The Regulatory Treatment of ISAs Just Got a Lot Clearer

A little more than a year ago, the Consumer Financial Protection Bureau (CFPB) announced that it had signed a consent order with nonprofit income share agreement (ISA) provider Better Future Forward (BFF). This marked the first time that a federal regulator had publicly stated its belief that ISAs are subject to the Truth in Lending Act (TILA), a key federal law that helps borrowers understand the full cost of financial products and helps protect them from predatory lenders.

But at the time of that announcement, the CFPB provided no guidance on how ISA providers should comply with the law. ISAs, after all, are different from traditionally structured loans where the borrower must repay the borrowed amount (principal) in full, as well as interest applied to that principal. In contrast, an ISA contract does not create an inherent obligation to repay any amount. The obligation is triggered only if the borrower earns a certain amount of income, with the monthly payment amount representing a fixed percentage of those earnings, and the contract expiring after a specified time period, no matter how much the borrower has repaid.

This fundamental difference makes it unclear how ISA providers should comply with TILA. For example, while traditional loans can easily disclose the loan’s cost in the form of a single annual percentage rate (APR), the income-contingent nature of ISAs means that there is a range of possible APRs. TILA’s regulations, however, require the disclosure of a single APR and do not consider multiple APRs, let alone a range.

Luckily, the CFPB has been working with BFF over the last year to design a TILA compliance plan, and BFF has recently published the application, approval, and final disclosure documents resulting from that plan. This development is noteworthy for several reasons:

• Compliance requirements are clearer. While this compliance plan technically only applies to BFF, it offers the first concrete guidance on how the CFPB views ISAs in the context of TILA. Risk-averse ISA providers may therefore choose to voluntarily redesign their disclosures to reflect the approach in this compliance plan. ISA providers still face a complicated and uncertain regulatory treatment, but this compliance plan represents a major step toward greater regulatory clarity.
• ISAs are officially unique. The compliance plan reveals that while the CFPB believes that ISAs are legally considered loans and, therefore, under the CFPB’s jurisdiction, its position is that ISAs are a different kind of loan, one without interest. This is exactly the position for which JFF has been advocating: The CFPB should have jurisdiction over ISAs, ISAs should be subject to TILA, and how ISAs comply with TILA should take into account that ISAs are unique and not like other loans. The CFPB appears to agree with this position.
• Federal legislation is necessary. The BFF compliance plan reveals that the CFPB is constrained by existing federal laws designed for traditionally structured loans. This forced the CFPB to pound a square peg into a round hole, with the result that, for many fields in the required disclosure document, ISA providers are directed to write “N/A.” This may check the legal compliance box, but it is clearly not optimized to ensure that borrowers know what they’re signing up for. It is a triumph of formalism—adherence to existing rules—over what is best for borrowers. The compliance plan is the clearest evidence yet that we need federal legislation to direct and empower the CFPB to create clear and thoughtful regulations that are unique to ISAs.

ISAs offer significant promise to improve accountability, access, affordability, and equity in the postsecondary education and training system, but lack of regulatory clarity has hindered the development of ISAs and left learners vulnerable. The CFPB’s compliance plan with BFF represents significant progress toward a clear and thoughtful regulatory framework, and the industry should continue proactively engaging with regulators at the federal and state levels. Ultimately, however, federal legislation is needed to ensure that regulatory guardrails are strong and clear, and that ISA providers are properly and responsibly serving learners.