Rajeev Parashar and Parul Gupta discuss an alternative to education loans

Parul Gupta is an Assistant Professor of Economics, ISBF; Rajeev Parashar is a research scholar at the Department of Economics, School of Humanities and Social Sciences, Shiv Nadar University, Delhi-NCR.

Income share agreement: A viable alternative to fixed-cost education loans

Almost every year, during admissions season, one hears a poignant story describing the struggles of a financially-challenged student in securing admission at a prestigious higher education institute (HEI). It is not uncommon to read about meritorious students having to forgo admission at HEIs due to financial constraints. Parents of many of these students are already under debt due to exorbitant coaching fees for entrance exam preparation, and cannot afford to pay counselling charges (for seat allotment) and fringe expenses, in addition to hefty tuition fees at HEIs (ranging from Rs 8 lakh for an engineering degree at IITs, to Rs 20 lakh for an MBA at IIMs). While medical institutes like AIIMS charge nominal fees, seats are limited, and so aspirants turn to private medical colleges where fees can be as high as Rs 1 crore. Clearly, higher education—which is a potential tool for socio-economic mobility and career progress—remains out of reach for many.

Although need-based scholarships are available at many HEIs, such opportunities are few, and are often targeted at the absolute poor. Many students with middle-class backgrounds rely on education loans to finance their studies, paying 7-16% interest per annum, in addition to high processing charges. While educational lending falls under the priority sector, RBI figures reveal that disbursal of student loans has fallen in recent years. This could be due to relatively high default rates (6-9%) on unsecured education loans (of less than Rs 7.5 lakh); estimates indicate that default rates on study loans are higher than on home loans (1%) and car loans ( 4%). The accumulation of bad debt dissuades banks from expanding credit in the education segment.

One possible solution is an income share agreement (ISA)—a contract through which a student receives upfront money for higher education in exchange for a fixed percentage of her income after course completion. This ‘equity’ styled instrument doesn’t need collateral, and repayment is based on future income. Moreover, repayments don’t start till the borrower starts earning a minimum threshold amount, and there is an automatic suspension of repayments during a period of unemployment.

ISAs are in a nascent stage, and are functional in the US, Columbia, Chile, Peru and Germany. Although higher education is greatly subsidised in Germany, about 40% students enrolled at private universities opt for ISA. In the US, the skyrocketing costs of college education and the vulnerabilities induced by student loans have allowed ISAs to emerge as a preferred alternative. Reputed schools such as Purdue University and the University of Utah find that students are attracted to the flexible terms of ISAs offered at these universities. ISAs can also be beneficial for the society by allowing better matching of candidates and work profiles. Candidates don’t have the pressure of choosing high flying jobs (to pay back loans with fixed repayment terms) and giving up on career opportunities they are passionate about. However, critics have argued that contracts can be complicated and may contain unfavourable clauses inserted by ISA providers. These problems, though, can be addressed with appropriate regulation.

The demand for educational finance in India is estimated to be worth several billion dollars. High-value traditional loan products have strict requirements of collateral and guarantor, due to which many talented but otherwise disadvantaged students find themselves in a tenuous position. The situation is untenable for first-generation learners and women students; even today, households prefer to save for their daughters’ wedding rather than for education. ISAs are a promising alternative to loans in such a scenario.

However, since ISAs are not popular in India, universities will need to play a central role in improving traction for this financial product. Availability of funds targeted towards marginalised communities and women students will be welcome. A regulatory framework along with ingenious solutions will be required to ensure repayment of the dues. Fintech and education are the latest trends in the entrepreneurial space, and lending start-ups are disrupting the market by conducting aptitude tests (to forecast earnings potential by using predictive analytics) and providing headhunting services (to facilitate job search) to the borrowers. These measures increase the likelihood of timely repayment of loans and similar tools could be used to design appropriate ISAs as well. For innovative minds who want to tap into the educational finance market, ISAs could be the next golden opportunity, which would help bring deserving students one step closer to achieving their dream of pursuing quality education.

The article was originally published in Financial Express. You can also read it here