What’s the market read on Karla Comacho? Not the potential value of the Frida Kahlo-like portraits she creates, but the potential return on her.
Is this studio art major at California State University, Long Beach a good risk? Some deep-pocketed Wall Street-savvy investors think so.
They’re also bullish on Ulises Serrano, a University of California, Berkeley senior and son of a migrant worker. Ditto nine other low-income California college students to whom they’ve fronted about $15,000 each in exchange for a piece of their future incomes.
Treating students like stocks is the idea behind an emerging kind of financial aid called income-share agreements, or ISAs. Under the concept, students get money from investors and they agree to pay a percentage of their future income to those investors over a set period of time.
Given worrisome student loan debt — now $1.23 trillion — ISAs offer a new spin on college financing. Or new-ish. They have been used for years in Latin America. In the United States, they have long fascinated politicians and policy wonks, but with no record of returns or clarifying legislation, they have failed to attract investors.
That may be about to change. In what would be the first big test here, Purdue University will decide next month if it will go ahead with a plan that could have 100 to 200 students adding ISAs to their financial aid packages this fall. There are no final details yet of the pilot “Back a Boiler” program, named after the school’s Boilermakers nickname (the cheeky original name, “Bet on a Boiler,” has been changed). But students who choose to accept ISAs could get up to $10,000 or $15,000 each for tuition, room, board, and expenses, in exchange for a portion of their postgraduate earnings.
“The real attraction to me is they might be a fairer and better option for some subset of our students,” said Mitch Daniels, Purdue’s president, who last spring spurred buzz by raising ISAs in testimony before a congressional committee.
What ISAs offer is insurance. If students earn less than, say $20,000 a year, they pay nothing. And when the repayment period, which may run 10-20 years and is set at the outset, ends, they walk away. That’s a buffer against problems borrowers face with loans, which continue to compound even under income-based repayments or deferments.
The downside? If students make a lot of money, they end up paying out more than was invested in them, and more than a loan would have cost. But then the investors win.
The Purdue pilot would be small, likely seeded with up to about $3 million from the Purdue Research Foundation. But Brian E. Edelman, the foundation’s chief financial officer, hopes it goes big. “We would love for income-share agreements to scale at the national level,” he said.
That would take billions of dollars, pools of students, and investors who see a worthy opportunity. Some already do.
“That’s not a bad piece of paper to own,” mused Casey Jennings, a cofounder of 13th Avenue Funding, a California-based not-for-profit that is advising Purdue: “’I own GE, Ford, Apple, and yeah, I have this weird piece of paper that’s students at Purdue.’”
It’s 13th Avenue that has invested in those California students, as part of a small pilot of its own that’s more philanthropic than profit-motivated.
“I saw that we have a whole bunch of students who don’t go to college because they don’t want to borrow,” said Jennings, a former managing partner at GE Capital who with co-investors Robert M. Whelan, Jr. and Ed Lowry put up $165,000 to see if ISAs could help low-income students earn degrees.
The team offered ISAs in 2012 to four students at the two-year Allan Hancock College in Santa Maria, California, who planned to go on to earn bachelor’s degrees. The next year, 24 students applied; 13th Avenue funded seven.
The students get up to $15,000 each, and agree to pay back up to 5 percent of their income for up to 15 years; when the total original outlay for the entire cohort of students has been recouped, everyone stops paying.
There’s still individual risk. “On a pool basis the interest rate will look like 0 percent,” because as a group students pay to reseed the original investment, said Jennings. Because recipients’ incomes vary, “some will pay a lot; some will pay less.”
Most surprising to Lowry, who disperses the money when it’s needed, is how critical cash is to these students — for rent, for car repairs, to replace crashed laptops. “It shocked all of us,” he said. “We thought all they needed was money for tuition.”
A few years ago, Corynn Wolfe found the tires slashed on the black Mazda she used to get to class at California Polytechnic State University in San Luis Obispo.
“I had $115 in my account and that was my money for the next two weeks,” said Wolfe, 25, a single mother of a 6-year-old. “I want to go to school to make a better life, but I can’t do that if my daughter doesn’t have daycare or my car isn’t working or my rent isn’t paid.” She contacted Lowry and got $275 to replace the tires.
Wolfe, who took out $20,000 in federal loans and got another $15,000 from her ISA, graduated on December 12, a Friday. After a grand party — her aunt made orange chicken, chow mein and fried wontons — she started work on the following Monday making $42,000 as a human resource manager for a home health agency.
“Without their help,” she said, of 13th Avenue, “I would not have been able to finish the way I did.”
Wolfe hasn’t started her repayments yet, but five percent of her income is $2,100 a year, or $31,500 over 15 years. That’s more than double what was invested in her.
If group members earn higher incomes the original investment is reseeded faster, she said, and “If enough of us do well, we’ll pay back less.”
If she pays more? “I feel better knowing someone else can have the same chance.”
Other students in the 13th Avenue experiment agreed, from Engels Garcia, now a San Jose State University graduate looking at law school, to Serrano, the Berkeley senior whose father picked strawberries, broccoli and cauliflower.
“At the end of the day, I don’t mind,” Serrano said.
Comacho, the art student, sought the ISA because loans make her nervous. The youngest of six from what she describes as “an agriculture-slash-farmer” background, she has no financial safety net. She’s watched “friends who graduated with $35,000 in debt and they can’t find a job.” Meanwhile, she said, “interest is adding up.”
Still, the idea of investors wagering on students is a tough image to get used to, said Ted Malone, director of financial aid at Purdue, who first pictured ISAs as being peddled by hucksters “walking up to our students and saying, ‘Buddy, I got a deal for you,’” he recalled. “I was skeptical.”
But Malone also worries about students in what he calls “the doughnut.” Those with family incomes of $50,000 to $125,000 can’t get grants but can’t write big checks for $10,000 either, he said. By the time they’re seniors, some have exhausted their allowance of low-interest loans. “What they tend to do is put [the rest] on a credit card or work astronomical hours,” Malone said. Some take expensive private loans. Some drop out.
Students who have seen parents lose low-wage jobs may find comfort in the security that ISAs offer — that the obligation is suspended when troubles arise that lower their income below the repayment threshold. That’s especially true for those who choose careers with unpredictable payoffs.
“The high-income fields are not necessarily the ones this will attract,” said Miguel Palacios, a finance professor at Vanderbilt who co-founded a company called Lumni that has offered ISA’s since 2002 in Latin America where students have few funding options and is now beginning to invest in the United States. “It will not be for MBAs or doctors or dentists. Those fields have relatively safe and high future income paths.”
For ISAs to be viable here, Palacios said, there needs to be expected returns of at least 6 or 7 percent, plus laws or court rulings that remove uncertainty for investors.
Without those, ISAs have so far made few inroads. Lumni, for example, has funded 7,700 students in Latin America using ISAs, but only 27 in the United States.
Also, unlike in Latin America, where Lumni’s average ISA of $5,197 covers most college costs, Palacios predicted, “in the U.S., ISAs will likely be gap funding.”
Until they become more widely known, it won’t be possible to see if ISAs will help those needing a leg up, or prey on them.
What’s clear is that high-cost loans are a serious and escalating burden.
Last year, Malone said, 3,961 Purdue undergrads took out $63.3 million in private and Parent PLUS loans. Median private loan debt for the university’s Class of 2015 was $14,884 for Indiana residents and $35,000 for non-residents; median PLUS debt, with which their parents are often stuck, was $22,690 and $71,569. And those amounts don’t include subsidized and unsubsidized federal loans.
Purdue ISAs will have the goal of helping to reduce these loan debts, said Michael Stynes, executive director of the Jain Family Institute, who is also advising Purdue. Part of that, he said, “will be doing the math correctly.”
For some critics, however, the math is exactly the problem. Purdue will lower student risk by capping the cost of the ISA at what a loan would cost (Malone said an online calculator will let students judge). But unlike loans with terms tied to creditworthiness, ISAs predict incomes. Which is where it gets touchy: How do you price a student?
To figure that out, Purdue has contracted with Vemo Education, a Reston, Virginia, company started last year.
“We don’t price people individually; we price across pools,” said Tonio DeSorrento, the company’s CEO. “If you had one group of people in a subgroup who will earn $60,000 and another earning $40,000,” he said, “one will pay a lower percentage of income with the aim of getting the same dollar-on-dollar return.”
Translation: If risk pools are constructed by major, engineers will pay a lower percentage of their income than theater majors because they’re expected to earn more.
Such distinctions are a reality, said Daniels, the Purdue president. “The minute they walk out the door of this university they will be treated differently.”
But this framing pokes at tensions over the purpose of college and puts dollar values on majors, said David Sanders, vice chair of the Purdue Faculty Senate and professor of biological sciences.
“We are telling people that if you go into the humanities it will cost you more than your fellow students,” Sanders said. Students, he said, “should be able to come to Purdue and pursue their own interests and their own dreams.”
So are students ready for ISAs? Just before Halloween, Sheriff Almakki, a member of Purdue’s student government, sat in a second floor conference room with a view of the recreation center as Purdue officials and advisers, including Jennings and Lowry from 13th Avenue, pitched ISAs to a focus group. Almakki, a double major in biochemistry and math, said he prefers to know costs up front. “With the income percentage,” he said, “you don’t know how much you are losing out on.”
But more than the dollars, he struggles with the concept: “The concern I had then and the concern I have now is that we are making higher education into more and more of a business model,” Almakki said.
That doesn’t faze fellow student-government member Miranda Campbell, a junior majoring in theater design and production.
“Students do need more options,” Campbell said. But ISAs “are a short-term Band-aide solution.”
Campbell said she wants leaders tackling what she said is the far more critical issue:
“I am in favor,” she said, “of finding a way of having higher education not cost so much.”