College tuition is high, but degrees are still worth it. Debt is growing, but the largest debts are held by people with the highest income. So what’s the problem? The really troubling trend is the growing risk associated with investing in higher education.
Paying for college: A riskier investment
Historically, making a bad investment in higher education was not a catastrophe. Wasting tuition dollars on a degree that didn’t pay off was like buying a car that turned out to be a lemon. There were financial consequences, but they weren’t ruinous. That has changed. The high price tag of higher education means that investing in a college degree means putting all (or at least many) of your eggs in one basket. Degrees still pay large dividends for the typical student, but there are many who will sink dollars into a degree that will see little or no return.
Insurance against downside risk
What can be done? The main response must be to help students to insure themselves against bad outcomes. Income-driven repayment plans, which have been expanded in the past few years, help students who use federal loans. But students who take on private loans to supplement federal borrowing are not protected in the same way. Borrowers who use private loans to finance their education are in the vulnerable position of investing large amounts of their wealth in a single, risky asset (i.e. their education). (Recent work from the Hamilton Project and Brookings Papers on Economic Activity show how widely the returns to college can vary.)
A private sector solution: Income-sharing
Until now, tools for mitigating this risk have not been widely available. But that might soon change. This summer, Purdue University announced that they will begin making Income Share Agreements (ISA) available to their students, perhaps as soon as this spring. There is also growing congressional interest in legislation to create a legal and regulatory framework to support a market for ISAs.
Income Share Agreements are an innovative tool that will, as I have argued elsewhere, allow students to finance college by selling “shares” in their future earnings. Graduates pay back in proportion to the pecuniary value they get from their degree. If the degree proves worthless, the students will pay little or nothing. If the degree is immensely valuable, then the students will pay back a lot. Either way, the payments are, by construction, affordable.
Private education loans put borrowers on a sharp financial hook, whether they can afford it or not. These loans are difficult to discharge in bankruptcy, making a risky situation even riskier. The typical borrower will do just fine repaying their private loans; but the borrower who gets a raw deal from their education will face serious consequences. As always, the devil is in the details. But with careful implementation, Income Share Agreements have the potential to patch this hole in the safety net for students investing in higher education.
Up next: Susan Dynarski on income-contingent loans.