Over the past few years, a handful of traditional colleges and coding bootcamps, in partnership with finance companies, have reignited interest in a different type of private student loan, called an income-share agreement (ISA loan). This type of loan provides students with funds to cover a portion of their educational costs, but rather than require students to repay a set borrowed amount, it has them make payments based on a percentage of their annual income for a fixed number of years.
Companies offering ISA loans tout this financing option as an inherently different, more affordable way to pay for college. However, most students already have the federal Direct Loan option that they enroll in to pay back based on their income, and that comes with other federal protections; ISA loans still create a debt to be repaid; and the terms and conditions ultimately determine how expensive the financing option will be.
The way that ISA loans terms are structured means a student’s total repayment amount can vary widely depending on which major they choose, opening the door for disparate impact on students according to gender, race, and ethnicity.
Moreover, the way that ISA loans’ terms are structured means a student’s total repayment amount can vary widely depending on which major they choose, opening the door for disparate impact on students according to gender, race, and ethnicity, and the way in which companies market ISA loans can mask overall costs of both the loan and program of study. A review of private ISA loan products already on the market and current industry practices foreshadow serious future challenges in protecting consumers from unfair, discriminatory, or even predatory behavior—particularly if current deregulation efforts succeed.
ISA loans are in many ways similar to other private loans available to college students in that they are driven by investors. While in some cases, philanthropic organizations help seed ISA loans—which means that the loan terms are not set entirely to maximize returns—in most cases, typical private investor-driven demands will determine the overall price of the loan. The backers of an ISA program can include traditional investors, investors putting their money into “human-backed securities,” and, in the case of for-profit schools (mostly coding boot camps), investors in the schools themselves, who see their investment in the school and in these loans as intertwined. These investor demands typically will be based on some analysis of the risk profile of participants (in this case, the risk profile will be assessed by projecting the amount they think participants, on aggregate, will earn after leaving college)—and the profit margin they think they can charge consumers.
Because the federal government’s Direct Loan program already offers income-driven repayment (IDR) options that have significant protections for low-income borrowers, have interest rates offered at lower rates than private investors would offer, and are available without a cosigner, schools have thus far been marketing private ISA loan products primarily for educational programs that do not currently qualify for federal loans, to people who do not qualify for federal loans, or to cover costs that exceed the federal Direct Loan dollars available to students. Industry observers, including think tanks, policymakers, and advocates, have warned that many lenders are trying to ignore existing federal and state lending laws, and that the repayment terms offered by these loans may raise costs for consumers, make the loan difficult to assess in comparison with other options, and incorporate discriminatory lending terms.
Particularly troubling is the fact that companies establishing and supporting new ISA loans have made the highly questionable assertion that federal consumer protection laws, such as the Equal Credit Opportunity Act (ECOA, which prohibits discriminatory lending), the Truth in Lending Act (TILA, guiding disclosures), and state usury caps (limiting how high interest rates can be), should not, or do not, apply to ISA loans. In fact, those companies should be worried about following such laws, and current industry practices show why those (and potentially additional) protections are important.
Private ISA Lending Terms May Have a Disparate Impact on Women and People of Color
Because private ISA loans allow students to opt-in to the product, the financing scheme holds the potential for adverse selection. In theory, an ISA plan available to students across an institution would utilize cross-subsidization; that is, students who graduate and go on to earn higher wages would pay more, to make up for the lower returns from people earning less. But in this model, a student expecting to earn a high salary may find a traditional loan to be more appealing, because in the long run, it would be cheaper. Without a corrective, ISA loan programs would run the risk of signing up mostly students who expect to earn lower salaries, greatly limiting their returns.
To solve for this adverse selection issue, some ISA loans charge projected higher-income earners a smaller percentage of their income to participate than they do for those they project will earn lower incomes. They base those projections off of the college major of the student. This design raises discriminatory lending questions, however. Because college major is highly stratified by race and gender, women could easily end up entering into contracts with worse terms and paying off higher levels of ISA debt than men, and students of color could easily end up with more ISA debt than white students. In other words, the ISA loan terms could result in a “disparate impact” based upon race and gender. This, in turn, raises questions as to whether those terms would violate ECOA (a risk acknowledged by a range of observers).
Because college major is highly stratified by race and gender, women could easily end up entering into contracts with worse terms and paying off higher levels of ISA debt than men, and students of color could easily end up with more ISA debt than white students.
This appears highly likely in the University of Utah’s ISA loan program, which offers different repayment term lengths by major. Different terms mean that students in Utah’s top three female-dominant fields in which ISA funding is available at the University of Utah would end up paying over $1,000 more to fund a $10,000 loan for their education as compared to those in the three fields most dominated by men; that is, it is highly likely that women are paying far more for these loans than men (see Table 1). These products likely also open the potential for disparate impact by race and ethnicity. In Utah, for example, the ISA loan is only even offered in majors where Hispanic students are underrepresented.
ISA Loan Terms for Top Three Majors for Women versus Men, University of Utah ISA Loan Program
||Percent Women Statewide
||Percent of Income and Length of Repayment (Utah ISA)
||Total Paid for $10,000 ISA Loan
||Percent Men Statewide
||Percent of Income and Length of Repayment (Utah ISA)
||Total Paid for $10,000 ISA loan
||2.85%, 127 months
||2.85%, 79 months
||2.85%, 127 months
||2.85%, 79 months
||2.85%, 98 months
||2.85%, 79 months
|Note: All of the University of Utah’s ISAs have an income rate of 2.85 percent. Length of repayment, however, varies by major. Major enrollment is based off of statewide data from the PUMS Census survey data and analyzed by the author, and are not specific to the University of Utah
ISA loan companies are, undoubtedly, nervous about the potential legal liability—so much so that they sought a carveout from some ECOA requirements in their most recent attempts to get Congress to limit consumer protection regulations from applying to the products; the Senate’s new bill, the ISA Student Protection Act, states that it will not be considered discrimination “to set the terms of a Qualified ISA or an income-share agreement . . . based on the earnings reasonably anticipated by the creditor with respect to any program of study, certificate program, degree program, or institutions of higher education where a Qualified ISA is offered.”
Current Practices Often Mask the Costs of ISAs Loans, and the Programs They Support
There are good reasons for being concerned about the way that ISA loan companies—and the schools that work with them—talk about the price of higher education programs, because it makes apples-to-apples price shopping difficult for consumers.
Rather than stating a tuition, coding boot camps, for example, often highlight the ISA payment terms and “maximum pay-off.” Discerning the actual tuition requires searching. (Just try finding the tuition for this engineering program.) And because investors in the school are often investing in the ultimate pay-off of the ISA loan, not just in the educational program, in some cases, that “tuition” doesn’t really exist as a set number—it is simply the maximum loan pay-off amount.
Workforce development programs are starting to express interest in these loans, and raise similar questions about overall price. The new University of California–San Diego (UCSD) Extension and San Diego Workforce Partnership collaboration offers ISA loans for a number of certificate programs. The Workforce Partnership contracts out to UCSD to provide the coursework, paying them a fee of $4,500 per student. The contract stipulates that the Workforce Partnership would provide wraparound services, and sets the total “ISA value” at $6,500. It is unclear what an “ISA value” means, and the contract offers no guarantees to UCSD of the loan terms being offered to their students.
In fact, the ISA loan terms currently being offered to potential UCSD Extension–Workforce Partnership students require payment rates of 6–8 percent of income, with repayment length terms of 36–60 months, and a maximum total payment of $11,700. Taking a sample certificate program—Java Programming—and applying the most generous terms they have available (6 percent over 36 months), someone earning $40,000 after graduation would wind up paying $7,200 for the program. It turns out, however, that obtaining a certificate in programming from the UCSD Extension program without an ISA would cost between $2,875 and $3,475—as low as 40 percent of the minimum cost if the student were to enroll through the partnership’s ISA model. In traditional loan terms, to pay that base cost, the total payout of $7,200 over three years would be the equivalent of an APR of 55–75 percent for a person earning $40,000 (and paying off without pausing payments due to low income, which the plan does allow for). The terms of the underlying contract also mean that UCSD pockets more money, bringing in as much as $1,625 for each Java Programming certificate student they enroll through the ISA program rather than as a traditional direct enrollment (Only the in-person version of one of the four certificate programs being offered actually costs the $4,500 that UCSD receives from the partnership). None of these price differentials are readily apparent through marketing materials.
At times, companies and schools do provide easy-to-find comparative information to students, but the assumptions behind those comparisons raise questions
At times, companies and schools do provide easy-to-find comparative information to students, but the assumptions behind those comparisons raise questions. For example, the total cost of a $10,000 ISA loan for nursing degree at the University of Utah is portrayed as $14,944, requiring a repayment rate of 2.85 percent of income over 98 months. The comparison tool produced for students compares that option to a Parent PLUS Loan at $15,727. Yet the U.S. Department of Education projects that a $10,000 Parent PLUS loan would cost a total of $14,616. Although Parent PLUS loans go into repayment immediately after disbursement, the comparison tool assumes all parents will accrue capitalized interest by using both an in-school deferment and a six-month grace period. It is unclear why they make that assumption.
In another example, Purdue ISA loan calculator at times projects entry-level salaries for Purdue graduates far below actual Purdue survey data on the salaries of recent graduates—an assumption that makes the cost of the ISA loan appear cheaper. For example, the Purdue ISA loan website projections that a student studying elementary education can expect to earn $32,000 upon graduation; Purdue graduation data puts the median starting salary at $38,000. An assumption like this makes the total projected cost for a $10,000 ISA loan look about $3,000 cheaper than it actually is for a median earner. It is unclear why there is a discrepancy or which data source the calculator is using.
To be sure, not all salary projections in the calculator make Purdue ISA loans look cheaper, just as it is true that some Parent PLUS borrowers take deferments, and certainly not every student with an ISA loan would pay usurious interest rates. But these features highlight the critical importance of oversight to prevent confusing or misleading marketing—or worse, future predatory practices or terms. Instead, proponents of ISAs are attempting to exempt these ISA loans from usury caps, state “ability-to-pay” rules, and Truth in Lending Act protections.
These challenges also call into question one of the key upsides cited by ISA proponents: that because lender success will follow only from students’ income success, ISAs will bring a more market-driven approach to high-quality programs. In other words, the industry seems to be arguing that ISA loans available for bad programs offering low returns will wither because they won’t receive financial backing. In reality, if loan terms are difficult to assess, or if salary returns are unclear or misleading, ISA lenders can set rates so high that they will receive a return on that investment regardless of whether their financial product (and the program it purchased) is a good deal to the consumer.
Existing private ISA loans validate warnings that vendors of these products could charge high rates, include confusing terms, and could be more likely to increase the cost of education for women and people of color. Many ISA loans also present other serious consumer protection concerns not detailed here—mandatory arbitration provisions are common in ISA loans; protections for low-income borrowers available in federal loans are often far more generous than in ISA loans; some ISA loans have invasive contract terms that give private loan companies open access to consumer bank accounts. And, of course, the push toward ISA loans doesn’t solve the larger challenges fueling much of the interest in the growth of this industry: unacceptably high college costs and student debt burdens.
The author would like to thank Peter Granville for his work analyzing statewide Census data.