Financial Literacy and ISAs
In December 2014, the Brown Center on Education Policy at the Brookings Institute conducted a study using nationally representative data and found that “among students with federal loans, 28% reported having no federal debt and 14% said they didn’t have any student debt at all.” In addition, they found “half of all first-year students seriously underestimate how much student debt they have, and less than one-third provide an accurate estimate.”
As I watch the spike in Financial Aid need and appeals driven by the COVID-19 pandemic, I’m thinking back to my own experiences in college and how I navigated financial aid. I only vaguely remember applying for my student loans in college, but I clearly remember making each payment. After graduation, I counted each month of deferment before my student loan payments kicked in, taking a chunk out of my meager salary as a first-year teacher. I agonized over the snowball and avalanche methods, using online tools like unbury.me and payoff.io to understand how interest accumulated and model different paydown scenarios.
In parallel to my student loans, I took out an income share agreement as I was graduating. Calculating those payments went much more smoothly; using math skills I’d acquired back in middle school, I multiplied the income share percentage by my monthly income and simply sent the payment in—no online tools required. When I left teaching, my income became more variable, but the simple math remained the same. Given that the payment stayed proportional to my earnings, it was always predictable and manageable.
When I interviewed at Vemo, I peppered our co-founders with questions about how they designed programs with the needs of both institutions and students in mind. The Vemo team knows that ISA programs are only successful if the program serves students well. Vemo has developed a proprietary model that guides program design by illustrating how different contract terms would impact both students and the originator. Vemo works with the originator to structure an ISA program that ensures students’ payment obligations are proportional to the value of the services students receive and that program cash flows to the originator match its needs.
Studies on debt literacy indicate that only one-third of the American population understands compound interest. In 2018, the National Financial Capability Study showed that 51% of student loan holders did not try to calculate their future monthly payments before taking on their loans. Research from Vanderbilt shows that a lack of financial literacy contributes to loan aversion, which can result in underinvestment in postsecondary education. At Vemo, we value the importance of financial literacy and take our role of helping schools help students seriously.
For most of our school partners, we collaborate on print materials and video content that explain the terms of ISAs in plain language and also include examples of different earnings scenarios that illustrate how ISAs change in different circumstances. Prior to applying, students can use tools like the ISA comparison tool which allows students to model different scenarios based on their terms. During the application process, we have questions that assess mastery over ISA terms, including questions like “How is your monthly payment calculated?” The first page of our income share agreements prominently displays the terms of the ISA and has a payment illustration featuring the monthly payments associated with different earnings. When students and obligors call, they speak with members of our operations team that collectively have more than 100 years of experience in higher education student finance.
A nationally representative sample of over 30,000 college students found that only 35% of college students took a personal finance course in high school. Of the other 65%, it’s safe to assume many students don’t know what they don’t know about personal finance. They’ve studied for exams in school, but after graduation, they may be blindsided with a new kind of test. Across public school leaders, financial aid administrators, student loan providers, and student success companies like ours, each of us has a role to play in ensuring that our college students have the tools necessary to make informed decisions about their financial futures.
- Brookings Institute— Are College Students Borrowing Blindly? [link]
- Debt literacy research [link]
- Boatman research [link]
- National financial capability study [link]
- AIG— Money Matters on Campus [link]