More than 5 years ago, in episode 45 of Money for the Rest of Us, I introduced participation agreements to partially fund the university. An income participation contract is a contract by which individuals agree to pay a certain percentage of their income for a certain period of time in exchange for a down payment normally used to finance education costs. But can be used for other things. (A recent paper from the Consumer Finance Institute of the Federal Reserve Bank of Philadelphia analyzes the emerging market for income participation agreements in post-secondary education. Those who support revenue-participation agreements have argued that many potential problems simply require directors or legislators to carefully structure programs. Uniform consumer protection measures, such as the requirement for additional time after certain life events, could enhance student safety. Parliament could also set caps for the percentage of income a program can calculate or for the duration of payments. Only a handful of schools currently offer income-participation agreements, so the idea will likely depend on the results of these programs over the next few years. But many schools pay attention to it. Tonio DeSorrento, chief executive of an organization called Vemo Education, which helps schools design the agreements, told the Wall Street Journal that more and more schools have expressed interest. University courses are high, but degrees are always worth it. Debt is increasing, but the largest debt is held by the highest earners.
So what`s the problem? The really worrying trend is the growing risk of investing in higher education. Next: Susan Dynarski on income-based credits. The second argument is that ISAs are the best for students who are reluctant to pay, who may not be reluctant to take action. The sheer aversion to debt is, in my opinion, overestimated as a financial barrier to access, but it certainly turned out, even if it`s not in the way most people think it does (key point: it doesn`t seem to be related to the origin of income). ISAs are probably a niche instrument for providing equity assistance, which is reluctant to debt, rather than debt-based assistance. I`m a little skeptical that it works – and there`s no empirical evidence to prove it one way or another – but I guess it can`t hurt to try. For example, Align Income Share Funding says you can pay an ISA for home repair, debt consolidation, a medical bill or even plan your wedding. I`m not sure I`m going to make a participation agreement for most of these things. They are traditionally used to invest in what is called human capital, our ability to make money by getting more education.
Another name for income participation agreements is the human capital contract. Some critics have also raised the idea of a moral hazard inherent in these programs. Students could, they suggest, enroll in income participation and then deliberately accept jobs where they earn much less than they would otherwise to minimize or even eliminate their payments. Essentially, they would let the repayment period expire and then start their careers seriously. But that doesn`t seem terribly realistic to me for a variety of reasons. Intentionally earning less early in a career has long-term consequences on profitability.