By: Joseph Reinke, CFA, CEO of FitBUX
This article discusses:
- Why tuition rates have increased at a record pace; and
- Two benefits of Income Share Agreements that would help control rising tuition rates.
(Note: If you would like to learn more about Income Share Agreements, click here.)
Where We Are at Today
When it comes to funding education, the Federal Government has been extremely generous with the amount of financing offered to students regardless of the field of study or the school attended. These amounts have grown astronomically, due largely to the lack of underwriting by the Government; basically, if you apply, you shall receive. Universities, which are constantly strapped for money, have seen this as an opportunity to raise tuition. This, and a handful of other factors, are leading to the historic rise in tuition rates. In short, there is currently no system of checks-and-balances.
It is not uncommon for us to speak to students and recent graduates who have over $150k in student loans but earn $70k a year. However, just because you can get a blank check to finance your education does not mean you should take it. If you want to understand what I mean, look no further than the recent housing debacle, when lenders were led by greed and at the same time were being influenced by the government to hand out “free money” to buy homes.
Building your finances and preparing for retirement takes time, but you can very quickly (and easily) destroy your finances. The choices you make early in life can really set you behind, if not completely take you out of the game. The amount of student loans you use to finance your education is a major choice. To help determine how much you should barrow, you may contact us.
This article discusses one solution, Income Share Agreements (“ISAs”), that can establish a checks-and-balances system for tuition and insure students don’t borrow too much to finance their education.
To be clear, ISAs and income based repayment (“IBR”) options provided by the federal government are two different products. Primarily, IBR is a reactive program targeted at individuals who are already over-levered and need financial assistance. FitBUX’s ISA, on the other hand, allows students to take proactive steps to manage their complete financial profile. For more information on the differences between IBRs and ISAs, click here.
How ISAs Can Help Control the Costs of Education
Benefit 1: No Co-Signer
An ISA is based on the individual's merit and potential. Therefore, a co-signer is not needed. Terms of the agreement are based on the human capital an individual has developed as well as their present and future financial situation.
The lack of a co-signer, combined with the structure of an ISA, aligns the interest between financier and student. To understand this, we can look at how most traditional student loans are issued: most Federal Loans require co-signers and private loans offer lower rates to borrowers who have a co-signer. If you graduate from school and are unable to afford your loan payments, the lender’s financial stake is protected by the co-signer’s pledge to pay the loan. This limits the risk to the lender and assigns that risk to the co-signer. However, the co-signer gets little to no reward for the amount of risk they are accepting. This also creates a bias towards high-income households with parents who have the ability to co-sign. In this situation, someone from a low or middle-income household faces a higher interest rate if the parent is unable to co-sign. This is not logical: two people receive the same degree, but one has to pay more than the other simply because they come from a family that is not as well off?
A finance company that provides ISAs shares risk with the student, meaning that they have “skin in the game.” If a student earns more than predicted when they graduate, then both the ISA provider and the student shares in the gains. The same is true if the student makes less than predicted. This lowers the risk of going to college because it gives the student “insurance” against the downside risk of lower earnings. This is discussed further by Beth Akers in her recent article for the Brookings Institute.
By not having a co-signer, financiers will spend greater effort to scrutinize the risk for given levels of financing a student receives relative to the reward and will make the borrower more aware of the amount of debt they are taking on.
Benefit 2: The Benefit of Auto Feedback
One often cited criticism of ISAs is that they favor those individuals with degrees in high paying careers, but his couldn’t be further from the truth. ISAs, and in particular our FitBUX ISA, informs the consumer on how much they should finance for the degree of their choice given how much income is expected with that degree. For example, if your area of study is expected to earn $50k per year, an ISA might recommend you only borrow up to $50k. ISAs don’t suggest “if you need to borrow more than $50k, then you shouldn’t get your degree”. What they do suggest is that you should do everything in your power to only borrow up to $50k so that you put yourself in a great financial situation when you graduate.
For example, students have the ability to pursue work study, scholarships, grants, internships, or part-time work to help offset the cost of tuition while in school. Creating budgets and living frugally limits the amount of borrowing that a student will ultimately need to borrow for school and are just a few other methods that students have at their disposable to pay down debt.
The best part about the auto feedback that ISAs provide is the feedback being summarized into one easy to understand number. When you apply for an ISA, the provider will tell you what percentage of your income you would have to pay each year to fulfill your agreement; the lower the percentage, the better and of course, the more you finance, the higher the percentage will rise. For example, if the ISA provider says that you will have to pay 30% of your income for ten years after graduation, you automatically know that you are borrowing too much money to finance your education.
Since ISA providers have skin in the game and share the risk with the student, they will have performed the analysis and research to determine the percentage of income to charge the student, therefore saving the student hours, if not days of having to do the research themselves.
This feedback automatically caps tuition amounts because it gives students feedback on their educational investment, as well as the knowledge and transparency needed to help students value their education and ultimately provide a checks-and-balances against student debt.
Experience the benefits of an ISA
As mentioned, feedback is provided by one simple number, the percentage of your income. With FitBUX, you get additional feedback: (1) we provide the percentage of your income and (2) your FitBUX Score. The FitBUX Score includes additional information and transparency into your personal financial picture. For example, we include items in your score that affect how employable you are. This allows us to provide tools to prospective, current, and recently graduated students. One such tool we are working on will allow individuals to see the optimal amount of student loans to take out based on their personal situation.
Would you like to learn more and gain real-life feedback? We are now accepting applications from individuals that want to be part of our pilot program. If you, or anyone you know is interested, please request a free invite below. Specifically, we are looking for students pursuing an advanced degree, students who have recently graduated with an advanced degree, or students who recently completed their undergraduate degree. If you have questions, please let us know.