Are Income Share Agreements a Healthy Alternative to Traditional Student Loans?
Income Share Agreements (ISA’s) have become an increasingly popular credit option among public universities, as well as a new financial product offered to for-profit colleges and career schools. Under an ISA, students pledge a predetermined portion of their future income to pay for their present-day tuition. Payments are typically 5-10 percent of the student’s annual salary for a set number of years after graduation.1
Repayment terms often vary depending on the graduate’s earning potential. For example, a philosophy major typically will pay a higher percentage of salary than an engineering student.
A typical ISA looks something like this: Martha, a coding school student, chooses an ISA, rather than a traditional loan, to pay the $15,000 tuition required to attend. Martha is required to pay 10 percent of her gross income for 48 months after graduating. If her annualized income falls below $30,000 in a given month, she doesn’t have to pay. When her income exceeds $30,000 again, she will need to resume making payments. Martha’s total payments are capped at 200% of her tuition.
When Martha enrolled, she could have signed an installment contract with the same 48-month term, an APR of 8.99%, and a monthly payment of $373.20. So which option was better?
Traditional Loan Option
At $373.20 per month for 48 months, Martha would have paid a total of $17,913.81, or 119% of her tuition.
The average annual salary for a software developer is $59,000. If Martha earned an average of $59,000 during the repayment term, she would pay $23,600, or 157% of her tuition.
For both Martha and her lender, the contract is a gamble. If Martha goes on to a lucrative job, her lender earns more (limited by the 200% cap) and Martha risks paying more (as she did in the example above). But if Martha earns very little and pays back less than he or she received, her lender absorbs the loss.
ISAs seek to align the goals of students with their expectations from the education provider they attend. Proponents note that colleges have a financial stake in the success of students whose education is funded this way, something that is not the case with regular student loans. With income-share agreements, schools make less if their graduates make less and more if they make more.2
There are also downsides. In addition to the student’s risk of paying more as a reward for earning a higher salary, some ISA’s have provisions that pause the repayment period during months where people don’t earn enough. This could effectively extend an income-share agreement for someone’s entire working life. Payments as high as 20 percent could last longer than a decade.2
Repayment is also more complicated than with a regular student loan, because students have to regularly provide tax returns, payroll stubs or other evidence of how much money they earn. Failure to provide that information in a way that meets the exact terms of the agreement could throw the contract into default, converting it into a debt subject to collections, even wage garnishment.
Another potential risk is the possibility of inequities among repayment terms among similar students attending different schools. A study performed by the Student Borrower Protection Center (SBPC) provided examples tougher repayment terms for students of historically black colleges and universities (HBCU’s), despite choosing the same major as a student who did not attend a HBCU.
A defining feature of the marketing of ISAs is the idea that the contracts are not student loans or not even a form of credit. However, legal experts increasingly agree that ISAs are simply another form of consumer credit that are subject to consumer protection laws like the Truth in Lending Act, the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, and the Consumer Financial Protection Act of 2010.
What’s the right answer? Income Share Agreements do offer unique alignment between a student’s desired outcome and his/her school’s responsibility to offer high-quality training. But any student or school should be aware that they are a new, unregulated financial product with no shortage of risks and uncertainty.
1 A Novel Way to Finance School May Penalize Students From H.B.C.U.s, Study Finds, New York Times, March 25, 2021
2 New Kind of Student Loan Gains Major Support. Is There a Downside?, New York Times, December 16, 2019
3 See generally Aryn Bussey, “Educational redlining? The use of educational data in underwriting could leave HBCU & MSI graduates in the dark”, Student Borrower Prot. Ctr. (Jul. 24, 2019), https://protectborrowers.org/educational-redlining/.