-old profit restriction: usury caps. Industry-backed federal bills in Congress include a preemption of state usury laws for ISAs, and legislators in about a half dozen states have either proposed state-backed ISA products, or filed bills to create a new regulatory structure for ISA loans in their respective states. Legislators in Washington, California, and Pennsylvania have bills that create such structures. (No proposed new structure has gained traction.) But for those interested in consumer protection, such new frameworks may simply be unnecessary.
Those charged with interpreting existing laws are taking issue with the industry’s stance; many state regulators have come to the opposite conclusion.
In fact, those charged with interpreting existing laws are taking issue with the industry’s stance; many state regulators have come to the opposite conclusion. In Iowa, regulators clearly stated not only that ISAs are still debt, but also that these products are “regulated by the Iowa Consumer Credit Code, and the terms of most ISAs would violate the law’s limits on interest rates, late fees, grace periods, and more, if they were offered to Iowa students.” In Washington, the state financial aid agency clarified that ISAs are a student loan product. And at a recent conference, Oregon attorney general Ellen Rosenblum called the claim that ISAs are not credit or debt, and thus should not be subject to typical consumer protections, “a red flag for regulators and law enforcement officials.” At the same conference, Pennsylvania’s senior deputy attorney general Nick Smyth stated that, while his office heard all the time from businesses trying to argue that their particular financial product is not covered by existing laws, “these are clearly credit products.”
In California, as a part of a number of other causes of action, the state’s Bureau of Private Postsecondary Education deemed the Holberton school out of compliance for offering a “note, instrument, or other evidence of indebtedness” (an ISA) without licensure; the state attorney general has now brought an action on the agency’s behalf to halt operations. The agency is similarly engaging in oversight of Lambda School’s ISA.
Meanwhile, although the Trump administration has done nothing to protect ISA borrowers, a more consumer-friendly administration would clearly have the ability to do so. For example, last month, former CFPB regulators published an analysis refuting industry lawyer analysis and detailing some of the ways that federal laws already apply to these products.
Adding New Borrower Protections?
Although almost all currently proposed legislation would remove consumer credit protections, there is one notable exception that builds new parameters within an existing regulatory framework—a new bill in Illinois. Near the end of 2019, the Illinois governor signed the Student Investment Account Act into law, allocating up to $1.5 billion to the state treasurer for the purpose of entering eligible participants into ISA programs and facilitating arrangements between participants and eligible ISA providers. Perhaps as a response to consumer protection concerns raised by the bill, this year, the Illinois House and Senate put forth a proposal to amend the Consumer Installment Loan Act to require that ISA loan providers be regulated as any other consumer installment lender, but with additional specific requirements: that ISA providers disclose terms and the effective APR under specified scenarios; that payments may not exceed 5 percent of a borrower’s qualified income, and the term may not exceed sixty months; that total payments must not exceed 1.1 times the amount loaned; and that the loan itself cannot exceed $5,000.
The Illinois bill also requires that a borrower exhaust all sources of federal student loans and state grants for which the borrower is directly eligible before entering into the ISA. Lastly, the bill provides that an ISA provider must have readily accessible methods for consumers to submit a request for assistance to the provider, and for the borrower to escalate any request for assistance. The bill hasn’t left committee, so its passage isn’t imminent. However, it provides an notable exception to the overall trend of efforts toward deregulation that most other state bills have proposed.
Looking Forward
Regulators interested in protecting consumers are not clamoring for a new framework for ISAs—credit and student loan protections are being applied. It is possible that new legislation could add protections to these products and retain existing protections of relevant consumer credit laws such as a state’s installment loan framework, but the history of small-dollar lending regulation shows us that industry calls may lead to fewer protections instead.
ISA Industry Relies on Age-Old Strategy to Ignore Existing Regulations
The recession caused by COVID-19 will sink incomes and, if historical trends hold, may spur more people to return to school when they are out of work and opportunity costs are lower (though this effect may be delayed, given the unique challenges of the pandemic). With families now having fewer resources to pay for school, and colleges likely facing state funding cuts—particularly if Congress does not step in—and other significant losses in revenue, more students than ever may have no choice but to turn to debt to finance their education.
In this context, a crop of lenders are offering a different type of private student loan, called an income-share agreement (ISA), and marketing themselves as an alternative to debt. Similar to historical pushes behind “novel” products in the small-dollar lending space, the ISA industry is calling for new regulations that would define ISAs outside of existing consumer law and regulation. But this familiar call in the small-dollar lending space has begun to run into the reality that many state regulators seem to have no problem applying current state laws regulating credit to their products. This, in turn, means that we can expect the pursuit of the oft-utilized strategy of calling for new regulations will intensify.
Background on ISA Loans
ISA loans allow borrowers to pay back the principal based on a share of their income after they leave school. Although terms vary, most ISAs have a minimum income threshold, above which they require repayment calculated as a percentage of income (and below which no payment is due); a cap on the total amount that a borrower must repay, usually set as a multiple of the original amount borrowed; and a timeframe over which the borrower is required to repay. The design provides some income protections, but it is the details in these terms that really drive whether the loan will be more costly or less costly than other types of private student loans.
The ISA industry loudly claims that these products are “not loans,” but rather a novel financing mechanism. However, such claims have been made before in consumer finance particularly with products that rely on future wages for repayment, and when lenders wish to avoid usury interest rate caps stated in law and other consumer protections.
The Old Claims of “It’s Not a Loan”
Small-dollar lenders have, throughout history, argued that their particular form of credit was not a loan, and thus not covered by existing laws; at the same time, these lenders would fight for new regulations and legislation that would allow them to securely sidestep usury caps and to access the future wages of lendees as directly as possible—just like today’s ISA loan providers.
For these “salary buyers” (essentially, loan sharks) of the early 1900s, this meant that when trying to avoid a charge of usury, a lender would claim that a transaction was not a loan but a salary purchase, or a “chose in action”—the borrower’s legal right to use his wages. The claim by lenders was that the borrower was selling intangible property rights.1 Salary buyers would also maneuver questionable usage of jurisdiction to claim that loans originated in states with fewer usury restrictions, and also obtain a “wage assignment,” meaning that the lender could go directly to the employer to obtain repayment (much like today’s ISA contracts that require automatic payment withdrawal from approved bank accounts). When those practices were challenged, industry focused on building a new regulatory framework to legitimize its products.2
A few decades later, the strategy became a pattern. When purchasing household items on credit grew in popularity through the mid-century, installment loan providers avoided usury caps for many years by hiding under the “time–price” doctrine, which stated that the difference between the cash amount provided the borrower and the price of an item sold on “time” was not interest on a loan.3 Installment loan providers in the retail industry similarly often tried to rely on wage assignments, even if they had the option to repossess the chattel. When courts began to question the time–price doctrine and states began cracking down on these loans, it spurred lenders’ efforts to legitimize their products through state retail installment sales acts that allowed them to avoid existing, general usury caps.4 (Some of those laws were also later weakened even further over time.)
Another variation on this theme was rent-to-own products, which lenders also claimed were exempt from state credit and usury laws as well as federal laws. Rent-to-own lenders attempted to rename their loans as leases. Ultimately, a series of court cases with less than favorable results once again spurred lenders to make efforts to secure protective legislation;5 today, nearly every state has an industry-crafted law to remove consumer protections from applying to the rent-to-own industry, allowing high fees and even exposing consumers who cannot make payments (primarily already vulnerable consumers) to criminal penalties.
Yet another form of this ruse existed in the “deferred presentment” offerings at check cashing stores that gained steam in the 1980s, as lenders also claimed not-a-loan status for their products—which became harder to argue when they became known as payday loans.6 In the 1990s, lobbyists for the industry got to work (successfully) building safe harbors that, amongst other things, exempted products from usury caps, for their payday loan products in states across the country.7
As federal and state efforts to regulate ISAs move forward, this history is instructive: the push for new regulation in small-dollar lending space played out again and again, as the industry made the case that their new product was inherently different, and, buoyed by fear of bad court precedent or enforcement of existing laws, pushed for industry-friendly legal reform looking for greater legitimacy and protection.
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Regulators Weigh In on ISAs
Like their historical counterparts in small-dollar lending, the ISA loan industry has, for several years, attempted to carve out a new regulatory structure for these loans, claiming that their products are not loans and not debt. Doing so provides an avenue to remove existing credit restrictions, and, in particular, would extricate these products from the age-old profit restriction: usury caps. Industry-backed federal bills in Congress include a preemption of state usury laws for ISAs, and legislators in about a half dozen states have either proposed state-backed ISA products, or filed bills to create a new regulatory structure for ISA loans in their respective states. Legislators in Washington, California, and Pennsylvania have bills that create such structures. (No proposed new structure has gained traction.) But for those interested in consumer protection, such new frameworks may simply be unnecessary.
In fact, those charged with interpreting existing laws are taking issue with the industry’s stance; many state regulators have come to the opposite conclusion. In Iowa, regulators clearly stated not only that ISAs are still debt, but also that these products are “regulated by the Iowa Consumer Credit Code, and the terms of most ISAs would violate the law’s limits on interest rates, late fees, grace periods, and more, if they were offered to Iowa students.” In Washington, the state financial aid agency clarified that ISAs are a student loan product. And at a recent conference, Oregon attorney general Ellen Rosenblum called the claim that ISAs are not credit or debt, and thus should not be subject to typical consumer protections, “a red flag for regulators and law enforcement officials.”8 At the same conference, Pennsylvania’s senior deputy attorney general Nick Smyth stated that, while his office heard all the time from businesses trying to argue that their particular financial product is not covered by existing laws, “these are clearly credit products.”9
In California, as a part of a number of other causes of action, the state’s Bureau of Private Postsecondary Education deemed the Holberton school out of compliance for offering a “note, instrument, or other evidence of indebtedness” (an ISA) without licensure; the state attorney general has now brought an action on the agency’s behalf to halt operations. The agency is similarly engaging in oversight of Lambda School’s ISA.
Meanwhile, although the Trump administration has done nothing to protect ISA borrowers, a more consumer-friendly administration would clearly have the ability to do so. For example, last month, former CFPB regulators published an analysis refuting industry lawyer analysis and detailing some of the ways that federal laws already apply to these products.10
Adding New Borrower Protections?
Although almost all currently proposed legislation would remove consumer credit protections, there is one notable exception that builds new parameters within an existing regulatory framework—a new bill in Illinois. Near the end of 2019, the Illinois governor signed the Student Investment Account Act into law, allocating up to $1.5 billion to the state treasurer for the purpose of entering eligible participants into ISA programs and facilitating arrangements between participants and eligible ISA providers. Perhaps as a response to consumer protection concerns raised by the bill, this year, the Illinois House and Senate put forth a proposal to amend the Consumer Installment Loan Act to require that ISA loan providers be regulated as any other consumer installment lender, but with additional specific requirements: that ISA providers disclose terms and the effective APR under specified scenarios; that payments may not exceed 5 percent of a borrower’s qualified income, and the term may not exceed sixty months; that total payments must not exceed 1.1 times the amount loaned; and that the loan itself cannot exceed $5,000.11
The Illinois bill also requires that a borrower exhaust all sources of federal student loans and state grants for which the borrower is directly eligible before entering into the ISA. Lastly, the bill provides that an ISA provider must have readily accessible methods for consumers to submit a request for assistance to the provider, and for the borrower to escalate any request for assistance. The bill hasn’t left committee, so its passage isn’t imminent. However, it provides an notable exception to the overall trend of efforts toward deregulation that most other state bills have proposed.
Looking Forward
Regulators interested in protecting consumers are not clamoring for a new framework for ISAs—credit and student loan protections are being applied. It is possible that new legislation could add protections to these products and retain existing protections of relevant consumer credit laws such as a state’s installment loan framework, but the history of small-dollar lending regulation shows us that industry calls may lead to fewer protections instead.
Notes