That’s the approach taken by a social enterprise called Lumni that has raised $17 million to finance the education of a wide array of students in Chile, Colombia, Mexico and the United States. Lumni offers “human capital contracts” to people like Jairo Sneider, who grew up in a low-income, single parent family in Colombia.
Sneider’s dream was to attend college so he could become a nurse and serve his community. To do so, he needed $8,500 — a sum that is close to the average annual income in Colombia. The problem is that financial aid and student loans are far less abundant in Colombia than they are in the United States. Sneider, who was unable to provide collateral or a cosigner, had little hope of getting a loan from a traditional lender.
Here’s the deal that Lumni struck with him: In exchange for $8,530 in financing, Sneider agreed to repay 14 percent of his salary for 118 months after he graduated. At that point, regardless of how much he has paid, his obligation terminates. Although this might sound similar to a loan, an “income contingent” repayment plan like this is far less risky for a low-income student like Sneider. If he has trouble finding a job or switches careers and earns a lower salary than expected — very distinct possibilities — his payments will drop automatically. The terms are, in fact, determined based on his expected earnings. If he ends up earning the average salary for nurses in Colombia, he will end up paying the equivalent of an interest rate of 17 percent, which is the average rate in the country for a student loan. And if he ends up doing better, he will pay more, and Lumni will share in his success.
Lumni has made similar deals with 1,900 students to date. Fifty five percent of them are women and 90 percent are the first in their families to attend college. Most of these students would have otherwise been unable to pay for college. So far, the default rate is under 3 percent.
Education is a wise investment, but it carries risks. Many students fail to graduate. The attrition rate for university students in Colombia is over 50 percent. In the U.S., a third of college students fail to compete their degrees within six years; the most common reason is financial difficulty. But even those who graduate have no guarantees. Many graduates struggle to find work; others find that salaries are lower than anticipated. Today, as a result of the sluggish economy, many young people are defaulting on their student loans, something that can damage their future job prospects and make it difficult to buy a home.
Because of the risks, many students, especially from low-income families, are wary about taking on considerable debt. Millions underfinance their education. They live at home, go without meal plans, try to get by without purchasing text books, or work long hours — all of which make it less likely that they will complete their degrees.
So how do we finance something that is extremely valuable both for individuals and for society — something that, in most cases, shouldhappen, but often won’t happen because the risks are too high?
The best way is to spread the risk. That’s how insurance works. In Lumni’s case, students share the risk with investors, who make more or less based on how well the students do. But they also share it with one another. Lumni pools its investments into funds to balance out the risks. They know that some students will run into difficulties, some will achieve average success, and some will do very well — but they don’t know in advance how any individual student will fare. And students don’t know this themselves. Through diversification, however, their funds can achieve stable returns.
What this means is that the students who have the biggest problems benefit the most. And, in effect, those who decide to become investment bankers end up subsidizing the ones who decide to become social workers. Since a good society needs many different roles fulfilled, everyone benefits.
That, at least, is the theory. Economists are skeptical about human capital contracts — which were first proposed by Milton Friedman in the 1950s — because they have many potential problems and little track record. But Lumni seems to be making them work — at least on a small scale. Whether it can succeed at a larger level remains to be seen.
Lumni was founded by two Colombians, Felipe Vergara, a consultant and entrepreneur who is based in Miami, and Miguel Palacios, an assistant professor of finance at the Owen Graduate School of Management at Vanderbilt University. Growing up in Bogota, Vergara had attended a subsidized private school, which accepted students from a variety of backgrounds. After graduating, he was saddened to discover that some of his close friends could not afford college. Later, he met Palacios, who had done research in human capital investments. Together, they saw an opportunity to address a pervasive problem. “The idea was to provide capital not based on a family’s financial situation,” explained Vergara, “but based on a student’s potential — and without requiring collateral or a cosigner.”
Lumni now has nine years of experience doing this. Vergara says that more of its students have been happily surprised by their earnings than unhappily surprised. Only 11 percent of its students in Colombia have dropped out of college — a rate 80 percent lower than the national average. Economists had warned that human capital contracts would be difficult to enforce. But so far repayment has been consistent across all four countries.
The biggest difficulties have been getting over regulatory hurdles and raising investment capital. Even though Lumni’s early funds were for-profit and performed well, investors remain tentative. However, one set of investors — so-called impact investors, who like to achieve a balance of profitability and “social return” — have embraced the idea. About 80 percent of Lumni’s investments have gone into non-profit funds that are targeted to achieve social goals like financing the education of students who come from indigenous communities, are disabled, or want to work as teachers in rural areas. These nonprofit funds can finance more students than scholarships or grants, because the money is replenished. They act like “pay it forward” scholarships.
Lumni has just begun making investments in the U.S. to provide gap funding to low-income students in California, whose average shortfall, after other sources, runs from $4,000 to $7,000 a year. Krystal Shipley, a sophomore at the University of Redlands, received financing earlier this year. Shipley, who is the first person in her family to attend college, couldn’t make ends meet. “I didn’t really know what to expect until I was actually in college,” she told me. She didn’t want to put more financial pressure on her mother, who had struggled with unemployment. Lumni offered her $4,000 in exchange for 1.7 percent of her income for 120 months after graduating. (Lumni says that this would be the equivalent of a 6.5 percent interest rate if Shipley hits her expected salary.) Shipley prefers this arrangement to taking on more debt. Like many sophomores, she is undecided about her major and has little sense of her earning potential. Whatever happens, Lumni’s payments won’t be oppressive.
To date, 300 of Lumni’s students have graduated and 70 have finalized their obligations. Some have become successful enough to become investors. “Our history is too short to say it can work on a massive scale,” says Palacios. Nevertheless he and Vergara expect that Lumni’s for-profit funds will soon outpace its nonprofit funds as the organization continues to amass data about the reliability of the contracts — and the students. (It took a quarter century for bankers to recognize that micro-loans were commercially viable.)
For Vergara, proving that human capital investments work is essential to unleash the talents of millions. Government subsidies and financial aid are insufficient to address the demand for college financing at the global level: private investors will need to jump in — but it won’t work if they simply offer students more high-interest loans, as they have in the past. To serve millions of low- and moderate-income people, college financing has to be redesigned so it brings less risk and fear.
“The most important asset in the world is people,” says Vergara. “But modern society hasn’t organized itself in a way to invest in most people. I like to think of Lumni as a springboard that allows people to pursue their dreams — it offers a way out of a situation where the ceiling is very close to your head.”
If you have a story to share about your student loan experience, please write in. On Friday, I’ll respond to comments, discuss how Lumni’s experiences have challenged the expectations of economists, and explain how Lumni works to maximize its students’ success.
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David Bornstein is the author of “How to Change the World,” which has been published in 20 languages, and “The Price of a Dream: The Story of the Grameen Bank,” and is co-author of “Social Entrepreneurship: What Everyone Needs to Know.” He is the founder ofdowser.org, a media site that reports on social innovation.
