As you may have heard, Congress recently passed a last-minute deal on federal student loans that ties the rate to government borrowing costs.
Still, I’m not convinced that Congress will deliver any meaningful reform of education funding, or take action to curb the spiraling cost of higher education anytime soon.
This begs the question, can and should we rely on the private sector? Looking to startups and venture capital firms, my company Corporate Insight found three new approaches to financing an education on the horizon. While the class of 2017 may not be able to take full advantage of these new concepts, I’ve outlined a few to keep an eye on below.
Exchanging a stake of your future earnings
The general premise of this model is that a middleman, such as U.S.-based startups Pave and Upstart, raise money from investors, who are willing to lend money to a student for a stake in their future earnings.
These firms typically vet students, and set parameters for the loan that include the percentage of income (usually between 3 and 10 percent) and time period (usually about 10 years). Investors bear the risk that the student may not earn enough for the desired return, but also stand to gain if the student is exceptionally successful. A degree of mentoring and support is also offered, whether it’s from the investor who wants to see their student succeed or from the firm itself.
This idea isn’t without precedent, and there are at least four other international firms offering this type of loan. Nor is it limited to the private sector. The Oregon legislature recently approved a pilot program along these lines for the entire state. The Australian government also offers a similar program where unpaid student fees are converted into debt (indexed to CPI but otherwise interest free) and repaid through the tax system once a student graduates and meets an income threshold.
The appeal to a prospective college student is clear. The notion that you only need to pay a portion of what you’re earning is appealing. It’s far less intimidating than the prospect of taking out a large loan that may be difficult to pay off unless you take a high-paying job. These startups should also appeal to middle-income families who don’t qualify for subsidized federal loans and are shopping around for the best possible deals to finance their child’s degree.
What’s good about it? Many students find this less intimating then taking on a huge debt burden.
What’s bad about it? Can a 17-year-old really grasp his future earnings potential vs. a standard to loan to determine which is better?
Who does it appeal to? Students who don’t qualify for subsidized federal loans.
Can this business model succeed? How do you structure contracts to protect investors if the student decides to go to graduate school or join the Peace Corps? What rates would you charge a pre-med student vs. a communications major? For a private business, there are many difficult questions with little to no precedent to follow.
Micro-finance your tuition costs
I often hear it said that education is the best gift you can give. In that spirit, several startups now offer websites to help parents and students raise small donations toward tuition from their friends, family or their local community. Done early enough, these small donations can add up.
If you’re a parent looking to collect donations for a 529 plan, try Give College, Gradsave, or Instagrad. If you’re a student, Campus Slice, BrainFund, Goalfrog (currently only available at two schools), or GreenNote can help you solicit donations.
It’s important to note that you may pay handsomely for the convenience. Fees typically range from 3 percent to 8 percent. If you’re a parent collecting small donations for a baby shower or a birthday, then using one of these services may be worth the convenience. But if you’re thinking about making a significant donation to someone’s education fund, it’s worth the extra hassle to contribute directly to their 529.
What’s good about it? It’s convenient and it’s a better gift then a gift card!
What’s bad about it? You’re paying for the convenience … those fees add up!
Who does it appeal to? Parents with young children or high school/college students.
Can this business model succeed? Since donations only come in a few times a year, a firm would need to bring on a huge number of customers to make this a profitable business. Is doing only this a viable business model? It seems like it should be attached to a broader service.
Students loans from alumni
Successful alumni looking for ways to give back to their beloved alma mater may soon have a new and potentially more fulfilling way to support their school. Rather than putting a drop into the proverbial bucket of the general fund or the athletic fund, alumni could directly finance the loans of current students. Students benefit from a loan from loyal alumni at a lower rate than a private lender. They also potentially benefit from the opportunity to connect with the individuals who are funding their education, something you don’t get when you’re borrowing from a faceless financial institution.
This idea is still years away from entering the mainstream. Providers like SoFi and CommonBond are currently only available at a few institutions. They have found great success in their relatively short lifetimes, however, and are demonstrating the potential of alumni loans.
Like the stake in future earnings approach, it’s an opportunity for investors to support a good cause and hopefully earn a respectable return in the process.
What’s good about it? Students enjoy lower rates and potentially network with successful alumni
What’s bad about it? What happens if the middleman firm fails?
Who does it appeal to? Students looking for financing options.
Can this business model succeed? This concept seems like a win-win. So long as the middleman keeps his fees reasonable, loans from alumni should become more common.
Tackling the rising cost of college
Of course, none of these services solve the underlying problem — the ever-rising cost of a college degree. If you haven’t heard, a different group of startups such as Coursera are developing what are known as MOOCs, or massive open online courses.
MOOCs are online versions of college courses designed to be taken by huge numbers of students for free or a relatively low cost. Broadly speaking, such firms are still figuring out their business model and have a lot of homework to do to improve the low completion rates for their courses.
We hope that someday MOOCs will start putting downwards competitive pressure on tuition costs.
Grant Easterbrook is an analyst at NYC-based research and consulting firm Corporate Insight. Grant tracks over 130 personal finance and investing-related startups as part of the firm’s research effort to understand the trends and innovations that will shape the future of the financial services industry.