Paying for College – Radical New Concept Could Eliminate Student Loans

When it comes to funding the costs of higher education, there is growing sentiment that our current system is in bad need of an overhaul.

By all measures, the costs of college continue to soar. At the same time, securing affordable credit amidst the current economic downturn has never been more challenging.

With many experts insisting that a college diploma is slipping beyond the grasp of a number of students, a radical concept for funding higher education first proposed by economist Milton Friedman in 1955 is now gaining traction. The concept, called human capital contracts, provides the out-of-the-box thinking that could dramatically shift the student financial aid landscape moving forward.

Equity-Like Instrument
The idea is to move from traditional debt-style methodology to what economists call an equity instrument. In essence, a group of investors agrees to cover a portion of the cost of higher education for a student in return for an equity share of the student’s future earnings for a fixed period of time.

Since students would not be borrowing a sum of money at a specific interest rate, they would theoretically graduate with zero college debt. At that time, the repayment on the initial investment would come from a specific percentage of the student’s earned wages. Because the student does not need to earn a specific sum each year to meet past debt obligations, the future financial hardship for graduates would be dramatically reduced.

A student choosing a lower paying profession would pay back a smaller sum during the time period that someone choosing a higher paying profession. In human capital contracts, the greatest risk moves from the student to the group that has funded a portion of the student’s education.

The thinking is that such a concept would likely increase the pool of students willing to consider careers in non-profit sectors such as teaching or health care. Instead of shaping their career choice around the need to pay back what they might have borrowed, students would be free to pursue any line of work they deemed most rewarding.

It would also definitively shift some of the costs of higher education away from the more traditional funding methods, especially federal and state grants. This would help both levels of government deal with the challenges of multiple funding priorities at a time when taxpayers want to see tax reductions.

Concept Catching On
It seems that the concept has been catching on in both Europe and Latin America. One such company, Lumni, appears ready to bring the concept to the United States.

Critical to making the concept work is a complex sliding scale of terms. A company investing in a student majoring in a profession like engineering and attending an institution like MIT would need a smaller overall percentage of return since that student would likely have substantial future earnings. On the flip side, a history major attending a community college would face a higher overall assessed percentage.

The concept holds great weight for those who want to see higher education itself be more responsive to students. Once the concept is rolled out, the thinking is that investors would offer the best terms to students attending schools that produce real value, well-educated students and high degree completion rates.

The responsibility for seeking out such information would move from students to the investors. Savvy companies wanting a solid return on investment would theoretically force colleges to be more forthcoming about critical data related to student success rates.

Ultimately, proponents of the concept insist the process would push schools to prepare students for future success.

Creative Concept
While no one is suggesting the complete elimination of state and federal involvement in higher education, many believe the time has come for the concept of human capital contracts to enter the funding formula. Legal ramifications, including those related to default and bankruptcy, still exist and therefore must be carefully resolved.

Still, those who are asking for more creative, out-of-the-box thinking, now have a unique idea to consider. The critical question may well be how students feel about selling a piece of their future earnings.

Flickr photos courtesy of djukami and LeeBennett.