Income Share Agreements: A Loan By Any Other Name

This article was my initial foray into researching income share agreements. Since I wrote this, I’ve learned a lot, and while this initial blog post is still valuable, I recommend reading the updated version, which has new information.

Let me paint a picture. You want to learn to code and you can’t afford to go to college. Or maybe you went to college and are having trouble finding a job that you like. You are told that there is a for-profit school called Lambda School and that they do a great job of getting people high paying tech jobs. You are told that the education at this for-profit college is fantastic: it’s even better than the education at an ivy league university. To pay for the school you are told that you should take out a special kind of loan called an ISA (which stands for “Income Share Agreement”). You are told that you won’t “pay upfront” and that you will only pay if you get a job. You are shown testimonials from many former and current students, and you might even talk to former and current students online, and they all have great experiences or stories about how they doubled or otherwise dramatically increased their income after attending this for-profit school.

Right off the bat, does this sound like a scam? It certainly does to me, and it should to anyone who knows anything about the for-profit education industry. But for some reason rather than being treated with skepticism, Lambda School was profiled in The New York Times as a possible solution to the student debt crisis. The company is certainly liked by investors: Lambda School recently raised a $30M series b. Maybe Lambda School is the greatest thing to happen to higher education. But it deserves a lot more scrutiny given the history of for-profit ed. This post is an attempt to begin the process of providing that scrutiny.

To students who had positive experiences with Lambda School: I truly am happy for you. But I think there are a lot of reasons why student feedback should not be the only metric used to evaluate education. There are enough red flags here to make a reasonable observer suspect that ISAs in general (and Lambda School specifically) should not be promoted as a solution to problems in higher ed.

I need to state upfront that I have absolutely no inside knowledge of lambda school. This is just my perspective trying to understand the website and the twitter. From the outside looking in, it’s very clear that some things don’t add up.

The costs do not add up

To provide the quality of education they claim to provide, Lambda School needs to spend money: money on teachers, money on technology, and so on. At the same time, Lambda School is a for-profit, and they need to make a significant profit to satisfy their investors. (If their investors just want to make education more accessible they could donate to community colleges, which have a proven track record providing pathways to education.) Lambda school, according to their website, is a nine month program, and the upfront cost of attending the program is $20,000. Admittedly, I don’t have any information on their per-student costs since that doesn’t seem to be information they provide, but it seems obvious to me (and hopefully it is to you) that while $20k (the upfront cost) might be enough to cover the expenses of a student for nine months, there is no way it would cover the profit margin Lambda School’s investors want. This price might be the result of investors subsidizing the cost of something to get traction in the early stages of a company, but expect either the prices to rise or the quality of education to drop in the future. Something isn’t adding up and people should be suspicious.

In this blog post, I’m using the costs given on the Lambda School website, but keep in mind that these costs are almost certainly going to increase.

ISAs: A predatory loan with gimmicks

Every loan has some sort of selling point to try to convince the borrower that the loan is risk free. In Lambda School’s case, the four gimmicks are:

  1. You don’t start paying back the loan until you get a job in tech.
  2. You don’t start paying back unless your starting salary is at least $50,000
  3. After 5 years, you no longer have to pay back any remaining debt.
  4. The maximum students can pay (including interest, although lambda school doesn’t call it interest) is $30,000

Some of these gimmicks are genuinely great. For example, it’s absurd that student loans can last longer than five years. (It’s also absurd that student loans exist in the first place).

But I think there’s a tendency to cherry pick specific gimmicks as evidence that ISAs are a fantastic deal. In reality, given the whole context, I think there’s evidence that ISAs are predatory.

ISAs are loans: understanding interest rates and repayment plans

The Lambda School website misleadingly claims that there are “no student loans” in its program. Part of the confusion might be that since ISAs don’t calculate interest in the same way other loans do, there’s a perception that ISAs don’t have interest and aren’t loans. First of all, ISAs absolutely have interest, it’s just that they word the terms of the ISA in a confusing way so it seems like they don’t have interest. And second, interest isn’t what makes something a loan. There are actually loans with negative interest, i.e. the borrowers pays back less money than they borrowed, although these loans are typically for governments, not individuals. In general, the defining feature of a loan is that someone gives money to someone else in the present, and the receiver of that money is obligated to pay back money in the future. That’s exactly what’s going on with Lambda School’s ISA.

Lambda school’s website with the claim that Lambda graduates have no student debt.

Lambda School FAQ: "What are the interest rates for the income share agreement? The income share agreement has no interest. It's a flat percentage that goes away once you've reached the $30k payment cap, you've made 24 payments, or five years has passed since you graduated (even if you haven't paid us anything)."

As of the time of this writing, the upfront cost of attending Lambda School is $20,000. Upfront means how much a student would pay without taking a loan (what Lambda calls an ISA). This seems low given both the costs of providing the quality of education Lambda school claims to provide and Lambda School’s need to make a profit to satisfy investors.

For students who take a loan (an ISA) to pay for the upfront cost, the maximum amount they are expected to pay back is $30,000. The maximum length of time students repay the loan for is two years. Students pay 17% of their salary either until either they reach $30,000 or until the two years are up. There are a few caveats to this: students don’t start paying until they have a tech job that pays them at least $50,000, and after 5 year have passed since they last attended they don’t have to pay any more money.

Lambda School doesn’t use the word interest. But how does the cost of Lambda school go from $20,000 to up to $30,000 for students with ISAs? They charge interest, and the interest rate depends on the income of the student. Let’s take a student who gets a job after Lambda School with a salary of $50,000 and holds that job for two years. According to Lambda School’s calculator they pay $708.33 a month for 24 months, which comes out to $16999.92. In this case the interest rate was negative. That seems like a good deal!

However, most student loans require a much lower monthly payment than the student with a $50,000 salary would pay with a Lambda school loan. According to the federal reserve’s 2018 Survey of Household Economics and Decisionmaking, the average monthly payment is between $200 and $299. (This statistic is a range because in surveys if you ask respondents for exact numbers, the respondents will round the number in inconsistent ways). Meanwhile, in Lambda School, the monthly payment is $708.33 for someone making $50,000. Needless to say the monthly payment is on the high end for student loans. For someone living on $50,000 a year, with taxes and bills, that could be really steep.

In general, a supposed advantage of an ISA is that the loan goes away much quicker than a regular loan. I think everyone can agree that paying off loans quickly improves people’s lives immensely and that people would prefer to get rid of loans on a fast timetable. So the question is, since the typical monthly payment is approximately $250, why are lambda school students able to pay at minimum almost three times that? Admittedly I would like a more accurate number than $250, and I would like to know how payment size is affected by income; if anyone is familiar with research in this area please reach out!

The interest rates of an ISA don’t stay negative for long. For students who graduate and make $70,000, they’ll end up paying $991.67 a month for 24 months, which comes out to $23,800.08. This is an interest rate of 8.7% (yearly interest rate compounded monthly). For context, the federal student loan rate is 4.5% and the average private loan fixed rate is 9.66% . This isn’t a particularly good deal.

For students who make $90,000, they’ll end up paying $1,275.00 a month for 23.5 months, which is $30,000. The interest rate here is an insane 20.86%. (Yearly interest rate, compounded monthly.)

Annual Salary Monthly Salary Payment per month Months until payment completed Total payment Total Interest Simple yearly interest rate (no compounding) Yearly interest, compounded monthly
$40,000.00 $3,333.33 $0.00 N/A N/A N/A N/A N/A
$50,000.00 $4,166.67 $708.33 24 $17,000.00 -$3,000.00 -7.50% -8.10%
$60,000.00 $5,000.00 $850.00 24 $20,400.00 $400.00 1.00% 0.99%
$70,000.00 $5,833.33 $991.67 24 $23,800.00 $3,800.00 9.50% 8.73%
$80,000.00 $6,666.67 $1,133.33 24 $27,200.00 $7,200.00 18.00% 15.47%
$90,000.00 $7,500.00 $1,275.00 23.5 $30,000.00 $10,000.00 25.50% 20.86%
$100,000.00 $8,333.33 $1,416.67 21.2 $30,000.00 $10,000.00 28.33% 23.20%

The average student loan debt for most students is around $30,000 (CNBC gives $28,400) This is a bit misleading because students can end up paying more due to interest rates adding up. In 2015-16 the average tuition for a year at a two-year institution (e.g. a community college) is about $10,432 and for a year at a four-year institution it’s about $26,120. Lambda school takes about a year according to their website so on a year to year basis it’s not like students are saving enormous amounts of money or avoiding more debt than if they went to a different school. Admittedly, one of the questionable claims about Lambda School is that it compresses multiple years of education into one year, so depending on how you feel about the quality of education at Lambda then you might feel like you’re getting a good deal. But this is something to be taken with a huge grain of salt. Independent analysis of for-profit curriculums is hard to come by.

Since ISAs are essentially unregulated, lambda school borrowers don’t really have any protections. And although protections for student loans aren’t by any means great, they’re certainly better than nothing. The Lambda school website doesn’t seem to provide a lot of information as to what would happen to students who, perhaps, can’t make the ISA payments even with a $50,000 job. Students are essentially left to the mercy to Lambda School, and given the history of for-profit ed I don’t see how that will turn out to be good.

If nothing else, it’s misleading that Lambda School makes it hard to compare its terms to the terms of most student loans. They should immediately remove the claim that lambda students graduate with no debt from their website. They should also state the interest rates of their loans so that students can better compare them to traditional student loans. I think most people would find that Lambda’s ISA doesn’t compare as flattering to student loans as most people portray it to be.

And the thing to remember is that this is the best case scenario as far as pricing is concerned. It’s very easy to see that the prices are low given the profit Lambda School needs to make, and that prices will likely increase.

ISAs don’t incentivize for-profit schools to provide good education

A common claim is that ISAs are good because since schools get more money if their students make more money, schools are incentivized to provide really good education to ensure that their students get jobs.

I think if anything, it’s the reverse. For profit schools make more money in bad job markets. The reason for this is simple. If the economy is bad and people don’t have jobs, then people are going to be more willing to take on debt to get credentials and training to try to get better jobs. ISAs can stack up just like normal loans: it’s easy to see someone attending two bootcamps, or attending a bootcamp and a traditional college, and then getting one job and having to pay for two loans. This is what people already do: the number of degrees people are getting these days is steadily increasing.

For what it’s worth, the Lambda CEO is very open to the idea that students could return to Lambda for career retraining. The way it’s framed is that as people’s interests change, so will their career preferences. This is a completely legitimate view on career retraining. But the other half of the equation is that it’s easy to see how for-profit schools could be incentivized to create an environment where students keep returning to the school and keep taking out ISAs.

Like all loans, ISAs run the risk of a borrower not paying back the full amount. It’s possible to have a viable business model where not everyone gets a job within five years after graduation and therefor not everyone pays back the ISA. If the cost of providing education is low enough, then Lambda school can still make plenty of money even if they don’t get all of their students jobs. Some of the people who don’t get jobs immediately after Lambda School will attend other schools and bootcamps, take on more debt, and potentially get a job after that: despite Lambda school not being fully responsible they’ll still get paid. Remember, while it genuinely is great that students aren’t responsible for ISAs after five years, five years is a very long time for a job search, and is plenty of time for a student to get another degree or credential and then join the job market.

And it’s not like the Lambda CEO doesn’t have a history of lying about the incentives. Here he is implying Lambda is incentivised to spend money advertising to employers and disincentived to spend ad money recruiting students:

We’re filming for our next ad today. Unlike most schools our ads are going to be targeted at hiring companies, not students. That’s the power of aligned incentives. A school spending its ad dollars to get its students hired.

And here’s an ad for Lambda School. It’s not like this is hidden or anything: all I did was type “Lambda School” into Google:

Google adwords campaign for lambda school

ISAs are discriminatory.

It’s well established research that incomes correlate strongly with social factors like race, gender, and parental income. This research holds up even when controlling for things like career choice and length of time in the workforce. Tying interest rates to income means tying interest rates to factors like race, gender, and parental income. This is obviously discriminatory. And while Lambda School doesn’t do credit scoring, I find it hard to believe that the future of ISAs doesn’t involve credit scores just like other loans, meaning different populations would be offered interest rates based not only on their income but other factors as well. For “riskier” students, the terms of the ISA would be different: maybe instead of a cap of $30,000 students would be asked to pay a maximum of $40,000.

I’m not trying to claim that regular student loans aren’t discriminatory but it would be nice if something seen as the future of education would solve a problem like that.

If the Lambda School website are any guide, Lambda School seems to be trying to market itself as a solution to help companies hire more diverse workforces. It’s concerning that Lambda School is doing this while building around a fundamentally discriminatory model, and while seemingly taking no steps to at least understand the potential consequences of this.

Employers should bear the risk of training employees

It’s ridiculous that we’ve collectively accepted that the risks of job training should be born by students. If there truly is so much money in tech and if there truly is a huge unmet demand for qualified programmers, shouldn’t tech companies start paying for coding bootcamps themselves? Why is everyone recommending that people take out unregulated loans to attend untested institutions? The whole thing is completely unethical.

This post isn’t finished

I’m deeply concerned that even though the risks of for-profit education are well known, for-profit institutions are being allowed to reinvent themselves as places that “invest” in students. I’ll be doing my best to keep this post updated.