Here's An Alternative to Student Loans

Students pay a percentage of their income after graduation.

July 23, 2013— -- The higher education system that so many students see as a ticket to a better life sometimes seems to work against them -- particularly if they're from low-income families. College is getting more expensive, students are taking out more loans than ever, and Congress can't agree on how to get interest rates under control.

One microlending program in California, 13th Avenue Funding, thinks it might have found that alternative to the current education-lending market.

Call it the "pay it forward" approach: 13th Avenue gives low-income students access to critical funds, then offers pay-as-you-go terms to graduates. Those who benefit from their college degrees pay back. Those who don't pay less, or nothing at all.

It's not so much a traditional loan as a venture capital approach to college funding, says Bob Whelan, chief executive of the initiative.

13th Avenue isn't operating in a vacuum: Different versions of the "pay it forward" model are starting to garner attention from government officials.

Oregon's legislature recently passed a bill that calls for a pilot program to test the idea. It would let students at the state's universities pay back their tuition as a percentage of their income after graduation without having to pay tuition up front.

Australia, too, has a similar model, where students pay a percentage of their income after graduation to cover their college costs.

In each case, the idea is to have current students pay back money that will eventually fund the college costs of future students, who will in turn fund a new set of students down the line.

In the case of 13th Avenue, students who previously attended community college receive $15,000 to help pay for their third and fourth years of a bachelor's degree program. Once they begin earning more than $18,000 per year, they pay five percent of their salary to the group for up to fifteen years.

The students are encouraged to go after scholarship money and possibly even federal loans as other options, and to use 13th Avenue to fill the gap.

The program launched just last year in Southern California, and there are only 11 student participants so far. It's far too early to decide whether it will be a success since no students have graduated and started jobs yet.

But for a student who graduates and makes just $20,000 per year (people making minimum wage and working full-time earn about $15,080), it actually makes some sense.

The program is obviously less ideal for students who graduate and immediately begin earning sizeable salaries: They would pay out far more than they were initially given. Someone who makes minimum wage, however, would never pay for their degree.

Zakiya Smith, strategy director for Lumina, an independent, private foundation looking to increase the proportion of Americans who have access to a college education, says she sees both benefits and drawbacks to the "pay it forward" model.

"It could potentially ease some of the concerns about the financial risk people take when they go to college," said Smith, who previously served as a senior policy advisor to President Barack Obama.

But there's also uncertainty, because students don't know exactly how much they'll make after graduation, so they don't know how much they'll pay. For student loans with fixed interest rates, students have the ability to calculate the ultimate cost at the beginning.

Eddie Triste, 32, a member of the program studying sociology at Sacramento State University, said he likes the idea of paying more out than he was given, because it goes toward another student's future, a student from a poor background that has gone through the same struggles to get to college.

"It's not putting it into a machine," he said. "It's a way to develop future students and bring a little humanity back into the education system."

There are still risks involved in the 13th Avenue model. The program is new and the founders are still working out how to handle those who default. And on the students' ends, greater career success could theoretically translate to a whopper of a bill.

Different "clubs" of students who receive the funding are contractually bound together, meaning if three members of a four-person club earn less than $18,000 and one earns $200,000 per year, the richer member could be on the hook for the entire club's debt.

But Whelan counters that they plan to grow the operation by having students join together, so the clubs could consist of students who trust each other. The students, or club members, can negotiate terms among each other, too, such as a year off from payments to take care of a sick relative -- a flexibility that most educational lenders don't offer.

Membership also comes with community-building obligations, Whelan said. Students have to do 20 service hours per year. That can range from "evangelizing" about the organization to volunteering with younger students, whatever the club agrees upon.

The students in the program are hand-selected, and Whelan said he and his co-founders are cognizant of the fact that so many young people are financially illiterate and could benefit from mentorship.

The program's current participants all attended Allan Hancock College, a community college in Santa Maria, California, and are the first in members of their low-income families to pursue higher education. Most are Hispanic, and many learned English as a second language. One is undocumented, which means he was unable to apply for some loans and scholarships. The young man cried when he was told his immigration status didn't matter to 13th Avenue, Whelan said.

Smith can see how the model would appeal to Hispanics, in particular. Latinos are more likely than other demographics to distrust things like banking institutions, and the fact that something like 13th Avenue creates a sense of community around its participants might hold appeal.

Right now, the program is seeking funding from foundations, but it's been slow going. The idea is to export the model to other cities. Potential donors like the concept, Whelan said, but want to see if it works out before shelling out any money. The founders and some of their family members are funding the venture at the moment. 13th Avenue is also in talks with an all-black college on the East Coast (Whelan declined to say which one) to implement the program college-wide.

Whelan, who worked in investment banking for about 25 years, said he was blessed to live in a family that was able to put him through college at Dartmouth and then a business degree from Stanford, and that there's nothing more "fundamental" than education.

"I think debt is absolutely insidious for a poor kid with no shock absorbers," he said. "It's a very bad way for a poor kid to finance a college education."

Smith says she's approaching such new loan models with "healthy optimism and healthy skepticism." It's still too early to see whether 13th Avenue or a pilot program in Oregon will be successful.

"More than anything, we need people talking about new models," she said. "That's the best thing."

What do you think? Would you consider a program like 13th Avenue as an alternative to traditional loans?