Income-share agreements are starting to gain traction as a college-funding option. But because they are so new, many students and families don’t know much about them.
In short, an ISA is a contract between a student and school in which a student receives education funding in exchange for a percentage of his or her posteducation salary for a set number of years. These agreements have the potential to make higher education more affordable, but that doesn’t mean they are necessarily a good deal. As with student loans, there can be risks.
Here is what students and families should know:
1. How can students find an ISA?
Students can ask the financial-aid office at the school they attend or are planning to attend if an ISA is available; only a few dozen schools currently offer one. Each has its own eligibility requirements and terms.
The list of interested colleges and universities continues to grow, according to Tonio DeSorrento, chief executive of Vemo Education, which helps higher-education schools design customized ISA programs. The company works with about 45 institutions, including around 30 colleges and universities. ISAs are also becoming more widely available as a funding option at specialty schools such as coding academies.
2. When should a student consider an ISA?
Generally, experts recommend students consider an ISA only after exhausting options for scholarships, grants and certain federal student loans—namely Direct Subsidized Loans and Direct Unsubsidized Loans.
These federal student loans “can offer more favorable terms, including income-based repayment, public-service loan forgiveness and teacher loan forgiveness,” says Ethan Pollack, associate director of research and policy for the Aspen Institute’s Future of Work Initiative, who has researched ISAs.
In some cases, ISAs may be a viable alternative to private student loans or Direct Plus Loans offered by the federal government, he says. This can depend on factors such as how much a borrower would pay in interest on these types of loans and for how long.
3. What are the terms of an ISA?
Each school’s ISA program is different, so students need to pay attention to the details of the particular contract and make sure they understand the terms. Legislation is being worked on to provide a framework for ISAs, but for now each program is school-specific.
“There is no standard, and that’s part of the problem,” says Michael Lux, founder of Student Loan Sherpa, a website focused on student-loan education, strategy and borrower advocacy. He says it’s especially important for students to read the contract carefully. “An income-share agreement isn’t a contract you want to gloss over,” he says.
4. What are the main elements students should look at?
In particular, students should look at the percentage of future income they are expected to pay, the time period in which they are expected to pay and the cap on total ISA payments, says Mary Claire Cartwright, who manages the ISA program at Purdue University, one of the first universities to offer this type of aid.
The percentage of future income, as well as the time period students have to repay the funded amount, can vary widely, depending on factors such as the school, the ISA amount and the student’s major. Some schools vary the percentage of income depending on the major; others use a fixed percentage regardless of the program. The percentage can be less than 1% to around 15%, depending on factors such as the amount of the ISA and the program.
Repayment time frames also vary widely, generally between three years and around 10 years. This, too, depends on the school and the student’s major, as well as the student’s ability to make payments.
Generally, students aren’t expected to pay more than one to 2½ times the amount of initial funding. This also varies by school. Having such a cap can limit the risk if a student earns way more than expected.
5. What might the numbers look like compared with a traditional loan?
There’s no hard and fast rule about how an ISA compares with a traditional loan. In some cases students could be better off, in others they’d be about the same, or perhaps worse. To help students make more-informed decisions, some schools offer online comparison tools that take several factors into account, such as their major, their expected graduation date and the amount of the ISA. Using these calculators, students can also input different rates and terms for Federal Plus Loans and private loans, as well as different starting-salary scenarios. Those details can help determine whether an ISA is a good deal for a particular student; changing a variable or two can result in radically different outcomes.
Consider a hypothetical student majoring in computer science who is expected to graduate in May 2020. Assuming the student took an ISA of $10,000, at an income share of 2.57% payable for 88 months, the student’s total payments for the ISA would be $15,253, according to one school’s comparison tool. (The calculation is based on an estimated starting salary of about $70,000 and assumes the student’s income will grow at 3.8% per year on average.) By contrast, for a 10-year private loan with 10% interest, the student would pay $17,576, according to the comparison tool.
On the other hand, if that student was able to get a private loan with a 6% interest rate for 10 years, he or she would pay only $14,189 in total payments, according to the comparison tool, making an ISA potentially less compelling. Rates for private loans can vary widely depending on factors such as the borrower’s (or the co-signer’s) credit, the term and whether it is fixed or variable.
Meanwhile, a Plus Loan at an interest rate of 7.6% would cost $16,176, assuming a 10-year repayment term, according to the comparison tool. (Note that the calculator is based on current rates for Plus Loans; new, slightly lower, rates take effect July 1.)
One thing this comparison doesn’t account for is the fact that interest payments on private or Plus Loans are tax-deductible up to $2,500 a year, depending on the borrower’s income. ISA repayments aren’t tax-deductible.
Here’s another example, this time assuming the student accepts an ISA of $6,000. The income share in this case would be 1.54% for 88 months, with the same salary assumptions as before. Under this scenario, the student would pay $9,152 for an ISA; the cost for the Plus Loan at 7.6% would be $9,706. For a 10-year private loan at 10%, the cost would be $10,546; for a 6% private loan, the cost would be $8,513.
Students considering an ISA should be sure to recrunch the numbers after the new federal loan rates and fees are officially announced and schools update their calculators to reflect these changes and any other updated data.
It’s important for students to use their own school’s calculator, if available, because it’s based on school-specific parameters. Students should also ask about the school’s eligibility requirements; some schools, for instance, only offer ISAs to students in select majors.
6. What else should students think about when considering an ISA?
There are many other considerations when it comes to an ISA. For instance, students should be sure to consider what their monthly payment might be when deciding whether an ISA is right for them, because even if the overall payment period is shorter for an ISA, the payments could be more per month than would be the case with a Plus Loan or private loan.
Another consideration is who bears responsibility for repayment. With an ISA, the student is on the hook. With a Parent Plus Loan, the debt belongs to the parent. Private student loans are typically cosigned, meaning both the student and the cosigner (often the parent) bear responsibility.
Students should also look at whether there is a minimum salary they need to attain before payments are required, and consider how their ability to pay might be affected if they were to earn only slightly more than the minimum, says Julie Margetta Morgan, a fellow at the Roosevelt Institute who has researched student debt and ISAs. Students should also understand the circumstances under which their term may be extended if payment is deferred, she says.
Ms. Margetta Morgan recommends students use an independent student-loan calculator to double-check the student-loan calculations on school websites.
They should also calculate what their ISA payments would be like if they were to earn much more than expected and whether this would be advantageous or disadvantageous compared with other types of aid, Ms. Margetta Morgan says. In addition, she says, students should read the fine print to understand the consequences of missed payments and what could happen if they default.
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