Venture Capital to Buy Equity in Purdue Students

Danielle Douglas-Gabriel at the WashPost writes that Purdue is going to run an experiment with income contingent loans.

This week, Purdue University [partnered]…with Vemo Education, a Reston-based financial services firm, to explore the use of income-share agreements, or ISAs, to help students pay for college.

Through its research foundation, the school plans to create ISA funds that its students can tap to pay for tuition, room and board. In return, students would pay a percentage of their earnings after graduation for a set number of years, replenishing the fund for future investments.

The Federal government already offers an income based repayment program for student loans but private plans would likely be more flexible and generate more useful information.

Douglas-Gabriel makes a useful point:

Say a student agrees to pay five percent of her income for five years on a $10,000 agreement. If that student lands a $60,000 job after graduation, she could pay $15,000 by the time the contract is up, more if she gets raises along the way. Yet if that same graduate loses her job during that time, she wouldn’t be forced to find the money to pay.

But then concludes with an odd criticism:

Either way students would have to be pretty informed about the earning potential in their field before signing up.

What the example illustrates, however, is that being unlucky or uninformed is less damaging with an income share agreement than with a traditional loan. Loans have the greatest burden when a student overestimates their potential earnings and is poorer than expected. Thus, the loan offers no relief when relief is most needed. In contrast, payments under an income share agreement fall when income falls. An ISA does cost more than a loan when a student underestimates their potential earnings but in this case the student is richer than expected and can easily bear the extra burden. Thus, ISAs offer income insurance.

Douglas-Gabriel also writes:

Some observers worry that students pursuing profitable degrees in engineering or business would get better repayment terms than those studying to become nurses or teachers.

Actually, that is part of the point. An ISA is about improving idiosyncratic risk sharing. To the extent that engineers are reliably expected to earn more than nurses, they should pay a smaller share of their income so the total payment for an education is about the same for both engineers and nurses (fyi, business is not a profitable degree).

Indeed, one of the prospective benefits of ISAs is that differences in prices will better reveal which are the degrees, programs and schools that most generate value-added.

Hat tip: Kevin James.

Addendum: See previous MR posts on this topic.

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