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What to Ask Yourself Before Using an ISA to Pay for College

May 24, 2016
Personal Finance, Student Loans
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Income share agreements enable students to fill a gap in college financing by agreeing to make payments to an investor based on a percentage of their income for a set period of time after graduation. As with most things having to do with money, there are a number of factors to weigh before you sign one of these deals.

Potential benefits

ISAs aren’t the same as debt. Unlike a loan, there’s no interest involved with ISAs, and you don’t have to pay back a fixed amount. Instead, you pay back a certain percentage of your income for the prescribed term of the contract, whether the total amount repaid is less or more than the full amount awarded.

As for your credit score, since you do have an obligation to pay, the fact that you make a payment will be passed on to credit reporting agencies, but no balance outstanding can be reported, according to Casey Jennings, chief operating officer of 13th Avenue Funding, a nonprofit that aims to improve college access for low-income students and that is running a pilot ISA program at Allan Hancock College in Santa Maria, California. “The idea is that you should get credit for making payments, and this will help you build up your credit history, but there will be no recording of your funded amount because there is no fixed obligation to make payments,” Jennings says. “As long as you’re making payments, it will reflect positively on your credit score.” 

Space to take a nontraditional path. Since ISA repayments are based on income rather than a prescribed amount, you may have more opportunities to explore after college — such as doing nonprofit work, traveling or starting a business — without worrying about big debt repayments immediately.

Dismissal in bankruptcy. Traditional student debt generally can’t be dismissed in bankruptcy. An ISA would be listed as an obligation in bankruptcy and treated like other unsecured payment obligations, such as credit card debt, according to the Purdue Research Foundation. A court could dismiss the payment obligation if a student were to become bankrupt. 

You won’t pay if you’re out of work. You can stop making ISA payments if you lose your job; after all, you can’t owe a percentage of your income if you have no income. Your repayment term typically will freeze until you find work again, and then the payments will adjust to your new income. Some ISAs, such as Purdue University’s Back a Boiler program, may also include a minimum income threshold you have to meet before repayments must begin. With private student loans, depending on the lender, the amount of time you can halt your payments due to financial hardship is typically limited.

Repayments might be capped. Depending on the ISA terms, you might have a payment cap. That’s most beneficial for those who end up earning very high incomes, so they don’t end up with exorbitant repayments. Purdue’s ISA program, for example, offers a repayment ceiling of 2.5 times the initial ISA amount.

Potential drawbacks

Your payments will fluctuate. You may prefer to make steady payment amounts, and you can’t expect that with an ISA. Unless your income stays exactly the same over the repayment term, your payments will rise as your income rises.

You can’t repay early. Unlike with a loan, you can’t pay off a balance early. Repayments must continue at the set percentage of your income until the end of the designated term is complete or a payment cap is reached.

Higher percentages can eat up your take-home pay. Depending on the terms of your agreement, your repayment could impact your budget more than you thought it would. If you end up making more money than you anticipated, you’ll owe more to your investor. However, your plan may include a cap on payments.

It’s not a loan, but … an ISA is still a legally binding contract involving repayment of money over time. “When someone owes somebody else back for money, it’s hard not to think of that as a loan,” says John Zurick, executive vice president of American Student Assistance, a nonprofit dedicated to higher education financing. Zurick says students must understand the fine print that outlines what would happen if they fail to make payments.

You can be sued for default. If you’re working but not making payments on your ISA, you may default on the obligation. If this happens, the ISA investor can take legal action against you.

There are no consumer protection laws explicitly for ISAs. Seth Frotman, student loan ombudsman for the Consumer Financial Protection Bureau, says it’s important for consumers to know the upfront costs and risks of financial products. The imprecise nature of ISAs makes it impossible to determine exactly what your monthly payments will be, so it’s more difficult to understand costs and risks ahead of time.

Look before you leap

Before you sign up for an ISA, consider these factors:

Your major. If you’re majoring in theater or poetry, you’re unlikely to get terms as favorable as your peer studying accounting or another field that’s viewed as potentially yielding a higher income.

Potential income prospects. Check with sites such as PayScale and Glassdoor or the Bureau of Labor Statistics to estimate starting salaries and average earnings for careers you’re interested in pursuing. This can help you better estimate what type of payments you may make on an ISA in the future.

The financing source. An unregulated market can breed predatory practices, Zurick says. Consider the source of the funding and the investor’s track record, particularly if it’s a private investor.

Income percentage you qualify for. Knowing the percentage of your income you’ll be expected to shell out each month is crucial in making a wise decision. If you can get a low percentage — in the 3% range, for example — an ISA could work well for you. If it’s much higher, it’s not so clear. Purdue’s program, for example, allows ISA percentages up to 15%. Before entering into an agreement for a high percentage of your income, weigh how it might affect your budget later on.

Location and cost of living. Research the cost of living in the area where you’d like to find work after you graduate. Will your prospective income cover the cost of living in that area, allowing for the percentage you’ll be repaying on your ISA?

The cost of your other college financing. If you’re seeking an ISA, it’s likely you already have student loans. Find out how much you’ll need to repay on those loans after you graduate and factor that into your budget to see if you can afford an ISA repayment as well.

Term length. The amount of time you’ll be expected to pay back your ISA may be standard or specific to your agreement. At Purdue, a typical term length for ISA repayment is nine years, according to the Purdue Research Foundation. Make sure you’re comfortable with the length of time you’ll be repaying a portion of your income.

Fine print. Any time you enter into a financial agreement, know the details. Find out what protections might be built into the ISA, such as a grace period after graduation, as the Purdue program allows. What sort of income will be included — will it be just your income, or will your future spouse’s income count as well? Will inheritance or proceeds from legal settlements count?

Find out how income share agreements compare with private loans, student loan refinancing and parent PLUS loans.

Anna Helhoski is a staff writer at NerdWallet. Email: [email protected]. Twitter: @AnnaHelhoski.