Transforming Higher Education Financing and the Emergence of Income Share Agreements as an Asset Class

Student debt has again soared to new levels. The temporary freeze on loan payments and the subsequent Supreme Court decision regarding the Biden Administration plan to forgive student debt have not only called into question how college education will be financed in the future, but the value of the education too.

As tuition continues to skyrocket (+1,245% since 1980), a college education has become an unaffordable luxury product. Student loans have long been the primary means of funding for aspiring college students, but they are burdened with high interest rates and inflexible repayment terms.

The Department of Education offers federal loans (direct subsidized and unsubsidized loans) to help pay for college but these loans are capped and cover only a quarter of the average cost of attending a private not-for-profit college. Instead, students must turn to gap financing such as Parent Plus, Grad Plus and Private Loans. These programs are expensive, discriminatory, and inaccessible for socioeconomically disadvantaged students, especially those lacking strong credit or co-signers.

The conventional student loan system, with its one-size-fits-all approach, has led to financial hardships for graduates. They find themselves grappling with substantial debt burdens which restrain their ability to pursue career choices that align with their passions and goals. The reason is the disconnect between their salary and the cost of their education. In other words, many students simply borrow too much compared to their expected salary when they started college. When it comes to earnings after graduation, not all fields of study are created equal. This has created an economy where 38% of students drop out of college due to financial shortcomings while 51% of parent cosigners feel that their children’s student debt is putting their retirement in jeopardy.

In the midst of that turmoil, an emerging number of edtech companies are attempting to reimagine the landscape of higher education financing by providing a more equitable and transparent college financing solution through Income Share Agreements (ISAs). ISAs were popularized by Nobel Prize-winner Milton Friedman in a 1955 essay titled “The Role of Government in Education” that ultimately made its way into Friedman’s 1962 classic, “Capitalism and Freedom.”

ISAs address the shortcomings of the traditional student loan system and offer students a lifeline of financial support after exhausting all traditional sources of funding such as federal loans, scholarships, and grants while creating an attractive investment opportunity to investors who are taking notice.

The core principle of an ISA revolves around students repaying a fixed percentage of their earned income (above $30,000 a year) over a defined period, generally 10 years, and up to a maximum amount. Rather than being shackled to a predetermined loan amount, ISA payments are tied to earnings providing students with a flexible and superior financing repayment schedule.

The concept of ISAs has gained significant attention in recent years, not just for their student-centric approach, but also due to their attractiveness as an investment option. The gap financing market, which currently stands at a staggering $350 billion, presents a golden opportunity for investors to tap into a previously untapped asset class. With $35 billion in new origination annually, the potential returns on investment (in the high single digit to low teens) have attracted both traditional financial institutions and private credit providers as ISAs offer a new avenue for investment within the consumer loan market.

Beyond their potential for financial gain, ISAs carry a distinct social impact. The innovative approach of ISAs aids in closing the funding gap in higher education, allowing students from various socioeconomic backgrounds to pursue their academic ambitions without the looming shadow of insurmountable debt. This represents a step towards a more inclusive and equitable educational landscape, where financial barriers do not limit one’s potential. This social impact investment model not only benefits individual students but also has the potential to reshape the broader landscape of higher education financing.

Additionally, ISAs offer a unique advantage as an inflation protection investment. Unlike traditional loans with fixed interest rates, ISAs tie repayments to graduates’ salaries. This dynamic nature of repayments acts as a safeguard against the eroding effects of inflation. As the economy evolves, and the cost of living increases, graduates’ earnings are likely to follow suit. This intrinsic link between income and repayment ensures that the value of the repayment remains stable and aligned with the economic landscape.

As the world of education and finance continues to evolve, it is imperative to embrace innovative solutions that empower students while providing sustainable returns for investors. ISAs encapsulate this symbiotic relationship, heralding a new era of higher education financing that emphasizes fairness, flexibility, and financial responsibility.

Investors may soon warm up to ISAs. Investing in future earnings may attract investors seeking an alternative to other fixed income investments, such as bonds. In short, it will come down to returns, and whether ISAs can outpace other credit investments. Investors could also be intrigued by the notion of helping to solve the student debt problem, akin to other forms of impact investing focused on solving climate and sustainability issues. 

The rise of ISAs as an attractive investment option has propelled this innovative financing approach onto investors’ radar screens. The immense potential of the gap financing student loan market has made them a promising asset class, offering both financial gains and social impact where investors are invested in the students’ success.

Daniel Rubin is the founder and CEO of YELO Funding. He has 25 years of principal investing, investment banking, restructuring and operational experience, including roles as co-founding partner of YAD Capital, a private credit investment firm, private equity real estate investor at Halpern Real Estate Ventures and JEN Partners, investment banker at Lehman Brothers and turnaround consultant at Deloitte. Daniel has invested in and/or advised on approximately $5 billion of corporate finance transactions. He holds an MBA from NYU Stern School of Business.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.