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Back in 1964, the economist Milton Friedman proposed a radical plan for funding a person's education. The idea was that people would sell "stock" in themselves in the form of a share of their future earnings. These shares would be purchased by investors and used by the borrowers to fund their education and training. The idea is that this stock would be profitable so long as the ROI (return on investment) on the degree exceeded the market rate of interest.
As outrageous as this concept might seem, now 60 years later, this is actually beginning to take shape in the form of income-share agreements (ISAs). These are contracts that permit investors to provide money up front to individuals in exchange for a percentage of their future earnings. This idea has been gaining in popularity due mostly because of the nation's huge student debt problem. There are companies such as Upstart, Pave and Lumni that have adopted this model to help talented people get funding for anything from a business venture to their educations.
Sen. Marco Rubio and Rep. Tom Petri recently introduced legislation to define the terms of these investment vehicles and broaden their use. This act is formally titled the Investing in Student Success Act. It is designed to provide a legal framework for ISA's so that people seeking funds and investors would both know exactly what they were signing up for. Among the other details specified in this act are the minimum lengths a contract can last and how much a person seeking funds can owe (15%). The bill also formalizes the fact that an income share agreement is not a loan, which is a question that companies such as Pave and Upstart have been grappling with in trying to define their contracts.
Could help all students
Rep. Petri, who is a member of the House Education and the Workforce Committee, has said that these plans should help all students get what they need in the way of financing, even students from disadvantaged backgrounds. The basic concept behind these ISAs is that they would make life easier for the borrower because his or her debt would be repaid in proportion to their earnings. For example, if a person received an ISA contract to pay back 6% of their earnings over a five-year period, their monthly payments would vary depending on his or her salary at any given time.
Won't solve every problem
It's not clear whether this program will actually help give people with disadvantaged backgrounds better access to financing for their educations. The problem with both Upstart and Pave is that they are dependent on algorithms that often result in investments in people who already have well-decorated resumes and top-tier educations.
Because it's not a loan
What's true is that an ISA, when compared to a traditional loan, does a better job of aligning the incentives of the two parties – the borrower and the lender. This is because the investor sees returns that are directly tied to how well the student or borrower – their investment – performs. Lenders who invest in a student that gets a good education and goes on to a high-paying job will get back proportionately more than a student who struggles in the labor market. Since investors can't force borrowers to do anything – because an ISA is not a loan – it's in their best interest to help people on their way to success.