College Loans Tied to Future Income Most Likely to Succeed

College costs skyrocketing; default rates exploding; The Student Loan Industry bubble is about to burst — but investing in students through a new lending product called Future Income Exchange rather than lending to them has huge potential. According to Bloomberg, the cost of college has increased 538% since 1985 (compared to a 286% rise in medical costs and a 121% rise in the consumer price index). Consequently, the ballooning costs of student loans have led to detrimental rises in student debt and default rates.

The Consumer Financial Protection Bureau released a report estimating the total outstanding federal student loan debt is approaching 1.2 trillion (a 20% growth from the end of 2011 to May 2013). Analyzing the downward spiral, big banks like JPMorgan Chase are suddenly shutting down their student loan departments, claiming the current student loan market unsustainable.

“We just don’t see this as a market that we can significantly grow,” Thasunda Ducket, Chief Executive for Auto and Student Loans at Chase, said earlier this month according to CNBC.

With the student loan industry in peril, many are suggesting a new, better approach in funding college – one that invests in students, offering tuition money in exchange for a percent of their future earnings.

Some in Congress believe this new model is the answer to the problem.

Senator Jeff Merkley (D-Oregon) is an avid advocate – announcing that he will propose a new student loan bill called The Guaranteed College Affordability Act this month.

The mission is to make the cost of college affordable no matter what happens. For example, a student might receive $20,000 for college in exchange for 3% of their future income over 15 years after graduation.

This model protects the student from being tied to a fixed monthly payment that is too high for their income. For example, a recent college grad with a low-paying job may find it hard to make fixed monthly payments. Under the new system, that same student would owe less since their payment is dependent on a percent of their income.

And, to offset the risk of low-income grads, Gregory Ferenstein from TechCrunch suggests that the investment approach would work much like venture-capital portfolios do; the profits from high-paid, all-star grads would subsidize the cost for low-income grads.

In Merkley’s proposal, he said that they are ready to try the business model on a state level to see if it works.

In the private sector, companies have already begun to test the model themselves. Three notable companies to watch are Lumni, Pave, and Upstart.

At Cumulus Funding, we commend this new approach to higher education. After all, we share the same business model.