INVESTMENTS: Purdue University’s new student loan program allows for individuals to invest in a students education, to be payed back at an agreed upon rate.
By Payton Alexander | Watchdog Arena
An innovative model of tuition financing from Purdue University in Indiana is poised to disrupt the student loan industry, solve the debt crisis, and open the possibility of higher education and well-paid careers to millions.
Beginning in 2016, University President Mitch Daniels wants to allow private investors to invest in the success of Purdue students using a new financial model: Income Share Agreements (ISA).
ISAs allow private investors to buy shares of a students future income for a fixed period of time in exchange for covering the cost of tuition an idea that has the potential revolutionize the student loan industry. This idea is not new.
Economist Milton Friedman first proposed the concept in 1954, likening the model to an equity investment where investors could buy shares in an individuals earning prospects in exchange for funding their training. Lenders would profit from successful individuals whose payments exceeded the amount paid for their tuition. This would balance out failed investments and keep the lender compensated. Because there is no principal balance or interest, payments adjust with the students income over the life of the contract at a fixed rate that makes them equally affordable throughout.
Students today are graduating from college with more loan debt than at any other point in the history of the United States. 43 million indebted students, as well as their families, are now shouldered with a financial burden approaching $1.2 trillion $1 trillion of which is comprised of federal student loans, with the total averaging roughly $27,000 per student. Many are struggling to pay back expensive loans taken out for low-paying college degrees, and some worry the debt may not be payable at all.
However, this crisis may be on the verge of becoming obsolete. At Purdue University, President Mitch Daniels plans to offer ISA plans to students beginning in the spring of next year.
This no-debt, low-risk option is another way we can help keep our land-grant school within financial reach of all qualified students, he explains in a press release. And Im convinced that those who support the education of a student at Purdue are making a very sound investment.
Though the idea has been around for over 50 years, and has performed relatively well in other countries, putting it into practice has proven difficult. Burdensome regulations, as well as a lack of legal clarity, have held back innovation in this direction for decades.
Upstart, a startup lender based in California, recently attempted to offer ISAs to their customers but were forced to suspend the service, citing regulatory obstacles. Fortunately, legislators from Indiana are pushing a bill in Congress intended to resolve these issues and pave the way for the widespread adoption of ISAs.
The class of 2015 will graduate with the most loan debt in United States history, said Congressman Young (R-IN). Many fear that student loan debt will be the next bubble to burst yet not enough is being done to address the affordability problem. This bill is the culmination of a years-long effort working with universities like Purdue, on a real market-driven solution thats not only good for students, but good for American taxpayers whose tax dollars arent involved and at risk.
While some have criticized the idea as a modern form of indentured servitude, Purdue University remains optimistic.
From the student’s standpoint, ISAs assure a manageable payback amount, never more than the agreed portion of their incomes, writes Mitch Daniels in an op-ed for the Chicago Tribune. Best of all, they shift the risk of career shortcomings from student to investor: If the graduate earns less than expected, it is the investors who are disappointed
According to a report by the Center on Higher Education Reform at the American Enterprise Institute, ISA investors will have an incentive to offer the best terms for degree programs that are expected to be of the highest value because they only turn a profit if the student is successful.
This process gives students strong signals about which programs and fields are most likely to help them be successful, the report explains. It would also help stem tuition inflation and improve the efficiency of the higher education system by rewarding high-quality, low-cost programs.
The student debt crisis is worsening, and calls for bailouts, federal subsidies, and tighter regulations are growing louder and louder. Instead of solving the debt problem, these solutions merely shift the burden of debt to the taxpayer. As more and more students realize their debts are not payable, innovative alternatives such as this one from Purdue will become more attractive.
These types of market responses to inefficient practices are the core drivers of creative destruction, and the student loan industry is heading for a serious shakeup. With so many students struggling under the burden of student debt, policy makers should be prepared to embrace it.
This article was written by a contributor of Watchdog Arena, Franklin Centers network of writers, bloggers, and citizen journalists.