A Debt-Free Alternative to Student Loans
With Americans owing more than $1.3 trillion in federal student-loan debt, some places are offering students an alternative: Pay us nothing up front, but give us a percentage of your future income. The government should encourage the spread of this innovation -- with regulations that limit its risks.
Similar to student loans, income-share agreements require students who receive financial aid to make scheduled payments after they leave school. But unlike traditional loan recipients, these former students don't pay interest and aren't locked into servicing debt indefinitely. Instead, they have agreed to pay lenders a share of their future earnings over a fixed period, with the exact percentage dependent on their major, profession and starting salary.
These agreements also differ from income-based repayment plans, under which payments are capped at 10 percent of a former student's income. This is an existing program that should be expanded, but it is still a government loan. Income-share agreements do not require public money -- and thus do not add to the public debt.
A small but growing number of colleges and trade schools have introduced these agreements to help students cover tuition and fees. The upside for students is the protection from being saddled with unaffordable debt, should they end up unemployed or in low-paying careers. Students who enter high-paying professions, on the other hand, may pay back more than the initial subsidy they receive -- which is what makes such agreements appealing to investors. The focus on future earnings also gives schools the incentive to teach students useful skills.
Most important, as noted, these agreements don't put taxpayer money at risk -- a feature that's particularly compelling given what the federal government expects to lose on its student-loan portfolio. But Congress and the administration need to establish rules that provide clarity to potential investors and protect students from abuses.
Two bills in Congress with bipartisan backing offer a promising start. They would cap the percentage of income that recipients pay, establish a minimum income threshold for payment and limit the lengths of contracts. The legislation directs federal regulators to draw up model disclosure forms for lenders to provide students. Lawmakers should consider additional rules to deter unscrupulous lenders from discriminating against low-income students and those from families with low credit ratings.
It's unlikely that traditional student loans will be replaced by income-share agreements anytime soon, if ever. But at least Congress can help them become a viable option.
--Editors: Romesh Ratnesar, Michael Newman.
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