Income share agreements have entered the fray as a way to pay for college instead of student loans. However, although an income share agreement (ISA) is not a student loan, it should still be evaluated with caution.
On the surface, these agreements can look like income-driven repayment plans for federal student loans in which you pay a percentage of your income for a certain period of time.
But in reality, making good on these agreements can end up being much more expensive than both federal and private student loans.
What is an income share agreement?
An income share agreement is an alternative to student loans, though it isn’t technically considered a loan. It’s a contract in which an entity (facilitated by the university or a private group) pays for an amount of your college education. In exchange, you agree to pay a certain percentage of your gross income over a period of years.
Often the payments are capped at a multiple of the amount of tuition paid through the ISA. For example, if an ISA is for $10,000, the contract can have a cap of two times that amount so that the payments made by the student can’t exceed $20,000.
The total cost of making good on the agreement will depend on your future income. You could end up paying less than if you were to take out traditional student loans, but often an ISA exceeds that amount.
Right now, ISAs are very common at schools that offer engineering or math-based majors, though they are growing in popularity across the United States.
How do income share agreements work?
Plenty of ISAs are offered through schools, but there are also private institutions starting to offer them as well.
There are no formal rules for ISAs, so the terms may vary from contract to contract. Because ISAs aren’t technically debt, they also don’t have a stated interest rate like conventional student loans do.
Each ISA contract has certain characteristics or terms:
- ISA funding amount: The amount of money that the ISA will pay toward the borrower’s education.
- Monthly payment: Typically a fixed percentage of monthly gross earned income (from wages and self-employment) that the recipient of the funding is agreeing to pay.
- Payment term: The set period of time in months or years that the fixed percentage of income is paid.
- Payment cap: The maximum amount that a student is required to pay regardless of the payment and term. It’s usually expressed as a multiple of the funding amount.
The terms are mainly based upon your major and career prospects. For example, an engineering major may have a lower income share and a shorter term than an English major because engineers typically earn more.
These terms are set in an effort to provide the funders with an adequate return on investment given the risk associated with the ISA.
Let’s explore the pros and cons of income share agreements for a college student.
Pros of income share agreements
ISAs do have some positives in paying for college:
- Most people are out of their agreements in 10 years or less: ISA repayment terms can range from two years to 10 years. After that, paying for college is over and done with.
- Schools or the private entities behind the ISA are aligned with helping you secure a good job: The more you make, the more you pay in the ISA, the greater the return is for the investor. That means the investor wants to see you earn as much as you can, so they may offer resources to help you achieve that.
- Contracts are based upon where you’re headed: The contracts don’t typically look back to how you or your family have handled money in the past. Any money mistakes usually won’t penalize you from securing college funding with an ISA.
- Payment floor: If you’re unemployed or underemployed, you may not be required to make payments. However, it usually ends up extending the term of the ISA agreement.
- An ISA may end up costing less than student loans under certain circumstances: This is not a full-on “pro,” but if your income doesn’t meet up to expectations, the cost of paying back your ISA may end up being less than the funding received in extreme circumstances.
- Last resort: If financial aid falls through and private financial institutions won’t issue you private loans, ISAs may provide the funding needed to complete school.
Cons of income share agreements
Consider these potential downsides of ISAs:
- Prepayment is at great cost: The agreement must be paid back based upon the conditions in the ISA, including the monthly payments, term of payments and payment cap. Those that offer prepayment may require paying up to the payment cap in the disclosure agreement, which could push the implied interest rate above 20%, for example.
- Lack of consistency between agreements: An ISA for one student may look different than for another. There is no set of standards on how these terms and conditions are set.
- Interest rate is unknown and unstated, so the actual cost of loan repayment is hard to forecast: Because this isn’t technically a loan, there is no interest rate. It can’t be calculated until all of the payments are added up to satisfy the agreement.
- Payment stacking: If a student has a mix of federal loans, private loans and an ISA payment, a huge chunk of their income could be going to pay back those three different types of student debt, leaving little to invest and grow their net worth.
- No loan forgiveness: If a college graduate gets a job working at a Public Service Loan Forgiveness program-qualifying employer or ends up with a high debt-to-income ratio, then federal student loans would be a much better option due to potential loan forgiveness.
Income share agreement example
Let’s look at a hypothetical case study to illustrate how income share agreements work.
Gene is an electrical engineer at Purdue University. He has been able to cover college for his first three years but needs some help to cover the $25,000 of tuition, room and board for his senior year of college.
Purdue offers an ISA program called “Back a Boiler” (Purdue’s mascot is the Boilermaker). According to the school’s student financing comparison tool, the ISA consists of the following:
2.31x or $57,750
Let’s take a look at his projected cost and interest rate equivalents of fulfilling the agreement based upon the income share of the average electrical engineer, the “high-earning” electrical engineer, the “low-earning” electrical engineer and the income required to reach the payment cap.
To Reach Cap
This is not good.
The average electrical engineer graduate from Purdue would end up paying a 9.4% interest rate. There’s no refinancing opportunity either. The only way out of the ISA is to pay back the capped amount of $57,750, so Gene would be better off just riding it out.
Even if Gene ends up earning the low end of the income spectrum, his rate is just about the same as if he were to take out a private loan or federal loan then refinance after graduating. The difference is that the ISA has little to no flexibility compared with student loans.
Although this is just one example of an income share agreement, analyzing other undergraduate majors and universities paints a similar picture.
How to decide whether to pursue an income share agreement
Income share agreements have the potential to result in credit card-like interest rates to pay for college, so they should be avoided or viewed as a desperate last resort.
All other options for financial aid should be exhausted before entertaining the idea of entering into an ISA. Start with exploring grants, scholarships and federal student loans.
If federal student loans aren’t an option, then consider taking out private student loans if you have a low projected student debt-to-income ratio and have no loan forgiveness options (like PSLF) available for your career.
Even in the extreme circumstance where your private student loan interest rates would be in the low double digits, you could have the ability to refinance to a lower rate or pay them off early. ISAs don’t provide those options.
At the end of the day, it appears that income share agreements are one of the most expensive ways to fund a college education. Proceed with caution and avoid them except under the most dire circumstances.
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