Purdue’s Fintech Experiment: An Alternative to Pricy Student Loans

Purdue University, which prides itself on teaching innovation, is joining with a financial technology startup in an unusual partnership that may pave the way for lower-cost tuition payment options for students at other higher education institutions some day.

Starting May 2, juniors and seniors at West Lafayette, IN-based Purdue can apply for a novel source of education financing that may help them avoid taking out high-interest private loans.

Purdue’s new mechanism for paying tuition and other university fees is probably more familiar to students at non-academic Silicon Valley code schools than at traditional midwestern U.S. colleges. Instead of taking on loan debt, students can pledge to pay a set percentage of the income they earn after graduation, for a fixed number of years. That fintech innovation is called an income sharing agreement or ISA, and it’s already used outside the United States and in a scattered group of U.S. schools such as the coding boot camp App Academy in San Francisco.

Purdue’s president, former Indiana governor Mitch Daniels, started exploring the idea last spring as a means to spare students from graduating with “a mountain of debt,” says Brian Edelman, (pictured above) chief operating officer of the Purdue Research Foundation, a non-profit that manages the university’s endowment, research funds, facilities, and intellectual property. Daniels asked the foundation to figure out whether income sharing agreements could work for Purdue students.

The foundation has been coordinating with Reston, VA-based fintech startup Vemo Education to design the terms of the income sharing agreements. Vemo is in line to become the “master servicer” of the financial agreements, handling underwriting and servicing of the contracts with Purdue students, both in-house at Vemo and through subcontractors. The foundation also hired two non-profits to get expert advice—-Sacramento, CA-based 13th Avenue Funding and the New York-based Jain Family Institute.

13th Avenue is running a pilot ISA program at Allan Hancock College, an 11,500-student community college in Santa Maria, CA. The organization says it is the first campus-based program for income sharing agreements in the United States. Like Vemo, 13th Avenue is offering to customize ISA programs for post-secondary education institutions. The non-profit has its own mechanisms in place to advance money to schools to cover tuition and fees while students with ISAs are still working toward their degrees. So far, Vemo only manages ISA contracts and doesn’t advance funds.

The initial capital for Purdue’s income sharing agreements will come from the Purdue Research Foundation, which is ready to invest $5,000 or more per eligible student, per year, foundation spokeswoman Cynthia Sequin says. The maximum amount depends on the total of the student’s other debts, such as student loans and previous ISAs. The foundation is not publicly specifying any limit on the total funds available, or the number of students that could be served during the ISA program’s test phase. “This will be gauged by the student interest,” Sequin says.

Edelman says Purdue may be the first large U.S. higher education institution to try ISAs—-he says he hasn’t heard of others.

“We know of none, which isn’t to say there aren’t any,” Edelman says. But the word about Purdue’s experiment is out, and other universities have been inquiring about the fledgling effort. For the time being, the foundation and Purdue’s financial aid office have been so busy constructing the program that they haven’t been able to advise other schools, he says. And first, they want to make sure it will work.

“We do not know whether we’ve created the New Coke or the first iPhone,” Edelman jokes. “We hope it’s the iPhone.”

The ISA idea has its critics, who have compared it to indentured servitude and have worried that some students will repay much more than they financed. The endeavor also has a choppy history among fintech companies. When San Carlos, CA-based Upstart was founded in 2012, the plan was to invest in the potential future earnings of promising graduates by advancing them funds to pay off high-interest student loans, or to found startups. But in 2014, Upstart set aside that plan and became an online loan provider. Pave, a New York-based online lending startup, received more than 10,000 applications for its short-lived college ISA program, the Wall Street Journal reported. But its plan to raise money for the students’ tuition foundered when institutional backers declined to invest—for fear the graduates wouldn’t pay up after graduation, according to the newspaper. Pave was only able to fund 70 students before it scrapped the program.

Meanwhile, Vemo is forging ahead with ISAs, but it’s working with schools one by one to tailor income sharing agreements to fit the specific needs of each institution and its students. Vemo recently announced that it signed a contract with its first programming school, the new Holberton School in San Francisco, whose non-accredited program trains students to be full-stack software engineers. Holberton’s first class of 32 students, who began their studies in January, are attending tuition-free. But future classes will be offered ISAs to cover tuition for the two-year program.

Vemo’s origins trace back to the founding in early 2015 of Austin, TX-based startup Vested Finance by entrepreneur Lorne Abony, whose original idea was to sell ISAs through a mobile app. But Abony later decided that Vested contained the seeds of two separate business models that would work better as independent entities—-an ISA platform and a mobile app offering guidance on college decisions. The app became San Francisco-based startup Schoold.

In August, three Vested staffers—Tonio DeSorrento, Jeff Weinstein and Bill Brosseau—founded Vemo, with Abony retaining a role as investor and Vemo board chair. Abony is now CEO of FastForward Innovations, an investor in Vemo’s $2 million seed financing round, along with Goal Structured Solutions and University Ventures.

Vemo, which has eight employees, is in discussions with other schools about income sharing agreement partnerships, chief of staff Kerry Schneider says.

Under Holberton’s program, the school will receive no tuition revenue from the ISAs (or from Vemo) until students complete its coursework and start working. At that point, graduates will pay 17 percent of their annual income over a three-year period to Holberton, via Vemo. In the meantime, Holberton spokesman Joseph Eckert says, the school is funding operations through its $2 million in seed funding from investors including Trinity Ventures, Partech Ventures, and Yahoo founder Jerry Yang.

Based on Holberton’s estimates of average starting salaries for software engineers, the school predicts that graduates will repay a total of about $45,000, Eckert says. The total payback amount is capped at $85,000, even if a graduate earns an above-average income. Holberton will separately pay an undisclosed amount for Vemo’s services. Students can forego an ISA and simply pay tuition fees. But they’d pay the maximum—$85,000.

At Purdue, tuition revenues will flow in immediately to the university, even though the student pays nothing on the ISA contract while earning a degree. The tuition money will come from a “Back a Boiler” fund created by the Purdue Research Foundation for this purpose.

“Boiler,” short for “boilermaker,” is a nickname for Purdue students that originated with the working class origins of early attendees at the state school, which was founded in 1862 as a land grant college. The legend is that the school recruited its athletes from the ranks of boilermakers, or other strong, blue-collar workers such as stevedores.

“Boilers” who sign income sharing agreements will make payments to the “Back a Boiler” fund once they start working.

Edelman says Purdue’s core mission—keeping costs low while delivering a high quality education—dovetails with the goals of the new income sharing agreement program. Undergraduate tuition for Indiana residents has been kept down to $10,000 a year, and 2017 graduates will not have seen an increase over their four years on campus, he says.

Even so, some students can’t meet Purdue’s relatively modest charges through scholarships, grants, and federal education loans alone. Edelman says all those sources should be tapped before students and their parents consider other options. (The interest rates on federal student loans range from 3.86% to 6.41%, according to the U.S. Consumer Financial Protection Bureau.) But if there’s still a gap, he says, an ISA can be a better bet than a private loan with interest that starts accumulating while the students are still working towards graduation, and continues to accrue after they start working.

Still, Purdue graduates will repay more than the face amount of the tuition money advanced by the foundation. The repayment terms are set to deliver “some return on capital” for the Back a Boiler fund, Edelman says. The student payments will also cover the cost of hiring Vemo, and of legal services to deal with hitches that may arise, such as students who decide “to go to Nepal and not participate in the labor force,” he says.

Depending on the design of a school’s ISA program, an ISA may be preferable to private bank loans. A school can include provisions that protect students from mounting debt they can never repay by linking their payment amounts to their income levels; capping the maximum total repayment; and offering flexible payback options under certain conditions. In contrast, private loans may have interest rates as high as 16 percent, and variable rates that could rise over time, according to a college financing guide by the Consumer Financial Protection Bureau. The interest also starts accumulating while the student is still in school. And there may not be flexible payment options during setbacks such as a job loss.

At Purdue, the ISA repayment schedule will vary for each student. The most important factor is the student’s major field of study, because that sets their future income expectations. Students can figure out what they’d pay using the comparison tool on the Back a Boiler website. In general, students preparing for a higher-paid profession will pay a smaller percentage of their incomes, for a shorter period of time, than a student studying to qualify for positions in lower-paid fields. This may seem unfair, but a slice taken from a high salary yields a higher amount to repay a debt than a similar share of a modest income.

The Back a Boiler comparison tool shows the following potential outcomes: Computer engineering majors who finance $32,000 through a Purdue ISA would pay 9.38 percent of their annual incomes for 7.3 years. The expected average starting salary is $60,000. If such a graduate never received a raise—the opposite of Purdue’s predictions—he or she would repay $41,084.

Keeping all other factors such as class rank equal, English majors who finance $24,000 through an ISA would pay 9.84 percent of their annual incomes for 9.3 years. The expected average starting salary is $33,000. If no raises came during the repayment period, such a graduate would repay $30,199.

But Purdue predicts the incomes of both types of graduates would rise over time—though at a higher rate for the computer engineers. So their annual repayment amounts would climb accordingly.

The Purdue ISA program has some built-in flexibility. When Purdue students get a bachelor’s degree and then go on to graduate school, their repayment period doesn’t start until they finish the higher degree and begin working, Edelman says. If a graduate is working after college, but makes less than $20,000 in any year during the repayment period, payments are waived for that year, he says.

The Purdue program also caps the total amount repaid by graduates, even those who are wildly successful. A “rocket scientist” who lands a job on Goldman Sachs’ trading floor after graduation, and pulls down $1 million in the first year, would not have to repay close to $100,000 that year, Edelman says. The total repayment is capped at 2.5 times the amount advanced toward university fees. The stock trader who had financed $10,000 through the Back a Boiler program could write a single check for $25,000 and be done with repayments, Edelman says.

“Hopefully, we have created something students will want to use,” Edelman says of the ISA program. If hundreds of students sign up, it could be deemed a success, he says. “Then and only then would we think we’d created something of note.”

During the test phase, the Back a Boiler fund will only draw on money from the Purdue Research Foundation. But if the program’s track record of repayments looks good after three to five years, Edelman says, the foundation would approach alumni as well as institutional investors to chip in money.

But the foundation’s long-term aim is to prove that income sharing agreements are beneficial, and thus “prime the pump” for the creation of a ubiquitous market for ISAs, he says.

“Our intent is to put ourselves out of business,” Edelman says.

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