With student loan default rates soaring, what are some education funding models besides debt. Plus is college even worth it?
In this episode, you’ll learn:
- How high are U.S. federal student loan default rates.
- Why education is an intangible asset.
- Why investing in one’s education is more akin to a venture capital investment in a start up company.
- Why bootstrapping your education can be a better funding model.
- What are income share agreements.
- What is the financial return on investment for a college degree.
- What are you really paying for when you go to college.
The Start Up of You by Reid Hoffman and Ben Cashnocha
How To Talk About Books You Haven’t Read
Student Debt Swells, Federal Loans Now Top A Trillion – Consumer Financial Protection Bureau
40 Million Americans Now Have Student Loan Debt – CNN
U.S. federal student loan default rates
Bank lending default rates – U.S. Federal Reserve
The Lean Start Up by Eric Ries
Lumni – income share agreements
Upstart was mentioned in the episode but they have discontinued income share agreements in favor of loans.
Is College Worth It – The Economist – April 5, 2014
Payscale College Return On Investment Rankings
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Solving the Student Loan Debacle
$1.2 trillion. That is the estimated amount of outstanding federal student loans according to the Consumer Financial Protection Bureau.
Forty million Americans have at least one student loan outstanding, up from 28 million Americans in 2008. The average balance is $29,000, according to the credit bureau Experian.
Unfortunately, a sizeable percentage of these student loans go into default.
The High Level of Student Loan Defaults
The Department of Education (“DOE”) says the national student loan default rate is 14% for students that entered into loan repayment in 2011. The default rate is 13% for public colleges, 7% for private colleges and 20% for private for-profit schools.
This represents only the defaults for students that never began repayment or stopped making payments in the initial repayment years. It does not represent the total default rates over the lifetime of the loans.
The DOE’s budgeted lifetime default rate for students that entered repayment in 2011 is 34% for attendees of two year public/private schools and 49% for attendees of two year for-profit schools.
For freshman and sophomores who leave four year schools without graduation, the DOE budgeted lifetime default rate is 25%. The budgeted lifetime default rate for juniors and seniors is 13% and for graduate students it is 6%.
Although these are budgeted lifetime default rates they are consistent with historical default rates.
Most student loans are issued and held by the federal government because with such high default rates banks could not survive unless they charged significantly higher interest rates than the 4.5% to 7.5% the federal government levies on student loans.
For comparison, according to the Federal Reserve, only 2% of consumer loans, including credit cards, are delinquent, even though credit card interest rates are much higher than student loans.
Education Is Like A Start Up
The problem with student loans is the borrower incurs debt for an intangible asset with a highly uncertain financial outcome. Investing in one’s education is more akin to a venture capital investment in a start up company.
Venture capitalists expect many of their investments will be unsuccessful in that they lose money or barely break even. They are willing to accept that risk because their few successful investments more than offset the unsuccessful ones.
Students who incur debt for education have made a highly leveraged, highly concentrated bet in one start up—themselves.
Admittedly, the student borrower is highly vested in ensuring the startup is successful. Yet, student loan default rates suggest this debt-funded education model is broken.
Pursuing post secondary education brings many benefits to students such as broadening their horizons and improving their skills, but these do not necessarily translate in to higher paying jobs that are sufficient to service the student loan debt.
Bootstrapping and income share agreements can be more appropriate funding mechanisms for students who are uncertain if they will like their course of study or if it is financially viable.
Many start ups today prefer the flexibility and discipline that comes through bootstrapping.
Rather than seek outside debt or equity funding, bootstrappers create businesses using a lean start up methodology in which they employ disciplined experiments, minimum viable products and rapid learning and iterations to determine if they can build a sustainable business around their product or service. Bootstrappers fund their growth organically rather than by seeking outside capital.
Likewise, students can bootstrap much of their education rather than use debt. Free online courses offered by elite universities allow students to sample different subjects. Volunteer opportunities and apprenticeships allow students to gain practical knowledge working with experienced professionals. Many employers still pay for education for their employees.
Workers today need to be creative lifelong learners so it is better to develop a sustainable plan for ongoing education rather than assume a debt-funded college degree or certificate program is the ticket to success.
Bootstrapping allows students to experiment and explore different areas so that if and when they enter into a formal degree program, they are more likely to complete it and find employment because the program is better aligned with their interests.
Raising Equity Capital For Your Education
If after bootstrapping a student determines a specific degree program will help them achieve their goals, a funding source apart from student loans is an income share agreement (“ISA”).
With an ISA a student receives funds to pay for tuition and fees in exchange for a percentage of his or her future earnings. Lumni and Pave are two companies that help or are considering helping students fund their education with income share agreements.
ISAs are similar to a start up company raising equity capital. The equity investor in the start up does not expect to get paid a dividend unless the company is profitable. Likewise with an income share agreement the student doesn’t have to begin making payments unless they are employed and that payment amount is variable based on income.
ISAs are still in their infancy and while some may balk at the idea of paying out a set percentage of one’s future earnings for a lengthy period of time, ISAs offer students more downside protection than student loans. Of course, bootstrapping one’s education offers even more downside protection than both student loans and ISAs.
307: Income Share Agreements—Good for Students or Investors?