Planet Money - A new way to pay for college (Update)

Episode Date: August 5, 2022

College has gotten incredibly expensive. And some colleges are offering students a new way to pay. It's not a scholarship. It's not quite a loan. It's more like the students are selling stock in themselves. We check in on how income share agreements at one school have been working. | Subscribe to Planet Money+ in Apple Podcasts or at plus.npr.org/planetmoney.Learn more about sponsor message choices: podcastchoices.com/adchoicesNPR Privacy Policy

This is Planet Money from NPR. As we enter a new school year, it is worth noting that college is as expensive, if not more expensive, than ever. And inflation is not helping that. But, you know, three years ago, we did talk about this novel, seemingly new, to the United States at least, this new way of paying for college, income share agreements. Now, if you have no idea what an income share agreement is, do not worry. We have an episode to play for you as some background, but we wanted to play that episode now so that we could give you a bit of an update now that this income share agreement product has been around and in the world and in the United States now for a little bit of time.

Here is that original episode from about three years ago. Lauren Newworth is a junior at Purdue University. She studies biological engineering and food processing sciences, which means she knows a lot about how food works. As a technical expert, is there some artificial flavor that's just like where they just nailed it? I would say like banana. Banana is actually pretty cool from a chemical standpoint. It's like a volatile compound. Lauren obviously is super into this stuff.

And she knew that Purdue was a good place to get into the food engineering industry. But she couldn't figure out how she was going to pay for Purdue. Yeah, it was extremely stressful. Like, I was telling Kenny before, every time I go into financial aid, I just start crying because it's just so much money. And, like, I come from, like, a single-parent household, so it's hard to rationalize, like, asking my mom for, like, extra money. When Lauren went off to Purdue, her mom gave her $30,000. That was her college fund. On top of that,

she was able to get some government-backed student loans. She's gotten paid internships in the summer. But all of those things combined are not nearly enough to pay her way through school. So I went into financial aid and I was like all set to basically like join the army because they said that they to pay for college. It was so new that even the person

at the financial aid office didn't know all of the details. They said like they didn't know a ton about it and that it was kind of a new program and that I should like go home and kind of look into it. And then I did. And I was like, yeah, I think this does sound better than the military. So I applied and I got approved. And then that's how I've been like paying for my last two years of school. Purdue gave Lauren a bunch of money, tens of thousands of dollars. It's not a scholarship. It's not a traditional loan.

There's no set amount of money that Lauren has to pay back. Instead, Lauren had to promise that she will give Purdue a chunk of her income for years after she graduates. The more she makes, the more Purdue makes. It's kind of like Lauren sold stock in herself. Hello and welcome to Planet Money. I'm Jacob Goldstein. And I'm Kenny Malone. Today on the show, this idea of selling stock in yourself or something like it has been kicking around for decades. Now, it's finally starting to happen. This thing Lauren Newworth did, it is called an income share agreement. And it is a new way to help pay for college.

But it is based on a pretty old idea. One of the people who helped kind of rediscover this and dust it off is a man named Miguel Palacios. Hello? Jacob, hi. Hey, Miguel, how are you? Good, thank you. How are you doing? Miguel is a professor of finance at the University of Calgary. He grew up in Colombia, and in the mid-1990s, he heard about this weird thing happening in the news involving David Bowie. We must have died alone. So David Bowie raised capital for himself, and the special thing about this capital raising was that he pledged his future earnings. This was in 1997, and by this point, David Bowie had been a rock star for like 30 years. He had this huge catalog of perpetual hits,

Under Pressure, Starman, The Man Who Sold the World. And every time somebody bought an album or played one of those songs on the radio, Bowie got a little money. He got royalties. So what Bowie decided to do at this point was instead of get a little money every year, he wanted a lot of money now. So he said to investors, if you give me a lot of money now, I will give you a chunk of my royalties for the next 10 years.

And it worked. Investors gave Bowie $55 million, and in return, they got a nice, steady stream of income for the next decade. When Miguel Palacios heard about this Bowie thing, he thought immediately that this kind of deal would be great, not just for rock stars, but for regular people. In particular, he thought of college students. particular, he thought of college students. And it all came from experiencing the fate of several classmates when I was an undergrad student who were doing okay, but basically had to drop off because they couldn't survive financially. And these people, I knew they were highly capable, they were very talented, they were plausibly much more talented than I was. And they were giving up on a degree that in Colombia is very, very valuable.

So you heard about the Bowie bonds and you thought about your friends, your classmates who had had to drop out because they didn't have enough money. And what did you think? I thought they should be able to do something like what David Bowie did. Not exactly like what David Bowie did, but Miguel wanted to give college students a choice, a choice that companies have had for hundreds of years. If you're a company and you need money, you basically have two options. Option number one, debt. Get a loan, sell a bond.

If you do this, you have to pay back everything you borrowed plus interest. Option two, equity. Sell stock to investors. If you do this, investors, people, give you money and you get to keep it. This is not a loan. You don't have to pay it back, but the people who gave you the money, who invested in you, get a share of your future profits. The more money you make, the more money you have to give your investors. Ordinary people don't have this choice. If you're a regular person and you need money, all you get is option one. You can borrow money if somebody is willing to lend it to you.

If you don't want to borrow money or if there's nobody who is willing to lend you money, you're out of luck. That is why Miguel's friends, who couldn't get loans, had to drop out of school. So Miguel keeps studying this idea. He goes off to grad school and he learns that people have tried sort of similar things in the past, but not really what Miguel was thinking of. He also finds a couple people trying to get companies off the ground doing this sort of thing in the 90s, but nobody's getting very far. And at some point, Miguel happens to come across this chapter in a book by Milton Friedman, the famous economist. Randomly.

So I was reading Capitalism and Freedom. As one does. As one does. And it was there, right? So there's this chapter, and there it is. It's laid out very clearly, the whole idea explained. Friedman just says it. We should have a way that you can give a student money in exchange for a cut of his or her future earnings. So you just happen to be reading this book at this moment?

Yes. Serendipitously. What did you think when you came upon this in the book? Two things. On one hand is, oh, I guess it's not an original idea. On the other hand, oh, cool. Milton Friedman also thought it was a good idea. Yeah, yeah. The big moment for Miguel came when he met a guy named Felipe Vergara, also Colombian, very entrepreneurial, and interested in education. Yeah, I described what I was writing about. Okay. And he thought it was very interesting. But this is where the entrepreneur is different

from the PhD student. I was thinking that I would spend several years studying and learning and then designing. And he said, why don't we do it? Let's try to have the first contracts by next month. And that was the birth of Lumni. LUMNI is the company that Felipe and Miguel founded to do this thing Miguel had been dreaming of, to make income share agreements for students. They did a little pilot program in Chile where Miguel had worked when he was in his 20s. They funded six students, $10,000 in total. Well, that went great. And that was, say, the first, the beginnings of a track record that allowed Lumni to start raising more capital to finance other students.

That was in 2001. Today, almost 20 years later? It operates in Colombia, Peru, Chile, Mexico, and to this point, something of 10,000 students financed through these contracts. In all, they've provided about $50 million, 5-0, in financing. And the investors who've put money in, they are getting paid back. But Lumni has not really cracked the United States market yet, a place where obviously people have huge problems paying for college. After the break, income share agreements come to the U.S.

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One moment. He's still in the meeting right now. Fine. One moment, please. Media who are taking notes. Purdue received a record number of applications. Purdue University, remember, is the school that is using an income share agreement to fund part of the education of Laura Neuwirth, the food engineer who we talked to at the beginning of the show. Whatever your pursuit, Mitch Daniels.

Mitch Daniels is the president of Purdue. Hi, it's Jacob Goldstein at NPR. I'm so sorry to hold you up. Oh, no problem. Purdue, as far as we can tell, is the first big four-year university in the U.S. to try income share agreements. year university in the U.S. to try income share agreements. And this happened because in 2015, Mitch Daniels went to Washington to testify at a congressional hearing on higher education. He talked about a bunch of different issues. And just in passing, he mentioned income share agreements. It was almost a throwaway line. But as soon as the hearing was over, I was swarmed with,

first of all, reporters who were curious about the concept. And then shortly thereafter, I began to hear from people who had hoped that somewhere, someone would try to get this concept airborne. So Mitch went back to Purdue and asked a team of people to figure out if Purdue could do this. And if so, what students might benefit? Just to be super clear here, let's step back for one moment. College is ridiculously expensive and income share agreements are not going to solve that. Also, there are better ways to pay for college if you can swing them. Government-backed student loans are better than income share agreements for most students. Also, grants and scholarships are obviously better for students

than income share agreements. But for lots of students, students like Lauren Newworth, grants and scholarships and government-backed loans and summer jobs all put together are not enough to pay for college. Those students often wind up taking out additional private loans. And for those students, Purdue decided income share agreements might be a good option. All I know is there are millions of students who are taking very expensive loans who might be candidates for this and who might find it to their advantage. Purdue launched its income share agreement program in 2016. And so far, they've funded about 500 students. And the details of how this program works are really interesting. So we're just going to run through some of those details to explain how it actually works for students like, say, Lauren Newworth.

I, like, printed out all my forms that I signed and everything last night. And I was kind of like, yeah, I'm pulling it out. last night and I was kind of like, yeah, I'm pulling it out. The school gave Lauren $50,000 and she promised to pay roughly 15% of her income for eight years after she graduates. So the more you make, the more you have to pay. Yes. But also the less you make, the less you have to pay. Yeah.

But I mean, we're hoping to make a good amount of money. One of the most interesting things about the program is that the percentage of income that students have to promise to pay depends on what their major is. We talked about this with Mary Claire Cartwright, who manages the Purdue program. I mean, we know that a chemical engineer's traditional salary out of school is going to be different than, let's say, an English major. And by different, you mean way higher. Correct. I mean, for most people, right?

I say that as an English major, yes. Right. Here is the thinking behind how Purdue set this program up. They want everybody who participates to ultimately pay back the same amount. Now, English majors are probably going to earn less. So if they want money now, they have to promise a higher percentage of their income in the future. On the other hand, engineers are probably going to earn less. So if they want money now, they have to promise a higher percentage of their income in the future. On the other hand, engineers are probably going to earn more. So they are on the hook for a lower percentage of their future income. And this feels like, I don't know, a little weird, maybe a little judgy. Most schools, for example,

don't charge different tuition rates for different majors. They just set one average for everybody. So why not do that with income share agreements? So you could decide to just take the average income of all graduates and say, okay, we're going to base the number based on that, no matter what you're majoring in, we're going to charge you based on that. I mean, that's an option. It is, but it would be one that might cause there to be more adverse selection into the cohort. So you mean that if you average it out, all the English majors would say like, sure, that sounds like a sweet deal. Right. And all the chemical engineering majors would be like, no thanks, I think I'm just going to take a loan.

Right. Correct. Uh-huh. Correct. That's interesting. Adverse selection is this general kind of problem that occurs when exactly the wrong kind of people sign up for something. And one concern with income share agreements is that even when you charge different majors different rates, you could still have this adverse selection problem. Yeah, like say I'm an English major and I'm planning to go to law school and get some high-paying lawyer job. I'm going to make a lot more than the average English major. So for me, an income share agreement is probably not a good deal, right? I'm going to

be on the hook for a lot of money. On the other hand, if I'm going to go say, you know, be a teacher, get a good job, but one where I don't make a ton of money, in that case, an income share agreement may be a good deal for me. Now, Purdue doesn't have any control over what you do after you graduate. They're not going to tell you to take the higher paying job over a lower paying job. But there are some terms in the contract to catch, you know, like super slackers. I mean, if someone told me, like, you're going to pay a percentage of your income for the 10 years after you graduate, I would initially be like, great. So I'm going to Europe for at least two of those years. Great. You know, we want people to experience that.

And you've paused the contract because you're not seeking employment. Paused the contract. The students who do this, the students like Lauren who get income share agreements, are on the hook for eight years after they graduate. It's like there's this clock running down. the hook for eight years after they graduate. It's like there's this clock running down. But Purdue will stop the clock if the students, if, say, Lauren decides, you know, to bum around Europe or, for that matter, to go to grad school. On the other hand, if Lauren gets fired and she's looking for a job, the clock keeps running. And since she doesn't have income, she doesn't have to pay. On the other, I guess, other hand, if Lauren becomes, you know, some

food tech superstar, if she becomes a banana and a billionaire, she does not have to kick back 15% of that huge windfall to produce. She does not have to give them whatever, $100 million. There is a cap on what she and everybody in the program has to pay. And that cap is two and a half times the amount that Purdue gave her in the first place. In Lauren's case, it's $125,000. After she graduates, she'll have to tell Purdue or the company that's running this program for Purdue how much she is making. refuses to pay, they can come after her and demand that she pay two and a half times the amount they gave her in the first place, no matter how much she's making at that point. So those are some of the terms, the terms that Lauren Newworth signed up for. How do you feel about that?

Um, I mean, honestly, not great because like no one wants money taken out of their check every month. But at the same time, like maybe I don't make a lot coming out of college. Okay, well, then we're still doing fine. I'm not going to, like, default on my loans. The first students in the program have already graduated. They're making payments. Seems to be going well.

But really, it is too early to say how this is going to work. You know, will students like Lauren feel good about it in the end? Will the people who put money into the program get their money back? How profitable will it be? Will it be the kind of thing that draws in big money private investors? Or is it going to remain this kind of

semi-philanthropic niche thing? Okay, Kenny, in the present now again, and everything that you just heard, so that was recorded, reported a little more than three years ago. And we figured that now was a perfect time to check in on some of those very big, but very specific questions that we ended our original episode with. And a couple of days ago, we hopped on a video call with... Hello, can you hear me? Lauren Newworth. Hello, Lauren.

I'll get my video going. She was sitting in a very nice office, but was wearing this serious, almost air traffic controller uniform. Are you at your full-time job? Are we seeing you? Yes, yes. So I have my fire-resistant clothing on, so... Fire-resistant clothing. Yeah. So I work in a corn mill and that flour can be kind of explosive. So yeah, that's what I got. Yeah. Apparently flour particles can get in the air. And then if there's a spark or if it gets really hot, I guess, very bad news. But good news, Lauren did graduate in 2020 and found a great job. It's in Illinois in the food industry, the industry she was so passionate about.

Yeah. So basically we take in like raw corn from farmers and then we grind it down into flour and smaller pieces of corn and then send it off to, you know, Frito-Lay and General Mills and stuff like that. and then send it off to, you know, Frito-Lay and General Mills and stuff like that. So when we bite into a Frito-Lay, can we thank you in part for like the wonderful texture of the corn molecules or particles in that chip? Yeah, absolutely. It's our job to grind it to the right granulation. Now, before we get to some other updates about Lauren, let's look at some of those big questions

that Jacob was floating at the end of our original episode. And to be clear, since we focused on Purdue's program, we asked Purdue specifically about all of this stuff. And let's start with this question. Will the people who put money into the program get their money back? Now, we talked to a couple people at Purdue, and they say that the first thing you need to know is that the vast majority of people who put money in, that is Purdue and some philanthropic organizations. It's their money. And yeah, they are getting their money back, I suppose. Meaning that on average,

enough students are graduating and then landing good enough jobs so that when they pay back that like percentage of their salary, the income share agreement program can keep running. And by the way, Purdue says that they are up to about 1,500 students now on income share agreements.

Next income share agreement question from three years ago, Jacob. How profitable will it be? And answer, not necessarily super profitable. So for Purdue, the income share fund is making somewhere between 4% and 7% per year, which is way better than, you know, most of our bank's savings accounts would have been over the last six years. But, you know, the S&P was returning like double or triple that over the same time period, which brings us to the next question here. Will it be the kind of thing that draws in big money private investors, or is it going to remain this kind of semi-philanthropic niche thing? Yeah. Purdue tells us that in their case,

about 95% of the money that funds income share agreements comes from the university and other philanthropic organizations. And then there is that remaining 5% that is spread across, quote, a multi-strategy hedge fund, one family office, and then five individual investors. So yeah, a small amount of private money has come into this, but it is a very small amount. And there's one additional update that we should mention, because there have been some headlines that make it seem like Purdue is shutting this program down. It says maybe they're suspending this program. And that's partially true. So Purdue says that it is temporarily not issuing new income share agreements, but just for this coming school year. And Purdue tells us that this is a problem

that is completely caused by a change in vendors, as in, you know, they had to switch companies that collect payments, and this is what caused the problem. And so Purdue plans to keep issuing income share agreements when they are able to do that again. But all the existing agreements are still in place, which brings us to our final question. Will students like Lauren feel good about it in the end? We figured this one we can just ask to Lauren Newworth. I'm just grateful that you did reach out to me again, because I think that I definitely had a different opinion before I was graduating. But now after I am graduating, I feel like I see the other side of it. And it isn't as

positive. So you may recall that the income share agreement Lauren made with Purdue was as follows. When she graduated, she would have to pay 15% of her salary to Purdue for the first eight years of her working life. And Lauren ended up landing a very good job. And pretty soon, she was making about $70,000 a year. I recently got a raise, as in like a few days ago. And now, that's awesome, but I have to report that and pay more money a month. So I'm going to be paying, I think it's like $9.23 a month. Yeah, something, and it comes out to something like around $11,000 a year that you'll be

paying back to the income share agreement. It's a lot. Lauren says she is now paying more per month than if she had just taken out a more traditional student loan back in 2019. But this will be her reality for the next five years of her working life. And if her career really skyrockets, she'll pay even more. She may even end up hitting the maximum payback amount for this income share, which is 2.5 times the original amount Purdue gave her. Maybe, maybe. On the other hand, of course, Lauren is only paying a lot

because she is doing so well professionally. If she had struggled to find a job or barely made any money out of school, she would owe Purdue 15% of zero or not very much, which is zero dollars or not very much money. My boyfriend is a pilot, and we've had the conversation where he's probably going to be laid off at some point in his life. And so an income share agreement would probably be really good for him. But in retrospect, I wish that I would have just bit the bullet and maybe taken another private loan or some sort of more traditional route, just because I think then every time I would get a raise, I could throw extra money at my loan and actually pay it down quicker. And this is an interesting wrinkle that I maybe had not thought about when we originally reported this story. It's kind of a PR wrinkle, really, for income share agreements.

The most successful graduates are going to be the ones who end up paying the most, and therefore they may be the most likely to question their decision to enter into the agreement. Just as Lauren Newworth is doing from her great but potentially explosive new corn job, where, by the way, she does seem to be getting used to the steel-toed boots, hard hat, and fire-resistant everything. Yep, I just wear it all the time. Um, have there been fires that you needed resistance to? Thankfully, no. All right. Well, I will certainly think of you every time I eat a corn-based snack and that's wonderful. And it makes me so happy that you're working in food. That's really great. Yeah. Thank you. I guess we should say one additional update from the original episode.

The president of Purdue, Mitch Daniels, just retired as president. No longer the president of Purdue. If you have any specific questions about the economy at this very important economic moment, we would love to know what you're thinking about, what you're wondering about. You can email us. We are planetmoneyatnpr.org. We're also on social media at Planet Money. This episode was originally produced by Darian Woods and edited by Bryant Erstadt. This update was produced by Willa Rubin and edited by Molly Messick. It was engineered by Gilly Moon. Our executive producer is Alex Goldmark. I'm Kenny Malone. This is NPR.

Thanks for listening. And a special thanks to our funder, the Alfred P. Sloan Foundation, for helping to support this podcast.