Human Capital Contracts: A New Innovation in College Financing
Human capital contracts are an innovative financial instrument for financing higher education. They can potentially replace or reduce college loan amounts for promising students. With higher education costs skyrocketing, many prospective students are being priced out of the top schools. They will carry a mountain of student loan debt even if they attend. In some cases, the student has a choice whether to go to the best college they get into as long as they are willing to take on a mountain of student loan debt or to go to a college they are not as excited about that will lead to a more manageable student loan debt load. This is not a fair choice, yet with tuition skyrocketing and showing no sign of slowing down, this is a reality. Human Capital Contracts seek to solve these problems.
What are these contracts?
Boiled down, Human Capital Contracts involve students entering into a contract with a funding source. This funding source is usually a foundation or corporation, though sometimes it could be a wealthy individual. Consequently, the student agrees to pay a fixed percentage of their income after graduation for a set time. Traditional loans must be repaid beginning six months after graduation. The payments are often fixed and start at a high level immediately. Even those that are deferred carry increasing costs as time goes on. Human capital contracts, on the other hand, grow with you, becoming a fixed percentage of your income. Thus, you always have a high percentage of your income to keep, no matter what you make.
You will likely pay a relatively equal amount on a human capital contract than you would have with student loans. If you do end up paying more, it is likely because you were successful more quickly than is usual, a good thing all around! But you pay a percentage of your income with a human capital contract. This makes financing everything else in life much more comfortable.
Human Capital Contracts Risk
Human Capital Contracts are not without risk. The student risks paying back more than they might otherwise have had to pay on traditional loans. The investor in Human Capital Contracts faces the chance that the percentage of the student’s income that they will collect will fall short of what they would have gained through a more traditional investment vehicle.
The best evidence for the potential of Human Capital Contracts is a government-backed system in Australia, where students repay college costs by forfeiting a percentage of their after-college income. Instead of a fixed period, the students continue paying until their entire debt with reasonable interest is repaid.
Human Capital Contracts Market
Human Capital Contracts allow students to pursue an education they might otherwise not be able to afford with either money their parents or they have saved or through student loans.
Enter the corporation, foundation, or wealthy individual who has learned that investing in potential is a way to make money and fulfill a mission. These groups have traditionally sought to invest in companies, products, currencies, real estate, etc. But the bottom line is that they might be plenty willing to invest in anything that could provide a solid return. Human Capital Contracts allow corporations and foundations to invest in a person’s potential with a mutually beneficial outcome.
After College Choices
After college or graduate school is over, Human Capital Contracts continue to be beneficial as many companies hire those students they once supported. And even if they don’t directly hire the student, if they have chosen where to invest wisely, they end up with a good investment over time, and the student ends up with a payoff method that is much more fair and less burdensome than student loans during the initial years of building a career. The corporation or foundation is often incentivized to provide graduate training and help develop a successful career since that outcome is a win-win. It can also help their marketing and PR efforts if customers know they are generous in supporting promising students.
Human Capital Contract Types
Human capital contracts are most commonly associated with undergraduate education costs, the most common use for these financial instruments. Of course, this makes perfect sense given the high cost of an undergraduate education and the burden that a high student loan debt places on the student post-graduation. The risks and rewards are high for the investors, as they often fund a prospective student with little work history and an unknown post-graduate future. If the right students are matched with the right investors, a human capital contract can pay off while the student happily pursues a positive career path.
Specific Kinds of Contract
But what are the other types of human capital contracts? There are actually several:
Human capital contracts for graduate school.
These financial instruments are most commonly seen in fields where there is almost a guaranteed payoff or at least a likely path. For example, a student with high achievement as an undergraduate who wants to go to medical school may seem like a low risk – as long as they finish medical school, the later income stream from which the investor’s payoff will likely be high.
Human capital contracts for re-training or trade school.
Sometimes, the cost of picking up a trade, such as becoming a plumber or electrician or re-training to deepen and expand specific career skills, is high. Usually, the costs are not as high as post-graduate education, but still, they can be prohibitive or at least challenging. A human capital contract that covers these expenses and then asks for a payoff when the career begins, or resumes could be used.
Human capital contracts in business
A human capital contract could presumably be used by a small business owner who draws a salary and needs money for expansion or start-up. In this case, after the business improves, the investors will collect a percentage of the increase that the small business owner can pay him or herself. This less direct type of human capital contract is not usually seen but certainly fits the mold of what these funding instruments are all about.
These are the three most common uses for this type of funding instrument. We will update this page as we discover more ways investors and people with financial potential match their needs.
Others Who Apply for Human Capital Contracts?
Human capital contracts can provide prospective undergraduate or graduate students with programs that have more flexible terms and even better rates than traditional funding solutions. Most commonly, those who do not qualify for a conventional path or cannot get sufficient value to pay for their schooling use them.
However, those with superior academic or occupational achievement thus far may also use them. Unlike traditional funding based on purely financial factors, human capital contracts are more specifically counting on your potential, and students who meet these criteria may also want to preserve as much money as possible to build their early careers.
If you fall into this group and don’t like the rates and terms a traditional lender offers, you may want to look into human capital contracts.
Human Capital Contracts: The Bottom Line
Human capital contracts are not well known, especially compared to other types of crowdfunding and peer-to-peer lending you find here and elsewhere, but it may grow as more students and investors find new success with this method.
We predict that human capital contracts will take off in popularity and use. Since the funders of the human capital contracts can pick and choose among promising students and select those likely to pursue a fruitful path, this will be like traditional lenders being able to choose who they let borrow more carefully. We think defaults will be low, and the benefits will be substantial.
