The Education Department clarified this week that income-share agreements in higher education are private loans. As loan providers, the companies that provide these agreements are regulated in different ways than before the clarification, and colleges have specific requirements in terms of how they promote the arrangements.
Income-share agreements (or ISAs) offer students up-front financial support and, in exchange, require them to pay back a portion of their future income for a set number of years. They are offered in some cases through colleges and in other cases by companies. Some providers of ISAs have argued that they are not loans.
The Education Department acted after the Consumer Financial Protection Bureau in September issued a consent order against a student loan originator for misleading borrowers about ISAs, failing to provide required disclosures and violating the prohibition against prepayment penalties for private education loans. The CFPB concluded in its order that a student loan originator’s ISAs are private education loans. Additionally, in January, the CFPB updated its examination procedures for private student lending to explicitly reference ISAs. The Education Department’s action this week essentially applies that ruling to all providers of ISAs in higher education.
ISAs were initially mainly used by students at coding boot camps and other skills training programs that aren’t eligible for federal student aid. Interest rates in the agreements have steadily increased in recent years. Supporters say ISAs could be a solution to rising student debt burdens—because they’re offered by private investors who want to see a return on their investment, it’s expected that ISAs will only be used for programs that will eventually pay off in future earnings. And because the contracts are based on students’ income, they won’t be burdened with payments they can’t make.
Others don’t view the contracts as favorably. Critics argue that income-driven repayment plans for federal loans also allow borrowers to base their loan payments on their income and that borrowers with higher salaries could end up paying more under ISAs than through traditional student loans. Senator Elizabeth Warren, a Democrat from Massachusetts, along with other congressional Democrats, has said contract terms could be “predatory and dangerous” and “include some of the most exploitative terms in the private student loan industry,” such as mandatory arbitration agreements and class-action bans.
Rich Williams, chief of staff of the Education Department’s Office of Postsecondary Education, wrote a blog post on the change in policy Wednesday.
“It’s no surprise that students often look to their college as a trusted source of information as they determine how to pay for tuition, housing, books, and other living expenses,” he wrote. “Capitalizing on this trust, some banks and lenders have long viewed colleges as a gateway to new consumers, courting schools to become their preferred provider of education loans and other financial products. In many cases, these companies provide inducements and financial incentives to colleges who market their financial products above others. Without guardrails, these financial incentives can create conflicts of interest that may drive students to use financial products—branded by trusted college logos—that have high or unusual fees and fewer consumer protections than other widely available products.”
Williams continued, “Taking out private student loans can be financially risky for students, but the department’s rules for preferred lender arrangements can help reduce that risk by ensuring that students get unbiased, trustworthy information they need to make borrowing decisions. These rules ensure colleges provide transparency on the terms and conditions of any college-endorsed private student loan and publicly document why they endorse a particular private student loan. Additionally, colleges must commit to a code of conduct that prohibits revenue sharing agreements with a lender and eliminates other conflicts of interest. These are important practices for colleges to consider when endorsing any financial product.”
Few of those who provide ISAs wanted to talk to Inside Higher Ed. They fear more scrutiny from the Education Department.
One person who is in the loan industry agreed to talk as long as his name and company were not identified. He said that not all ISAs are like loans. Some ISAs, he said, cap what students pay and provide very generous payout rates. There is nothing to be gained by overregulating that sector, he said.
In the short term, he predicted that few would enter the business right now, with regulation increasing.
But Ben Kaufman, director of research and investigations at the Student Borrower Protection Center, said, “The department’s announcement makes clear that schools have to follow the law when directing students to take on risky private student loans—regardless of what novel-sounding name creditors slap onto these products. This move is a huge victory for students, and we hope it will be the start of a wide-ranging push by the department and its partners, including the CFPB, to protect borrowers simply by holding schools and lenders to their existing legal responsibilities.”