When Does an Income-Share Agreement Make Sense?

Income share agreements (ISAs), while not widespread, have crept into the financing mix for some colleges and universities. This form of financing is designed as an alternative to loans like Federal Parent PLUS loans and private education loans.

ISAs may be attractive if parent borrowers are ineligible for Parent PLUS Loans and private student loans are cost prohibitive. For those with a broader menu of financial aid choices, ISAs are compelling for a limited set of circumstances unless they are designed to offer lower-cost financing.

Federal Loans First

Federal student loans are almost always less expensive than income-share agreements. Students should exhaust eligibility for federal student loans before considering an ISA.

Most ISAs are designed to be comparable to the total cost of a Parent PLUS Loan. However, the actual cost of an ISA is dependent upon future earnings and may end up being more or less expensive than standard loan choices if income deviates sharply from what is expected.

A Parent PLUS Loan, if available, is usually a superior alternative to an ISA because it contains an embedded option for income-driven repayment in addition to more traditional level payment options. Low-income borrowers can reduce payments to 20% of discretionary income and have a portion of the loan forgiven after 25 years in repayment. Parent PLUS loan borrowers retain the flexibility to transfer the risk of lower future earnings to the lender while avoiding the possibility of paying substantially more than expected if their earnings are high.

ISAs make more sense when Parent PLUS Loans aren’t available due to an adverse credit history.

Mind the Cap

The most important term of an ISA is the maximum aggregate payment amount. Without a payment cap, a student’s payment liability would be theoretically unlimited!

This cap is typically expressed as a multiple of the total funding provided to the student. Most programs set the limit at 2x the amount of funding awarded.

This level of payment is comparable to what would be owed on a no-fee private student loan with a 10% interest rate and a10-year level repayment term or a 6% interest rate and 20-year term. This assumes an average of 32 months during the in-school and grace period, with accrued but unpaid interest capitalized once at repayment.

Purdue University’s Back-a-Boiler ISA program is a notable exception with a cap equal to 2.5x total funding. At the other end of the spectrum, Colorado Mountain College’s Fund Sueños ISA program has a cap equal to the funding provided. Purdue’s program is backed by private investors while the Fund Sueños program is a philanthropic initiative.

If the student believes they have the potential to earn far more than expected, an ISA is unattractive — particularly if the payment cap exceeds 2x.

But, a payment cap closer to 1.5x or less makes an ISA a risk worth taking for most students. Total student loan payments typically exceed that multiple if the repayment period is a standard ten years and the interest rate is 5.6% or higher.

Some ISAs base the cap on a multiple of income, not the amount received. That could significantly increase the total payments, so watch out for such sneakiness.

How Far Away is Graduation?

Most ISA programs change the income share percentage and payment period based on the year in school. Income share percentages tend to be higher the further away a student is from graduation. And payment periods tend to be longer. The result is the expected total cost of an ISA is higher for a sophomore than for a senior.

On the flipside, there is usually less risk for the sophomore that the total payment under the ISA will be substantially higher than expected due to the payment cap (which is the same for all ISAs in a given program). It is also less likely the ISA will exceed the cost of a private loan if graduation is a few years away — especially if the payment cap is set at 2x or less. If graduation is far off and a Parent PLUS loan is not an option, an ISA may be compelling.

Does the Major Matter?

Some ISA programs factor in a student’s academic major when setting the income share percentage and payment period. If a student has a major with a relatively low expected future income, they will often be required to pay a higher share of their earnings over a longer period of time than a student pursuing a more lucrative career. This is the case with ISAs offered by Purdue and the University of Utah.

Other ISA programs offer students the same payment terms regardless of major. These include programs offered by Colorado Mountain College, Clarkson University, and Norwich University. Students with less future earning power at these schools, based on their major, may find ISAs more attractive. These ISA programs effectively result in higher earning graduates subsidizing the education financing costs of lower earning students, even when all program participants’ income levels match the projections.

ISA Programs Are Still Evolving

ISA programs are still relatively new and will likely evolve. Most programs are still considered experimental and have limited funding. Every existing program provides for automatic payment deferral or forbearance when a graduate’s annual income is below $20,000. All existing programs are at least open to undergraduate students within a year of graduation. Most new ISAs are linked with specific colleges or universities, as opposed to directly with private investors.

Clarkson University

Clarkson University in New York offers the Lewis Income Share Agreement Program to 20 new students each year. The program application requires a brief video or essay submission. The income share rate range depends upon the year in school but is the same regardless of the student’s major. This makes the ISA program potentially more attractive to students that expect modest earnings in the first few years after graduation as they are not required to repay a higher percentage of their income than peers with higher expected starting salaries.

Colorado Mountain College

Colorado Mountain College offers the Fund Sueños (Dream Fund) for students who are not eligible to receive federal student aid. The program is designed to serve students with Deferred Action for Childhood Arrivals (DACA) status who live in Colorado. Charitable donations to the Colorado Mountain College Foundation provide funding. Students with a Fund Sueños ISA never pay back more than the amount of funding received — making this a true free-financing alternative.

Lackawanna College

Lackawanna College in Pennsylvania offers an ISA to students in selected associate’s degree programs and juniors and seniors in selected bachelor’s degree programs. The standard repayment term is about five years — shorter than most ISA programs.

Norwich University

Norwich University’s pilot ISA program currently serves about 35 students. Funding is provided directly from the Vermont university’s operating budget. The program is designed to retain students with financial need. The $5,500 dollar amount available per year is meant to replace the gap left by the end of the Federal Perkins Loan program in 2017. Students must have sophomore standing or higher to receive an ISA. The income share rate range is determined by year in school but is the same for all majors. This makes the ISA program potentially more attractive to students that expect modest earnings in the first few years after graduation as they are not required to repay a higher percentage of their income than peers with higher expected starting salaries.

Purdue University

Purdue’s Back-a-Boiler is the largest ISA program in the country. It is funded by private investors procured by the Purdue Research Foundation. The income share rate is determined by the amount of funding, year in school when funding is received, and major — sophomore standing is required to receive an ISA. One potential drawback is the maximum repayment amount is 2.5x the aggregate funding. The effective cost of financing could prove especially high for students that have higher than expected earnings. For example, an English major earning $75,000 per year after graduation would end up paying 40% more for each $1,000 of funding taken as a sophomore than with a Parent PLUS loan at 7.08%, and 25% more than a 10-year private loan at 9.5%.

University of Utah

The Invest in U pilot ISA program is available to seniors with one of 18 qualifying majors — including those related to engineering, education, business, and nursing. ISA recipients repay a flat 2.85% of earnings regardless of their major. However, the required payment period is determined by major. Payment terms are up to 79 months for engineering graduates but are as long as 127 months for education-related majors and other professions with lower expected earnings. Most other qualifying majors receive a 98-month payment term. For those whose earnings are consistent with national averages for their degree, the ISA option may be slightly cheaper than a Parent PLUS Loan if the payment period is 79 or 98 months. However, those with the 10-plus year ISA term will likely only save money vs. a loan if their earnings are lower than expected.

ISA Program Details Matter

If Parent PLUS Loans are not available and Direct Unsubsidized Loans don’t provide enough financing, a student may want to consider an ISA if offered. Especially if they are unable to obtain a cosigner for a private loan. ISAs do not require cosigners. The choice between an ISA and a private loan is more complicated. The right decision turns on the interest rate and repayment term of the private loan, the payment cap, income share percentage, and payment period of the ISA, as well as future income scenarios.

When comparing ISA programs, calculate the income percentage per $1,000 in funding received. It may also be helpful to multiply this figure by the length of the payment term.