Income Share Agreements as Alternatives to Student Loans: An Interview with Kevin James, Founder and CEO of Better Future Forward
Image courtesy of Kevin James
Income share agreements (ISAs) do away with the traditional loan model—and according to Better Future Forward Founder and CEO, Kevin James, they could radically reform the way students finance higher education and create an opportunity for mission-driven investors to support a sustainable, scalable means to increasing economic mobility for low- and moderate-income kids.
What are ISAs, and how can they reshape the student loan market?
ISAs are a consumer finance tool that helps students access more affordable money for higher education. While traditional student loans require a student to repay a fixed amount of money, with an ISA, the student pays a percentage of their income for a set period after graduating, usually somewhere between 6 and 8 percent, and only once they are earning above a certain minimum income.
With ISAs, payment size is determined by the amount of money the student earns, ensuring that they are affordable and appropriate to the student’s post-graduation financial situation.
They are a pay-for-success financial product that allow students to go through school confident that the cost of their education is based on their success.
Supporters say ISAs not only offer more affordable financing but also transfer the credit risk—the likelihood that the student will be able to repay the money—from the student to the investors. How does this risk transfer happen and why is it an important shift in how we approach student loans?
Like a mortgage, traditional student loans assume the borrower will repay a fixed amount of money over a certain period, and if the borrower cannot afford to repay that amount in its entirety, they are still on the hook for the money and will somehow have to resolve the debt.
Because ISA repayment is based on a percentage of income, the payments may vary over time, increasing as income grows, and, if necessary, decreasing if income drops.
Consequently, the borrower never “owes” more than they can afford and isn’t at risk of ending up responsible for repaying a huge loan they can’t afford. The investors know they may get back more money than expected if the borrower’s income ends up higher than projected, or less if it ends up lower than expected, but either way, the investor doesn’t have a claim on any additional payments the way a traditional lender does.
This risk transfer removes a huge constraint for students. Students who know that they will graduate with a huge loan hanging over them may either be reluctant to pursue higher education or may be limited in what they can do after school because of the debt. By removing that barrier, more kids can pursue higher education and whatever goals they have after graduating, confident that the cost of their education won’t be an obstacle to their longer-term success in life.
Who are these investors?
They can be a mission investor, a philanthropy, a nonprofit, or an educational institution that wants to fund its own students. Right now, a lot of Better Future Forward’s capital comes from program-related investments from foundations.
While I think we will always be reliant on impact investors, over time, as we demonstrate that these students can succeed when provided with the supports and money they need, we can prove to capital providers that investments in ISAs not only perform but perform in a way that is both sustainable and scalable.
In addition to financing, Better Future Forward offers supportive services to students who use an ISA. What are those supports, why are they important, and are they a standard component of ISAs?
In each community where we offer ISAs, we partner with college access organizations. In Chicago, we offer ISAs to students involved in four college access organizations that work with low- and moderate-income students. Those organizations provide mentoring and coaching to the students, including helping them with FAFSA applications, assisting them to navigate financial aid, or working through social and emotional problems if those come up.
A lot of our students are the first in their family to go to college and may need a little bit of help to navigate what is inarguably a really complicated experience. I was lucky to have two parents who went to college and when I reflect on that, there were probably 25 points in college when I talked to them about something and they helped me through it. We want our students to have that same kind of support. Without the great work of our partner organizations, a lot of students would be left to fend for themselves.
These supports are not a standard part of ISAs, but they are a critical piece of our model because they are imperative to creating a holistic pathway to education for low- and moderate-income kids. The combination of affordable financing and supportive services means these kids can go to school knowing that they can afford it, will receive the support they need and can focus on their studies.
The services benefit investors, too. Investors want the kids to succeed. If we want to grow the market for ISAs, we can’t just give students money. We need to consider what will give them their best chance at being successful and then build a pathway that incorporates those elements.
For that reason, we also look at the outcomes of the schools themselves. A lot of our underwriting is built around how well students tend to do upon graduation from various areas of study at various institutions.
By considering school outcomes in the underwriting process, you’re minimizing the biases built into underwriting systems that require a minimum credit score, for example. Do you agree?
I do, actually. Sometimes people ask how we “pick” the students. We don’t really pick them. A philosophical principle of ours is broad access. We want higher education—and ISAs—to be accessible to every student who can benefit.
In Chicago, we simply require the student be making satisfactory progress at their institution, that they be a full-time student, and that they engage with one of our college access partners. While we do have adverse credit checks for something significant, like a bankruptcy, we don’t look at credit scores, and we are fine to fund students who don’t have a credit score. That creates a much more level playing field.
What research would help Better Future Forward to further progress its work?
We are always in need of data on the quality of school programs. Most of our data come from the Equality of Opportunity Project. But it would be great to have access to even more granular data, like earning by major at a particular school and then the earning profiles of low- to moderate-income students in those programs.
Another modeling question is adverse selection: to what degree are there issues with the pool of students that we expect to use an ISA versus the pool of students that end up using one? The financial stability of ISA programs depends on us being able to accurately model our student population.
Lastly, it would be great to better understand what supportive services our students need and what interventions are of value to students, particularly cost-effective ones. In some sense, they would pay for themselves because if they improve outcomes, that’s better for the student, and what’s better for the student is also better for the investors.