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How Income Share Agreements Stack Up Against College Loans

May 24, 2016
Loans, Student Loans
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College is an investment in a student’s future. That future can also be a vehicle for investors, who front tuition money in exchange for a slice of the student’s income in years to come.

This arrangement is called an income share agreement. These agreements are not widely available now, but experts say ISAs will likely grow in popularity, so getting a head start on understanding them might help you down the line. ISAs are an alternative source of college funding for students who don’t want other types of private loans or who need money beyond the federal loan maximum. They are not meant to replace federal loans. With an ISA, the percentage of income you pay back and repayment time varies.

Are these agreements a good deal for students? And how do ISAs compare with other college funding possibilities? To find out, NerdWallet looked at three hypothetical scenarios to determine how different ISAs compare with mainstream loans and student loan refinancing.

Key findings from the study

The future is uncertain, and so is the financial impact of an ISA. Unless you have a time machine, there’s no way to decisively know if an ISA is best for you. ISA terms are based on income projections. Someone with lower predicted earnings will generally get less favorable loan terms than someone with higher predicted earnings. An individual’s earning situation can always change, but the terms of the agreement won’t.

ISAs are worth a look for those who can obtain favorable terms. With a 10-year repayment term, ISAs are a better option than Parent PLUS, private or refinanced loans for high earners as long as they only have to pay back 3% of their income. ISAs are also a better option for students projected to earn lower incomes of about $38,000, but only if they have payback terms of 3% or 5% of future income. However, those who are projected to earn lower incomes are less likely to get these favorable, low percentage terms.

High earners and those with high percentage terms will pay more than the original financing amount, while lower and middle-income earners with low terms can pay less. With an ISA, you won’t always repay more than the amount you received, as you would with interest on a loan, but you’re likely to if you’re a higher earner or have higher percentage terms. Students who get a $20,000 ISA and agree to pay 10% of their income over a 10-year term and who then go on to earn an higher annual income of about $75,000 could end up paying back nearly $90,000, if there’s no repayment cap. Even middle-income earners of about $52,000 would pay back more than their financing amount at the 5% and 10% level. But lower and middle-income earners with low percentage terms (3%) may pay less than the original $20,000 financing amount — $13,687 for a $38,000 earner and $18,730 for a $52,000 earner.

How ISAs work

Income share agreements are set up like the income-based repayment plans the federal government offers: Students promise to pay an agreed-upon fixed percentage of their future annual income in exchange for money to pay for college. Federal income-based repayment plans will range between 10% and 20% of a borrower’s discretionary income.

Unlike traditional income-based plans, however, ISAs have no uniform guidelines for repayment. Instead, the percentage of income and the repayment period are determined by private investors and might be based on a student’s field of study and school. Thus, private investors could view students at non-elite colleges who plan to enter lower-paying careers as riskier prospects, while students at top colleges who plan to enter lucrative fields could stand a better chance of getting the most favorable repayment terms.

There’s an element of uncertainty for the investor with any student, of course. If a student who expects to enter a lucrative career doesn’t end up making as much money as expected or chooses another, less lucrative career, that student would still owe only the agreed-upon percentage of income to the investor. If another student who wasn’t anticipating making much money ends up in a higher-paying job, that student would have to fork over the agreed-upon percentage.

Proponents of ISAs say they are more fair than standard private loan agreements because they take into consideration a student’s field of study and income prospects.

To help you decide whether to enter into an ISA, read on.

How much you might end up paying with an ISA

To find out how much different earners would pay on a $20,000 ISA over a 10-year repayment term, we compared three income levels — $38,000, $52,000 and $75,000 — and assumed each income stream would increase over those 10 years at an annual rate of 4%. These income levels are approximate representations of low, middle and high incomes. We also compared three repayment income percentages: 3%, 5% and 10%.

Starting salaryISA 3% of incomeISA 5% of incomeISA 10% of income
Income 1: $38,000$13,687$22,812$45,623
Income 2: $52,000$18,730$31,216$62,432
Income 3: $75,000$27,014$45,023$90,046

How you fare with an ISA versus current financing alternatives

Since ISAs are meant to supplement — not replace — federal loans, we compared our ISA findings with two common student loan options: Parent PLUS loans and private loans.

First we looked at a $20,000 Parent PLUS loan with an APR of 7%, repaid over 10 years. Then we considered a private loan of $20,000 with an APR of 9% with that same 10-year repayment period.

We also wanted to see how ISAs compared with student loan refinancing, since refinancing is one method of reducing private loan debt. We looked at how much a borrower would spend after refinancing a $20,000 private loan to a 5% APR and new standard 10-year term after two years of regular payments.

Parent PLUS loanPrivate loanRefinanced
private loan

Who is using ISAs?

ISAs have roots reaching back to a 1955 essay by famed economist Milton Friedman that explored the potential of investing in “human capital” to pay for education. However, more formal ISA programs gained steam only recently.

In the private sector, App Academy and Cumulus Funding are the only two firms actively offering ISAs, according to the American Institutes for Research, a not-for-profit research corporation. However, those firms’ products aren’t aimed at the higher education market.

13th Avenue Funding, a nonprofit that aims to improve college access for low-income students, is running a pilot ISA program at Allan Hancock College in Santa Maria, California.

The most prominent ISA program is Purdue University’s recently launched Back A Boiler. (Boilermakers is the nickname for the school’s teams.) At Purdue, rising juniors and seniors can apply for amounts starting at $5,000, taking into consideration their expected income, field of study, overall debt and financial need. Students are expected to make payments over nine years, according to the terms of their ISA.

Brian Edelman, chief operating officer for the Purdue Research Foundation, which funds the program, says it hopes to add institutional investor money once a payment history can be demonstrated and it becomes a more accepted means of financing education. “We would like to see a whole market at scale for ISAs,” he says.

There’s also room for private financial services companies to partner with colleges that want to offer ISA programs. Vemo Education, which helps colleges develop custom financing programs, is handling the terms of the ISA agreements for the Purdue Research Foundation.

As Purdue and other schools begin to adopt their own programs, other colleges likely will follow, says Robert Kelchen, assistant professor of higher education at Seton Hall University in South Orange, New Jersey, and an ISA expert. However, Kelchen cautions, “The questions remains: Are these ISAs going to be run by private companies trying to make a profit, or is it going to be something that colleges basically run for themselves as a nonprofit enterprise?”

Income share agreements may be an appealing prospect for students at top colleges who plan to enter lucrative fields such as STEM or business, when compared to loan options beyond federal borrowing. These students would likely get the best repayment terms because private investors would consider them the cream of the crop. In addition, if these students opted to pursue graduate degrees, they wouldn’t have to repay the ISA while in school, as long as they have no income.

Much like refinancing, an ISA isn’t for everyone. If you’re interested in pursuing this method of paying for college, consider all the advantages and disadvantages as well as your own unique situation before making an agreement.

Victoria Simons is a data associate at NerdWallet, a personal finance website. Email: [email protected]. Anna Helhoski is a staff writer at NerdWallet. Email: [email protected]. Twitter: @AnnaHelhoski.