Pros and Cons of Income Sharing Agreements (ISAs)
No matter how you slice it, college is expensive. The average debt load per student borrower reached $37,000 in 2017 and most proposals floating around Washington involve managing that debt, not making college cheaper. College costs keep climbing and will probably continue on that track for the foreseeable future. However, student loans aren’t the only way to pay for college. Last month, we touched on a few ways to pay for college without loans. One of those methods was through Income Sharing Agreements (ISAs).
ISAs turn the concept of student loans upside down. Instead of taking out a ton of money before college, a student with an ISA will attend school on an investor’s dime and then repay their college costs with a percentage of their income after landing a job. Sound like a good deal? In many cases, ISAs are superior to student loans, especially private loans that offer little assistance to borrowers and can’t be forgiven after so many years of on-time payments. But are ISAs a better deal for everyone? You’re probably sick of hearing this answer, but as usual – it all depends.
How Do ISAs Work?
Imagine you want to attend a high-ranking university to get a mechanical engineering degree. It’s a field very much in demand with a generous starting salary, but you’ll need $40,000 to complete the degree. You’ve been awarded a $30,000 loan from the federal government and need to come up with an additional $10,000 to make the cut. This particular school gives you two options to make up the shortfall – you could take out a private loan from a bank or you could enter an income-sharing agreement with them.
With this hypothetical ISA, you won’t pay anything back until you get a job after college. Once you’re gainfully employed, you’ll owe your school 2% of your salary over a period of 10 years. According to the Bureau of Labor Statistics, the median entry-level salary for a mechanical engineering major is $65,000. Let’s be generous and assume you’ll get a 2% raise every year, too. Under this ISA, you’ll pay the following yearly schedule (divide each number by 12 to get the monthly amount):
- 1st Year: $1300 per year ($65,000 annual salary)
- 2nd Year: $1326 per year ($66,300 annual salary)
- 3rd Year: $1352.50 per year ($67,626 annual salary)
- 4th Year: $1379.57 per year ($68,978.52 annual salary)
- 5th Year: $1407.16 per year ($70,358.09 annual salary)
- 6th Year: $1435.31 per year ($71,765.25 annual salary)
- 7th Year: $1464.01 per year ($73,200.56 annual salary)
- 8th Year: $1493.29 per year ($74,664.57 annual salary)
- 9th Year: $1523.16 per year ($76,157.86 annual salary)
- 10th Year: $1553.62 per year ($77,681.02 annual salary)
GRAND TOTAL: $14,234.62 paid
Your other alternative was a $10,000 private loan with a 9.66% interest rate (which was the national average in 2017) over a 10-year repayment term. With the private loan, you’d be paying $130 per month for 120 months. According to our favorite loan calculator, that comes to a total of $15,663 after 10 years. In this instance, the ISA saved our prospective college student over $1400. The keywords, of course, are ‘in this instance.’
Pros and Cons of ISAs
Let’s get a few misconceptions out of the way first. Are income sharing agreements different than loans? Yes, but they’re still debt. Someone else is paying for your college and they’re expecting to get that back (and then some). ISAs may not be considered loans, but they’re most certainly a form of debt and ISA investors are expecting profits.
That being said, not paying until you find a job is definitely appealing. Who stands to benefit most from ISAs? Here’s a pros and cons list to help you decide if an ISA is right for you.
Pro: Borrowers only pay when they’re employed
Probably the biggest perk of ISAs is the payments go on hold if you’re unemployed for any reason. If you voluntarily leave your job, the ISA will be paused until you resume working. For borrowers with health conditions, this is an important caveat. If you’re unable to work, your bills don’t keep piling up, nor does your credit score plummet due to late or missed loan payments.
Con: Low salary professions pay higher rates
For our mechanical engineering student in the example above, the ISA was a solid plan. But what about English majors who can expect a median entry-level salary 50% below the engineer? Then the terms become more onerous. On Purdue University’s ISA plan, mechanical engineering graduates borrowing $10,000 will owe 2.7% of their salary over 92 months. But English graduates will owe 4.5% of their salary over 116 months.
Pro: ISAs have caps on the total amount a borrower can pay
ISAs usually have firm caps on the maximum amount a borrower must pay, unlike loans which can theoretically amortize for eternity. According to Forbes, the most common cap level is 2.5x the amount borrowed. If you take out an ISA for $10,000, the most you’d pay back is $25,000. Is paying $25,000 for borrowing $10,000 a good deal? Of course not! But if you get laid off while paying back student loans, you’ll see the power of compound interest work in reverse. Negative amortization occurs when the payments you make on your loan fail to cover the accrued monthly interest. Your principal will actually INCREASE each month when interest is charged on top of other interest. When you hear nightmare stories of student loan borrowers who’ve been paying for decades and haven’t even dented their principal, understand how negative amortization factors in.
Con: ISAs don’t have the same protections as federal student loans
Federal student loans come with a number of benefits over private loans, including income-driven repayment plans and Public Service Loan Forgiveness (PSLF). While ISAs do protect borrowers from extreme downside risk, federal income-driven repayment plans do a better job limiting the burden on low-income borrowers. And no ISA will be as generous as the PSLF program is to eligible public servants.
Pro: ISAs typically have minimum income requirements
Not only do ISAs protect the unemployed, but the underemployed too. For example, at Messiah College in Pennsylvania, any graduate making under $25,000 will have their payments waived. And unlike loans, no interest will accrue during during periods of unemployment or underemployment.
Con: Few schools offer ISAs and the market is highly unregulated
Purdue University is the largest school making headlines with ISAs. But they’re still exceedingly rare and usually only available at small colleges like Messiah or Lackawanna College in PA, Clarkson University in NY, and Norwich College in VT. Additionally, no two schools have the same ISA stipulations and regulators have no firm guidelines on these deals.
The Bottom Line
When it comes to paying for college, federal student loans are still the best game in town. They offer unique protections and don’t unfairly squeeze low-income borrowers. ISAs certainly have a place in the higher education landscape, but right now, they should mostly be considered replacements for private student loans only.
ISAs can greatly benefit graduates going into high demand fields or contract work, but read the fine print carefully. Compare the total amount you’d pay an ISA provider versus a private student lender. Understand where the caps lie and how much you’d pay if your salary increased unexpectedly. If an ISA and private loan offer similar repayment terms, the ISA is probably more beneficial. But as always, every borrower’s situation is different. Do the math and only take the ISA if you’re sure it’s a better than deal than a private loan.
Dan graduated from college with a degree in journalism and about $25,000 in student debt. He luckily landed in a career that allowed him to pay his loans off at a reasonable rate, but not without making some sacrifices (sorry grandmom). Dan buried himself in personal finance books to better manage his debt and start saving for retirement. He thinks $25,000 is more than enough to pay for a good education and is stunned by some of the near six-figure balances he sees student borrowers carrying around.
Born 45 minutes north of Philadelphia, Dan went to Penn State in 2004 to pursue a journalism degree with a minor in political science. He graduated into the worst recession in 80 years and got his first post-college job serving hamburgers and Miller Lite. Dan eventually settled in as a purchasing agent at a printer manufacturing company, which isn’t a profession you’d think would be #2 on a journalist’s list.
Dan now lives in Elkins Park, PA with his girlfriend, who graduated with over $80,000 in student debt herself after getting an education degree from Arcadia University. Seeing a new teacher forced to pay nearly $1000 a month in loans drove him to action and LoanGifting gave him a platform to not only help his significant other, but all kinds of borrowers struggling with student debt. Dan’s hobbies include poker, weightlifting, and watching the Eagles beat the Patriots in the Super Bowl twice a week on BluRay. His writing has been published on Benzinga, Fora Financial, and Credit Donkey.