The Consumer Financial Protection Bureau (CFPB) took action against an income-share agreement (ISA) provider “for misrepresenting its product and failing to comply with federal consumer financial law that governs private student loans.”
This is the first time the federal government has cracked down on false and misleading statements by proponents of ISAs.
The CFPB complaint alleges that the income-share agreement provider falsely claimed that ISAs are not loans and failed to provide borrowers with the private student loan disclosures required by law. The lender also violated the ban on prepayment penalties for private student loans.
So, are income-share agreements educational loans? The CFPB clearly thinks so, but what does the law say?
What Is An Income-Share Agreement (ISA)?
An income-share agreement is a form of debt in which the borrower pays a percentage of their income (or discretionary income) for a specified period of time. For example, an ISA might require a borrower of $10,000 to pay 4% of income for 10 years. Like a student loan, the borrower makes a monthly payment in exchange for money to pay for their education. How the payment is calculated is irrelevant to both ISAs and student loans being forms of debt.The idea of ISAs aren't new - it's been around for over half a century. However, with the rise of the student loan crisis, the popularity of these programs is rising.
Milton Friedman, the Nobel Laureate, first proposed the idea of ISAs in 1955 in a paper, The Role of Government in Education. Yale University tried a cohort-based version of ISAs in the 1970s but abandoned it after borrowers complained about never satisfying the requirement to end the obligation.
What Is Debt (A Quick Primer On The Law)
A debt is an obligation to make payments according to an agreement. [15 USC 1692a(5)]
Interest is the right to have the benefit that accrues from something, such as money or property. In the case of a debt, interest is an amount paid for the use of money. Interest is a type of finance charge, which is defined as “the sum of all charges, payable directly or indirectly by the person to whom the credit is extended, and imposed directly or indirectly by the creditor as an incident to the extension of credit. The finance charge does not include charges of a type payable in a comparable cash transaction.” [15 USC 1605(a)]
The law gives examples of finance charges, including “interest, time price differential, and any amount payable under a point, discount, or other system or additional charges.” A time price differential is the difference between the immediate cash price of a product or service and the amount paid in installments or at a future date. The definition of finance charge does not require an amount to be identified as interest.
Thus, the legal definitions of debt and finance charges are sufficiently broad as to cover ISAs.
The Truth in Lending Act (TILA) [15 USC 1601 et seq], also known as Reg Z [12 CFR 1026], requires lenders to disclose the amount financed, the finance charge and the equivalent annual percentage rate. TILA also requires several disclosures for private student loans upon application/solicitation, approval and acceptance. [12 CFR 1026.46] These disclosures include information about the interest rates, fees, repayment terms, cost estimates and eligibility. Lenders must also disclose alternatives to private student loans, such as federal education loans, and various rights of the borrower.
Where Do ISAs Fall?
Proponents of ISAs often claim that ISAs aren't loans because they don't charge interest, per se, and the borrower might end up paying less than the amount borrowed. But, they are still a form of debt according to the legal definitions above.
A student loan is still a student loan even if it charges a zero percent interest rate, offers loan forgiveness and bases the loan payments on a percentage of income as opposed to the amount owed.
For example, federal student loans offer income-driven repayment plans with monthly payments based on a percentage of discretionary income. The remaining debt is forgiven after 20 or 25 years in repayment. Yet, federal student loans are still considered loans.
Contrary to the claims of ISA proponents, ISAs are not the solution to the student loan problem. They are just another form of debt.
Some borrowers may end up paying more in total under an ISA than under a traditional student loan. Some ISAs may violate usury laws. Some ISAs may limit eligibility based on the borrower’s academic major, GPA, age, race, gender and geographic location, potentially violating anti-discrimination laws.
Mark Kantrowitz is an expert on student financial aid, scholarships, 529 plans, and student loans. He has been quoted in more than 10,000 newspaper and magazine articles about college admissions and financial aid. Mark has written for the New York Times, Wall Street Journal, Washington Post, Reuters, U.S. News & World Report, MarketWatch, Money Magazine, Forbes, Newsweek, and Time. You can find his work on Student Aid Policy here.
Mark is the author of five bestselling books about scholarships and financial aid and holds seven patents. Mark serves on the editorial board of the Journal of Student Financial Aid, the editorial advisory board of Bottom Line/Personal, and is a member of the board of trustees of the Center for Excellence in Education. He previously served as a member of the board of directors of the National Scholarship Providers Association. Mark has two Bachelor’s degrees in mathematics and philosophy from the Massachusetts Institute of Technology (MIT) and a Master’s degree in computer science from Carnegie Mellon University (CMU).