Good news for ISAs: CFPB Consent Order offers new regulatory clarity
September 13, 2021
By Jim Courtland
Last week, the Consumer Finance Protection Bureau (CFPB) published a Consent Order with Better Future Forward (BFF), a nonprofit ISA provider.
Importantly, the Consent Order clarifies how Income Share Agreements should be regulated and asserts that ISAs are a form of loan.
While the ISA industry has long sought to differentiate Income Share Agreements from conventional loans, Outcome welcomes this new regulatory oversight. Moreover, we believe this development to be good news for the ISA industry, paving the way for higher education providers and investors alike to enter the ISA space at scale.
What the order does:
– The Consent Order defines ISAs as a form of consumer credit – a type of loan. It therefore indicates that communication to borrowers may not imply that an ISA is not a loan or does not create debt for the borrower.
– The Order clarifies the regulatory framework under which ISAs will be handled (i.e., as loans) and recommends several disclosures to be included in ISA contracts. These disclosures are derived from the Truth in Lending Act (TILA), and include effective APR, nominal finance charges, etc.
– The Consent Order requires ISA providers to allow students to prepay their obligations without incurring prepayment penalties. Outcome Group has already pioneered the use of APR caps, which address the prepayment penalty issue which the CFPB highlighted. Outcome’s APR calculations mimic the APR calculations on a loan and differ in meaningful ways from BFF’s practice of marking up the ISA borrowing amount and then applying a growth rate, which was cited as problematic by the CFPB.
– The consent order requires ISAs to be dischargeable in bankruptcy.
Despite the initial reaction by many in the ISA sector, this CFPB guidance is great news for the ISA industry!
The Order appears to be an example of CFPB rule-making via enforcement action rather than a condemnation of ISAs or Better Future Forward specifically. This is illustrated by the fact that the CFPB chose not to fine BFF, and instead simply highlighted a few steps BFF needs to take to come into compliance.
Additionally, in deciding to regulate ISAs at all, the Consent Order suggests that ISAs are a valid way to offer education financing in the first place. This order specifically does not invalidate any existing ISA contracts, it just requires amendments to specific elements of the obligations. To us, this is extremely encouraging.
This move by the CFPB is well-aligned with Outcome’s prior views.
Specifically, we believe that while ISAs are an innovative form of financing, they still constitute a credit obligation on behalf of student borrowers. While we will be the first to highlight the many benefits to borrowers of the ISA structure relative to a traditional loan, we have never believed that the ISA structure requires a novel regulatory framework.
What’s more, we certainly do not favor an environment in which ISAs are outside of regulation. ISAs are a highly flexible financing tool, and one that can easily be misapplied as a novel way to take advantage of borrowers. Leaving the regulatory door open creates an opportunity for bad actors to misuse the ISA structure to the detriment of borrowers and the industry in general.
By bringing ISAs under regulatory oversight, companies like Outcome are enabled to bring safe ISA financing to a growing number of student borrowers. That said, since ISAs are different from conventional loans, much thoughtfulness will be required as to how to fit ISAs into an existing regulatory framework built for conventional loans. This Consent Order is a vital first step towards determining what constitutes best practice and what should not be permitted in the ISA industry.
What this means in practice:
The Consent Order’s identification of a prepayment penalty in BFF’s ISA contracts offers guidance on best practices for issuing ISAs. Given the nature of the ISA structure, which depends on future outcomes unknown to both borrower and lender at the time of origination, there is no effective interest rate or APR that can be precisely known for a given ISA contract in advance. That said, we can use certain terms of the contract to calculate upper and lower bounds on the cost to borrowers and to ensure that these bounds are in compliance with regulatory guidance.
We can draw three broad conclusions from the recent CFPB guidance:
– ISA issuance should strive towards compliance with TILA. Outcome took this view even prior to CFPB guidance, including TILA-compliant disclosures and effective APR information in our ISA origination process.
– Marking up ISA amounts for the purpose of calculating rate-based total payment caps, per BFF’s process outlined in the Consent Order, should be avoided. In the absence of the markup, APR caps are a straightforward way to ensure that prepayment is affordable and fair. In fact, Outcome sought to add such a feature to our ISAs prior to this Consent Order. We did this because we felt it was a necessary student protection, and that the use of effective APR was the most logical solution despite it being a concept usually associated with conventional loans.
– Nominal aggregate payment caps can result in excessively high realized APRs for borrowers who prepay their ISA contracts early when applied in isolation (rather than in combination with other time-based caps). As a result, aggregate payment caps should be implemented with care to ensure that they do not constitute a prepayment penalty.
The bottom line:
While ISAs will always differ from loans in important ways—such as built-in repayment insurance for borrowers and forging shared incentives between schools, lenders, and students—this new guidance is a crucial step forward for the maturity of the rapidly expanding ISA industry. Minimizing risks to borrowers, educators, investors, and ISA providers allows us to focus on what’s really important: providing affordable, outcomes-based financing to the upcoming generation of leaders and thinkers.