Income Share Agreements: Educational Investments in Students’ Human Capital

As the amount of outstanding student loan debt in the U.S. continues to soar, some schools are offering alternative arrangements known as income share agreements (ISAs). Retirement Director Ben Rizzuto outlines the pros and cons of these new financial structures, which – in theory – are designed to align the goals of students and universities.

In 2018, 54% of young adults who went to college took on some form of debt, including student loans.1 Given that this burden impacts such a significant portion of Americans, it should come as no surprise that total outstanding student loan debt in the U.S. has surpassed $1.5 trillion.2

Paying off student loan debt is challenging. In fact, in 2018, two in 10 of those who still owed money were behind on their payments. And for those who are not able to complete their degree or who attended a for-profit institution, the likelihood of falling behind is even higher.3

While taking on debt may not be a student’s first choice, it is often necessary to further one’s education and career prospects.

Recently, however, an alternative to student loans known as an income share agreement (ISA) has been gaining traction. ISAs are designed to help put universities and students on the same side of the table when it comes to a student’s education and future career.

More than 50 U.S. universities and coding schools currently offer ISAs. In December, the Department of Education said it would begin experimenting with them, and legislation – in the form of the “ISA Student Protection Act of 2019” – was introduced last year to create a legal framework for these tools.

So, What Are ISAs?

The concept of the income share agreement was first introduced by Milton Friedman in 1955 but has only recently gained attention as the number of defaults on student loans has increased. Looking for alternatives, some schools have started offering ISAs, which serve as a contract between the student and the school in which the student receives education funding in exchange for a percentage of his or her post-education salary for a set number of years.

For example, one form of university or college ISA may take between 2% and 10% of a graduate’s income for the first three to 10 years after graduation, starting as soon as the graduate starts a job paying at least $20,000. The total payback amount is typically capped at 1.1 to 1.2 times the amount fronted.

Proponents of these agreements feel that they shift financial risk from the student to the school and create an incentive for the school to prepare students as best as possible to qualify for and get good-paying jobs.

Critics, on the other hand, feel that ISAs are just a new spin on debt. Plus, some ISA terms are worse than others. Graduates could end up paying two times the size of the initial amount borrowed or, if they earn too little, the repayment period could be extended. For example, under another type of ISA, students might pay their school $100 up front and be charged no tuition until they secure a job with a salary of at least $40,000. Once they do, they pay 13% of their monthly income for four years, up to a maximum of $42,000. If they lose their job or their income dips below $40,000, the payment time frame can stretch up to eight years.

Along with that, in many cases it isn’t clear what happens if graduates have difficulty making payments. And since this is an investment that schools are making, certain students who are pursuing less lucrative majors could be discriminated against based on their lower future earning potential.

What You Need to Know About ISAs

All of this highlights the fact that students need to clearly understand the terms of a school’s ISA offerings before deciding to go this route. Below, we’ve listed a few ideas to keep in mind and questions to ask your school’s financial aid office.

  • Have you already hit your federal borrowing limit, or are you attending a school that’s ineligible for federal and private student loans? In these cases, an ISA may be an alternative option for financing your schooling.
  • Consider your job prospects upon graduation. If you have trouble landing a job, many – but not all – ISA agreements won’t require you to make payments until you have secured employment.
  • What percentage of future income are you expected to pay under the ISA? Some schools will vary the percentage based on the major chosen, while others use a fixed percentage.
  • What is the repayment timeframe? This may depend on your school, your major and/or your future ability to pay.
  • Is there a minimum salary you must attain before payments are required? If so, it’s important to research average salaries for a given profession and think about how your ability to pay might be affected, especially if you expect to earn only slightly more than the minimum.
  • Finally, be sure to run the numbers to see how your total student loan payments (including interest) compare to those of an ISA.

Based on these factors, ISAs can be a good fit for some students but might not be a viable option for others. For example, students who want to become web developers, artists or those who are looking at trade schools may be better suited for ISAs since many of the schools that offer training for those types of vocations are not eligible for federal or private student loans. On the other hand, an ISA may not be a good fit for those considering government, nonprofit or teaching jobs, as dedicated loan forgiveness programs – which I discussed in a previous post – are available for these types of employers. Those who want to become doctors may also want to forgo an ISA: Given doctors’ higher salaries, the 10% of salary requirement of an ISA may be more than the interest on a federal loan.

Education costs and the debt that goes along with them are significant issues that borrowers need to consider, as they will impact their future for years if not decades. ISAs have their quirks, but these agreements may be a useful tool for certain types of students – especially if they have maxed out their federal loans.

Along with that, I like the fact that by offering these arrangements, schools are (at least in theory) investing directly in their students, which helps align the goals of both parties. Finally, ISAs may help provide a safety net since they will typically have a minimum income threshold before payments kick in. Having this downside protection is important from a risk management standpoint and may prove even more critical given the economic and employment uncertainty of this wave of college graduates.

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1Federal Reserve. Report on the Economic Well-Being of U.S. Households in 2018. May 2019.
2Federal Reserve. Consumer Credit – G.19. June 5, 2020.
3Federal Reserve. Report on the Economic Well-Being of U.S. Households in 2018. May 2019.