Can Income Share Agreements Replace Student Loans?
Here’s how an Income Share Agreement (or an ISA) works: An investor or the college itself provides funding for students – which is still a loan. When the student graduates, he or she agrees to pay a portion of their salary back for a certain number of years – not a set minimum payment as with traditional student loans. This means you can end up paying back less or more of what you were given, depending on your income.
“Instead of owing a set debt, students promise a percentage of their future earnings for a defined period,” says Jocelyn Paonita Pearson, founder of The Scholarship System where she shares her own experience of securing six-figures in scholarships and graduating debt-free.
Income share agreements use a percentage of pay to calculate what a graduate owes that month. “This can offer some level of security if a student takes a lower paying job, including down the road, making the monthly payments less, based on their income,” Pearson says.
Colleges Offering Income Share Agreements
Purdue University offers Income Share Agreements to their students. Here’s how the college breaks the “Back a Boiler – ISA Fund” down:
- For students who need additional funding, there is now an alternative to Federal Parent PLUS and Private Student Loans. The Purdue Research Foundation is now offering an Income Share Agreement (ISA) called Back a Boiler – ISA Fund.
- Back a Boiler – ISA Fund is available to Purdue’s Sophomore, Junior and Senior level students. The funding is limited. As the concept of an ISA is new, we have a list of Frequently Asked Questions (FAQ) that will help you learn more about it.
- In short, an ISA is an agreement where you receive funding while you are in school. When you leave school, you will pay a fixed percentage of your income for a fixed number of years. For some students, this will make sense and for others, the alternatives may be better.
Another example comes from the American Enterprise Institute, where resident fellow Jason Delisle penned a report touting a bank-like $50,000 line of credit to students. Under the AEI model, participating students would accept the line of credit in exchange for repaying 1% of their income after graduation for every $10,000 they receive, capped at 1.75% the amount borrowed over a 25-year repayment period.
“For many undergraduates, the repayment terms would be as good as they are today,” Delisle states in his report. “Students who borrow against their line of credit for graduate and professional degrees, and undergraduates who go on to earn high incomes, will pay more than under the current program because they would lose access to the current system’s overly generous loan-forgiveness terms.”
“The terms of a federal ISA will be easier for student borrowers to understand,” he adds. “Similarly, income-tax-based repayments will make it easier than today’s cumbersome income-based repayment program for borrowers to have their payments set.”
Pros and Cons of ISAs
Like any new college financing initiative, the early returns show both positives and negatives, according to Logan Allec, a CPA, personal finance expert and owner of the blog, Money Done Right. Here’s how Allec breaks the issue down:
Pros of Student Loan Income Share Agreements
1. You only pay when you are employed.
A Statistica study found that 3.8% of college graduates dealt with unemployment upon graduation. “If you end up being one of the many who struggle to find a job after graduation, you will not have to worry about paying off your ISA during this time,” Allec says.
Most ISAs pause payments if you are unemployed for any reason, Allec adds. “Also, most ISAs require a minimum amount of income before taking a percentage of your salary,” he says. “For example, the University of Utah pauses ISA payments for students making less than $20,000 a year.”
Additionally, unlike many student loans, interest will not accrue during your unemployment.
“You won’t have to deal with your credit score taking a nosedive or the persistence of student loan bill collectors,” Allec notes.
2. There’s a cap on payback amount and repayment period.
Generally, schools set a limit towards the amount that you will pay back through your ISA, which could be anywhere from 100% to 250% of your loan amount.
“If you end up starting a million-dollar company in the future, you won’t have to pay back an exorbitant amount of money to your investors,” Allec says.
With ISAs, repayment periods vary from 30 months to 10 years. “Unlike student loans, your financial obligation generally ends on a certain date,” he adds.
3. Low rates for high-income majors are an option.
Majors with a high starting salary – such as STEM degrees (science, technology, engineering and mathematics) generally have less expensive payback terms.
“For example, college students interested in a major with a high starting salary might have to pay back 3% of their salary for eight years,” Allec says. “This could end up being less expensive than borrowing a traditional student loan.”
“On the other hand, students interested in a major with a low starting salary (such as English or the creative arts) might have to pay back 5% to 7% of their salary over 10 years,” he adds. “Note that rates vary widely from school to school.”
Cons of Student Loan Income Share Agreements
1. An ISA won’t cover all college costs.
Most students choose ISAs as a part of their financial aid package, along with typical student loans. Generally, the maximum offered by an ISA is $10,000 per year, Allec notes.
That’s a problem as the cost of attendance can be upwards of $30,000, depending on if a school is in-state or out-of-state or a private school.
“If you haven’t gathered enough grants and scholarships to cover the cost difference, you may have to borrow traditional student loans as well,” he says.
2. It can potentially be more expensive than student loans.
Depending on the terms of your ISA program, it could ultimately end up being more expensive than student loans. “If you secure a high-salary job after college, you may end up paying more than you would be paying back a traditional student loan,” Allec says.
3. ISAs aren’t regulated.
ISAs are fairly new and few schools offer them nationwide. Each school, or investor, offers its own rules and regulations within its ISA program.
“These rules may include higher percentage rates for low-income students and higher repayment caps,” Allec says. “ISAs also don’t offer the same protections that federal student loans offer.
For example, ISAs don’t provide public service forgiveness, income-driven repayment plans and forbearance.”
The Takeaway on Income Sharing Agreements
Are income sharing agreements worth considering if it’s available to you?
A growing number of college financing market observers certainly think so – with some things to understand and keep in mind.
“The student loan system in America is broken and an alternative to traditional student loans is overdue,” says Michael Greig, a personal finance blogger at NinjaBudgeter.com.
That said, income share agreements are a fairly new concept, and there are multiple ways that a student could be taken advantage of in such an arrangement, Greig says.
“If you’re considering entering into such an arrangement, make sure that you understand the terms completely,” he advises. “Take the deal to a trusted lawyer, and make absolutely sure that you know exactly what you’re signing up for.”
“The last thing you want when you start your new career is to find out that you’re giving up more of your income that you thought because you missed some of the contractual fine print in the ISA.”