Even though income share agreements (ISA) have only recently gained popularity, the idea has been around since the 1950s. After Milton Friedman proposed the idea, it took some time before anyone attempted to implement it. In the 1970s, college tuition began to rise across the country and universities had to get creative to stay affordable. One such institution was Yale, which introduced their tuition postponement option (TPO) to counter a $500 tuition hike. This early example of an income-contingent loan led to the development of similar models today.
How the Yale Tuition Postponement Option Worked
First mentioned in the Yale Daily News in 1971, this program allowed students to "postpone" their tuition. They could postpone $1,000 at a time in exchange for 0.4% of their income once they graduated. Each person who joined the program was put into a cohort and Yale would take out a low interest loan for all the students. Everyone in the cohort would share their income until the entire loan plus interest was paid off.
This would mean that those who earn more would pay a bit more than those who earned less after graduating. To prevent those who expected to be high earners from joining the program, Yale also implemented a cap. The cap allowed those who paid 150% of the amount borrowed plus interest to exit the program.
During the repayment period of this program, many of the people who were paying a majority were able to get out of the loan early on, leaving the low earners to burden the rest of the loan. This led to the loan growing in balance over time and eventually Yale had to bail out the rest of the cohort. In 2001, the experiment finally ended when Yale paid the outstanding balances.
Why this program failed
Yale introduced the program in 1971 and by the end of the decade, they had scrapped it. One of the biggest problems with the TPO was that it had an adverse selection. Adverse selection was one of the main issues with the program. Those who had a low salary ceiling were more likely to opt into the program than those who thought their income would be much more. This led to cohorts that had a higher percentage of people, eventually paying less than necessary to repay the loans.
The program also failed due to the program's cohort structure. The use of a cohort to pay off a huge loan ended up leaving those who could not buy out, to foot a much larger bill than they had intended. This led to people staying in the program for over 30 years until Yale eventually bailed out the balance that piled up.
Effects of this program
After Yale scrapped the program and people saw the negative effects, it took some time before someone decided to try something similar. Finally, in the 1980s, Australia paved the way with its own national income contingent loans for university students. Eventually, in 1994, President Clinton, a Yale student in the 1970s, introduced his own federal program in the United States. This became the income based programs that are still available through the government today.
All this progress on income-based loans eventually led to the introduction of income share agreements. ISA programs remove the interest attached to loans. Instead of having to pay back a set amount plus the interest that has accumulated, an ISA allows the consumer to pay back a set percentage of income for a period of time. In an ISA, there is no interest or a "balance" that must be paid back.
If you're interested in learning more about ISAs and their benefits, check out Defynance.
