Federal Loans and ISAs

The U.S. Department of Education is poised to create an experimental program through which a limited number of colleges would take on students’ federal loan debt, with students then repaying the institution for the loan balance, potentially based on their future earnings.

As a result, the experiment would enable federal loans to be paid off through a form of income-share agreement, where students agree to pay a certain percentage of their future income over a set period of time in exchange for funding of their educational program expenses.

The idea is sure to be controversial. Some experts already have argued that the experiment could be illegal and would pervert the mission of the student loan program while threatening borrower protection.

Others, however, said the experiment could provide lessons about creative ways to finance higher education.

Details remain skimpy on the federal loan ISA experiment, which has yet to be officially announced. Federal officials discussed the idea at a financial aid conference earlier this month, and Inside Higher Ed obtained a short department document about it.

The department can waive federal aid rules to conduct limited experiments under its experimental sites initiative. The goal with such projects is to test ideas in a controllable scope and to use what’s learned to inform federal aid policy. However, such experiments during the last two or three administrations tend not to yield enough usable data or other evidence to adequately contribute to policy debates, some experts have argued.

A small but growing number of colleges and other postsecondary providers is trying income-share agreements. Purdue University and the University of Utah both offer ISAs, as do several small private colleges and boot-camp providers, among others.

(A recent paper from the Consumer Finance Institute of the Federal Reserve Bank of Philadelphia analyzes the nascent marketplace for income-share agreements in postsecondary education.)

The concept is increasingly en vogue in higher education policy circles and has some appeal across party lines, in part because it creates an arrangement that shares some attributes and intentions with income-driven repayment plans for federal loans.

Critics, including Senator Elizabeth Warren, say ISAs are just another form of private loan.

Diane Auer Jones, the principal deputy under secretary and top higher education official at the department, previously has expressed interest in federal funds being used in ISAs.

The Trump administration partially made the case for the experiment by citing another increasingly popular notion about how to hold higher education accountable: requiring colleges to have some skin in the game with student loan debt.

“The department believes that by providing students with more higher education financing options, institutions can take a larger risk position in student outcomes in a proactive way,” the document describing the experiment said, “and more carefully align pricing structures with projected student earnings to ensure the highest return on investment for students.”

Tuition discounts and scholarships allow colleges to redistribute the cost of attendance among a larger group of students, the department said. And those institutional grants also can mean that a college is taking a “risk position” on a student’s decision to enroll there.

Likewise, alternative college financing options such as ISAs can help institutions “enhance a student’s educational return on investment,” the department said, and “reduce the fear of daunting repayment obligations for students who are debt averse.”

Colleges tend to offer income-share agreements, typically with assistance managing those programs by outside companies or nonprofit groups, often only after a student declares a major and solely as a supplement to federal borrowing.

“This means that the student could be left with both a student loan repayment obligation and an alternative financing obligation,” the department said. “Having to make both payments could undermine the benefits otherwise provided by the alternative financing, including earnings-based repayment programs.”

Colleges that participate in the possible experiment would be permitted (at the request of the student loan borrower) to assume the repayment obligation for a student’s federal loans. In return, the borrower would repay the balance to the institution based on a predetermined methodology.

“Under such a plan, an institution has skin in the game because it is financially tied to the borrower’s return on their educational investment,” the department said. “Taxpayers will also be protected because an institution is more likely to meet their repayment obligations than a student who may struggle to meet multiple debt obligations and pay basic living expenses.”

Creating Risks?

Students would have the choice of participating in such an experiment, and could instead choose federal direct loans rather than the institutional financing option.

Even so, the experiment would create plenty of risk, said Clare McCann, deputy director for federal higher education policy with New America's education policy program.

McCann and four of her colleagues (including experts from the Century Foundation and the Institute for College Access and Success) co-wrote a blog post challenging the experiment based on its likely parameters.

“The department plans to oversee a perversion of the federal loan program in which, essentially, federal loan dollars will be used to fund private education loans,” they wrote. “Naturally, this announcement raised huge questions.”

The experiment would rely on two primary waivers from federal loan laws.

First, it would allow colleges to limit student borrowing beyond the currently permitted case-by-case basis, including limits based on their course of study or likely earnings. This waiver could be used on its own under the experiment, the department said, or as part of an institutional financing option.

In addition, the department would permit colleges to repay a loan on behalf of their students. This is currently not allowed because colleges could help students repay loans to help distort their federal loan default rate.

Colleges also would be allowed to raise private capital to supplement the federal dollars under the experiment.

McCann and her colleagues questioned whether the experiment would exceed what is possible under an experimental site, going outside of congressional intent for the program. Specifically, such experiments under federal law may not waive award rules for grants or loans, they said, including apparently changing the terms of the loan, which would be the case in this experiment.

The possible experiment also raises the risk of discrimination, McCann and her colleagues wrote. Discriminatory impacts are likely, they said, because academic program choices tend to be heavily segregated. And they cited arguments that ISAs could deepen equity gaps and expressed concern about whether the Trump administration would prevent colleges from offering unreasonable repayment terms.

Many questions about the experiment remain outstanding, McCann and her colleagues said. But they said one thing is clear: “Borrowers who sign these income-share agreements will not be getting the deal promised to them under the direct loan program.”

Weighing Possible Benefits

Other experts had mixed reactions.

Experiments can teach financial aid experts what works and what possibilities exist for further work, research and investment, said Alison Griffin, senior vice president and head of the higher education practice at Whiteboard Advisors.

“The department’s recent announcement of an experimental site which will allow education providers to maximize investments on behalf of student aid may further illuminate how an institutional financial commitment has the potential to be transformative in how students can finance their postsecondary education,” she said via email.

Griffin said it remains to be seen how the results of this experiment could inform the growing interest in income-share agreements.

“Right now, the most important work that Congress and the administration could do on behalf of the ISA space is to ensure consumers are protected by establishing a legal and regulatory framework,” she said.

Beth Akers is a senior fellow at the Manhattan Institute who has written about ISAs. She said she has mixed feelings about the experiment.

While she is optimistic about ISAs being able to help solve perpetual challenges in higher education like tuition inflation, financial risk and asymmetry of information, Akers is concerned about the structure of the designed intervention.

“I’d prefer to see the administration work to incorporate some of the advantages of income-share agreements into the existing loan program to make it more effective,” she said in an email. “For example, collecting repayment for student loans through an income-based plan borrows from the principles of income-share agreements. Shifting to a system that collects repayment that way and doesn’t require borrowers to enroll in confusing repayment plans would be an effective way to introduce innovation into federal lending without adding more complexity.”

In addition, Akers said she was concerned about the department’s ability to effectively oversee the experiment.

“Poor implementation could leave students worse off than they would have been otherwise,” she said.