Income-share agreements are growing in popularity as an alternative to student loans. They allow students to receive education funding right away in exchange for a percentage of their salary after graduation. While they do offer some major advantages, they do come with their fair share of risks. Understanding an income share agreements pros and cons and the way they work can help you make an informed decision on whether or not this is the right option for you.
What Is an Income Share Agreement?
An income-sharing agreement (ISA) is essentially a contract between a student and their school or a private lender wherein the student pledges to pay a percentage of their future earnings for a fixed period of time. The goal of such an agreement is to give those students who may need more financial support easier access to education.
Earlier, income-sharing agreements were looked at as an alternative to traditional student loans. But that’s not entirely accurate. They are in fact a variation of the traditional student loan.
With student loans, you borrow a specific amount to fund your education and agree to a pay it back within a certain timeline with interest. The interest date, loan term, and monthly payments are set at the time of drawing up the student loan agreement. These monthly repayment amounts remain unchanged till the debt is paid off regardless of your monthly income.
With an income share agreement, you receive funds to cover your education and agree to pay the ISA provider or lender a fixed percentage of your income for a set amount of time after graduating. Under these circumstances, only the â€˜percentage of income’ to be paid remains the same. The exact amount you have to pay back every month varies depending on your income. You may end up repaying more or less than the amount you initially received, depending on the terms of your agreement.
How An Income Share Agreement Works
Some colleges have their own proprietary income share agreements. Other colleges allow students to use income share agreements from third-party private lenders. The exact specifications vary from among schools as well as third-party private providers.
In some colleges, students only qualify for an ISA after reaching their federal student loan limit. Others require students to max their federal student loans and also be within a year of completing their degree before becoming eligible for an ISA. Still others only offer ISAs to students enrolled in specific majors.
Similar to the grace period with student loans, most income share agreements offer a no-payment grace period after graduation. If you entered an ISA, after the grace period ends, you’ll need to start repaying a percentage of your monthly income to your college or lender. It doesn’t matter how high or low your income – you pay a percentage of that to the lender. The higher your income, the higher your monthly repayments amounts. On the other hand, graduates with lower incomes or those who are unemployed won’t have to pay back anything.
An income share agreement should definitely state these terms:
- The amount of money credited to the student’s account
- The percentage of future income that the student agrees to pay
- The minimum income threshold to being begin paying back the money
- The maximum number of monthly payments to satisfy the terms of the agreement
- The maximum number of ISA payments the student will pay.
Now let’s explore income share agreements pros and cons.
Pros of Income-Share Agreements
Debt is more affordable
The biggest benefit of income-share agreements is that the debt is more affordable, especially for unemployed or underpaid graduates who won’t have to deal with student loans they cannot afford.
No interest rate
When you take student loans, you have to pay the money back with interest. The lender sets the interest rate at the time of disbursing the funds and that rate remains unchanged regardless of your income or other circumstances. With ISAs, there’s no interest rate. You pay back a percentage of your income for a specified period of time.
Credit report and credit score don’t determine your chances of approval or interest rate
ISA lenders do not conduct credit checks, neither do they check credit scores to approve your application or set your interest rate. All they consider is which school you’re enrolled in and which major you’ve chosen. This is because the school and major play key roles in influencing your future earning potential. Attending a reputed college and enrolling in a higher-paying major will get you approved more easily than another applicant enrolled in a less-reputed college or a major with lower-paying potential.
Payments pause when your income falls below the specified minimum threshold
This can be a huge relief to those who are unemployed or have very low paying jobs. If your monthly income falls below the threshold specified in the ISA, the payments get paused automatically.
ISAs can be used in conjunction with other forms of financial aid
You are not limited to either student loans or ISA funding. If you have a high financial aid need, you can use ISAs to supplement your scholarships, federal student loans and private loans
Income-Share Agreement Cons
- Monthly payments can be hard to predict. – Because payment are set as a percentage of your income, you won’t know what you’re monthly repayments are going to be until after you’ve started earning an income. You won’t know how much you’ll pay in total either.
- It could be more expensive for higher-wage earners. – With an ISA, you pay a fixed percentage of your income for a specified number of months. With this repayment model, the more you earn, the more you pay back every month. Depending on your salary, the total amount you pay back over the specified period could even work out to be higher than the original amount given to you.
- There are fewer deferment options as compared to federal student loans. – Federal student loans come with significant deferment or forbearance options, which can be a relief when you’re financially stressed. ISAs have limited relief options. Though they do pause payments if income drops below a minimum threshold, they don’t offer any other relief options if you’re financially stressed due to other reasons such as increased expenses.
Is An Income Share Agreement A Good Option For You?
As with any other type of financial agreement, an ISA may or may not be a good option for you.
An income-share agreement may be beneficial for you under these circumstances:
You’re entering a field with low earning potential. – Some types of jobs are historically lower paying than others. If your chosen major has a lower paying potential, an ISA is a great option for you. You’ll end up paying less than what you borrowed to fund your college costs. While there’s no way of predicting your future income, a look through the Bureau of Labor Statistics, Glassdoor or PayScale can give you a pretty good idea of starting salaries and average earnings for your career.
You’ve exhausted your other free and low-cost financial aid options. – It’s a smart financial strategy to always use up your free and low-cost funding options. Free funding includes scholarships, grants, institutional financial aid, and work study. Low-cost funding includes federal student loans, which have low interest rate. Only consider an ISA if you’ve exhausted the amount you borrow through these channels and need additional funding to cover your college costs.
Your low credit score doesn’t qualify you for private student loans. – You may prefer to take on private student loans over an income shared agreement. But if you have thin credit history or a low credit score, you may not meet the lenders minimum qualifying requirements. In that case, ISAs may help you get the funds you need as ISA lenders don’t consider credit scores to determine approval.
An income share agreement is not for you if:
You know you’re major leads to higher paying jobs. – With a higher paying job, you could end up paying much more than you borrowed. In this case, you may be better off taking on private student loan to fill your funding gap.
You’re uncomfortable about the lack of certainty. – Not everyone is comfortable with not knowing in advance what their monthly payments will be. If the uncertain nature of ISAs make you uncomfortable, private student loans with their predictable monthly rates may be a better option.
A Final Note On Entering An Income Share Agreement
If you do opt to enter an income share agreement over taking on a student loan, make sure to review the contract carefully and make sure you’re comfortable with all the terms before signing it.
As always, talking with a Financial Planner can help weigh income share agreements pros and cons along with any other financial questions that you may have.