Rethinking return on education investment

Remember when big banks used to offer high-interest but well-branded credit cards to college students? The “10 CDs for a penny” scam? Or worse, student loans marketed to a sophomore mulling a spring break trip who wound up saddled with decades of debt?

You’ll be glad to know that after a sustained regulatory assault (and, perhaps, a wiser generation of college students), 1990s-era on-campus marketing by credit card companies and financial institutions has been, largely, cleaned up.

Of course, that doesn’t mean that the risk — and opportunity — for students and financial institutions has diminished, as college is likely the second-largest expense for a person (after buying a home) and will drive their financial future for a generation.

Nearly half get their first credit card before turning 21. Twelve million Americans take out student loans, which now exceed credit card debt, each year. Recent graduates frequently check their student debt status more than once per month, providing loan servicers with unprecedented insight into the financial habits of tens of millions of young Americans.

As a result, a new generation of tech-enabled startups are beginning to reimagine how students finance their education — and make the financial transition from college to career. Higher education’s transformation is, in turn, fueling a trillion-dollar convergence of fintech and edtech that aims to blur the line between learning and earning — and will force students, colleges and financial institutions alike to think differently about return on education investment. Here are four mega trends driving the shift.

College search 2.0

Gone are the days when students read through college guides or US News and World Report to find the right college match. More than a million students have downloaded the Schoold app, which allows them to do their college searches from their mobile devices. Soon, high school students will be using smartphones to compare post-graduate salaries, by major, by school., which raised $4.5 million in 2015, helps high school students choose which courses (and extracurricular activities) to pursue to earn-down the cost of college by telling colleges enough information to underwrite a scholarship. Full financial aid forms are being filled out on SaaS platforms like CampusLogic, which radically alter the loan experience by allowing schools to, for example, recommend how much debt is appropriate for each degree program.

These new apps are quickly changing the dynamic of the customer relationship away from banks and financial institutions and toward companies at the intersection of edtech and fintech.

Shared risk and reward

Loans are no longer the only option for how students can pay for college. Students now have an equity alternative. Income share agreements, or ISAs, conceived in the 1950s and recently made famous through Purdue’s Back a Boiler program, now offer graduates flexibility: Payment obligations scale with a graduate’s ability to pay, preventing undue burden during times of financial hardship. This pay-later model enables graduates to pursue lower-paying, high-satisfaction or public interest career pathways. For low-income students, it means the cost of college will be based on their performance, more than their parents’ tax returns.

The intersection of fintech and edtech is not, of course, without risk.

The Back a Boiler program, powered by Vemo Education, allows schools to price programs differently (e.g. an engineer may have a larger percent of income due per year than a history major). On the other side of the risk equation, colleges can now purchase, through LRAP, an insurance policy that pays out if a student is unable to pay back their loans. Suddenly the “price” of failure becomes clear, and students (and perhaps regulators) can quickly ascertain which colleges (and even which programs) are adequately preparing students for employment. Purdue University announced a new initiative to help other colleges and universities adopt and adapt this model, offering a way to quickly scale this approach.

Radical community lending

A new generation of millennial entrepreneurs is correcting what the big banks and colleges got wrong by turning the aggressive marketing tactics of yesteryear into an “education first, sales second” perspective.

Student aid pioneer SoFi built itself on a community of borrowers hosting career networking sessions. Lower rates were a key selling point; however, as SoFi’s first chief community officer, Pete Hartigan, told me, “millennials are smart, and they want to be treated in a transparent and fair manner. Like the original days of small-town banking, digital brings back the importance of community with the goal of trying to help all players in the market to feel economically smart together as a community.”

This community translates into a redefinition of the lender-to-student relationship. Lenders are realizing that they are better off providing career counseling to students behind on their payments rather than initiating court proceedings. Some lenders estimate that helping a borrower find a job will increase their financial return (by as much as 10 percent) without the criticisms dogging many traditional lenders (see the recent Navient lawsuit, for instance).

The death of FICO

In the not-too-distant future, “A” students may pay lower interest rates than their less studious peers. Dan Feshbach, who exited fintech platform LoanPerformance, has turned his sights toward developing a FICO alternative dubbed a “Merit score,” to provide lenders, historically dependent on the credit scores of a student’s parents, with forward-looking insight into their risk or potential.

Here’s why: Eighteen-year-olds have a “thin” credit file, with little data for FICO to generate a score — making FICO almost irrelevant for a student borrower, which forces parents to “co-sign” loans for their children. Lower-income students rarely have high-FICO parents, putting them at a radical disadvantage for receiving loans. Students with rich parents may have an easy time finding a co-signer, but their grades may indicate they are not yet prepared for college.

Backed by data, suddenly a student’s transcript and historical academic performance creates an alternative Merit score, where — in a transparent manner — a student, their parents and their college can have an evidence-based, specific way of measuring whether or not a student will repay debt.

College students are trend setters for cheaper, technology-enabled financial products. Once these products gain traction in colleges and universities, it’s only a matter of time before the power of disruptive innovation is unleashed. It should come as no surprise if tomorrow’s fintech unicorns start out as edtech companies.

PeerTransfer (renamed Flywire) started in 2010 to help colleges process payments from international students. Today, they’re taking on the Western Union monopoly of international money transfers. Marketplace lenders like SoFi, Common Bond and Earnest began as student loan consolidation plays and have now raised billions in the transition into next-generation financial institutions. Together, these lenders have more than $5 billion of market value between them, and will originate close to 10 percent of all private loans in 2017.

The intersection of fintech and edtech is not, of course, without risk. The plight of credit card hawkers crowding college walks on orientation day should loom large. But there are risks that must be mitigated by government subsidy or other charitable investment. For example, with increased transparency, certain courses of study will be shown quite clearly as uneconomical — fewer history students and artists. There also is a risk for fewer second chances for students who struggle academically, perhaps for reasons unrelated to their own abilities.

However, done well, the new generation of lenders and information providers can create a new breed of company that can potentially apply pressure to education providers to invest in outcomes. These companies can help expand access, and unlock the promise of higher education for low-income students who might otherwise be left on the economic sidelines.

The Trump administration is expected to relax regulations to allow the free market to reign across the education landscape. These new “fedtech” companies would radically increase the information required for the free market to operate, but we should be mindful that the regulatory pendulum swings, and so each business model should be able to survive the free-market test of the current administration while also maximizing survivability in an era of increased regulation.