Income Share Agreements - Good For Students or Investors?
Welcome money for the rest of us. This is a personal finance show on money how it works, how to invest it and how to live without worrying about it. We host David Stein today's episode three seven. It's titled Income Share Agreements. Good for students. Or. Investors. Over five years ago and upset forty-five of money for the rest of us. I introduced income share agreement as a way to partially fund college. An income share agreement is a contract where individuals agree to pay a certain percentage of their income for a set period of time in exchange for an upfront payment that is usually used to pay for education cost but can be used for other things. For example, a line income share funding says that you can get an essay for home repairs, debt consolidation, paying a medical bill or even planning your wedding. Not sure I would do it income share agreement for most of those things. They are traditionally us to invest in what is known as human capital, our ability to earn money by getting more. Education. Another name for income share agreements is human capital contracts. Income share agreements were first proposed by the economist Milton Freeman in a nineteen, fifty, five essay titled The Role of Government in education. He wrote vocational or professional education is a form of investment in human capital precisely analogous to investment in machinery buildings are forms, of non human capital. Its function is to raise economic productivity of the human being. If it does. So the individual is rewarded in a free enterprise society by receiving a higher return for his services than he would. Be Able to command. We discussed this concept summit upset to forty five is college worth it. And determined, there is a positive financial return in investing in human capital. By attending college, you can earn more, you build your social capital, your network you gain knowledge. Having a college degree allows you to pass filters that many companies put in place with their hiring practice in that, they only hire individuals with college degrees. Freeman continued. If a fixed money loan is made to finance investment in physical capital, the lender can get some security for his loan in the form of a mortgage or a residual claim to the physical asset itself, and he can count on realizing at least part of its investment in case of necessity by selling the physical asset. In other words, the lender has some collateral that could be sold in the case of default. But Freeman a problem if the loan is made to invest in human capital. He writes the lender clearly cannot get any comparable security in a non slave state the individual embodying the investment cannot be bought and sold. Freeman then pointed out that because there isn't collateral that the interest rate charged on student loan would have to be sufficiently high to compensate for the capital loss because there wouldn't be collateral and that the interest rate would have to be so high making the loans unattractive to borrowers. Now. A solution was found. Federal guaranteed student loans. The total US Student Loan Dad. Private and federal is one point six, four, trillion dollars. Only a hundred and twenty, four, billion of that one point six trillion is private. The average federal student loan debt balance is thirty, five, thousand dollars and the default rate is high. Eleven point one percent. It's particularly challenging for individuals that have taken on a lot of student loan debt to pay off. A Brookings Institution study from two thousand eighteen found that the median borrower who had less than fifty thousand dollars in student loan debt in the early two thousands paid off the debt within ten years. While the median borrower, they had more than fifty thousand dollars in student loan debt ten years later still owed about seventy, five percent and most of the students falling behind on their student loan debt are those that have a balanced greater than fifty thousand dollars. Friedman's proposed solution income share agreements. They weren't necessarily called that, but he said that. A contract could be structure where an investor would buy a share in an individual's earnings prospects. To advance him, the funds needed to finance his training on condition that he agreed to pay the lender a specified fraction of his future earnings. In this way Friedman wrote, a lender would get back more than his initial investment from relatively successful individuals which would compensate for the failure to recoup his original investment from the unsuccessful. There seems no legal obstacle to private contracts of this kind even though they are economically equivalent to the purchase of a share in an individual's earning capacity and thus to partial slavery. These. Agreements have been criticized perhaps not slavery, but certainly indentured servitude. Although Miguel Palacios yet us in his book investing in Human Capital felt that the analogy to slavery or indentured servitude was incorrect because the students retain the full freedom of action they're not forced to stay in a given job or even a work in the field in which they trained in. So they have the ability to to work anywhere they want.