In 2016, Wake Forest graduate James Bacon made the decision to pursue a graduate degree. After paying his way through his four-year degree program and taking out student loans to cover the rest, he figured he would do the same for his advanced degree at the University of Pennsylvania.
Ultimately though, he uncovered a program that would cover his college costs without any student loans provided he agreed to forfeit a percentage of his salary later on. An income share agreement (ISA), as these contracts are called, is what made this all possible.
According to Bacon, an income share agreement was ideal at the time because it allowed him to avoid taking on more student loans. Not only that, but he liked the fact that the future monthly payment would be predictable and based on his income.
"When I was making more money I could afford to pay more, but when I wasn't I didn't have to worry about taking a job I wanted and being able to provide for my family," he said.
This flexibility is what led Bacon to work with his brother-in-law on a business venture called Edficiency, a scheduling software his brother-in-law had built for his own school that had already spread to 20 schools in the prior year. If he had fixed student loan payments to make instead of an ISA, it's possible he wouldn't have had the chance to work on a start-up with a lower salary, he says.
How Do Income Share Agreements Work?
If you're wondering how income share agreements work, they mostly function like they sound like they would. Financial attorney Leslie Tayne of Tayne Law Group says income share agreements typically come in the form of a contract between a student and a school or a third party. The main point of an ISA is letting the student avoid loans if they agree to pay a percentage of their salary for a set amount of time, so long as that salary lies within certain thresholds.
For example, Tayne says a school might have an income sharing agreement for 20% of the student’s salary for two years, with a $40,000/ year threshold and a maximum payment of $30,000.
"If the student made $50,000 a year, they’d pay $20,000 over those two years," notes the attorney, adding that a student who made $100,000 per year would pay $30,000 during that period due to the maximum payment cutoff.
According to Tayne, there are many potential upsides for students who qualify for an ISA instead of student loans. Where student loans are based on a set loan amount plus compound interest, income sharing agreements are dependent on the student’s salary. Not only that, but a student who loses their job would not be required to make payments until they find another job that meets the income threshold.
Mark Kantrowitz, author of How to Appeal for More College Financial Aid, also points out that if your income drops below a specific threshold, the payment obligation for an ISA can be suspended.
"After all, the lender wants to get a percentage of your income when your income is high, not when it is low," he says.
Further, Kantrowitz says ISAs can be a good choice for students whose religion or culture prohibits the paying of interest, such as Islamic and Russian Orthodox students.
Downsides Of Income Share Agreements
Interestingly, students who use an ISA may wind up paying more for college than they would if they had borrowed the money outright. This all depends on how their contract is laid out and how much they wind up earning in their future career.
"Some students, such as students in lucrative fields of study, may end up paying more under an ISA than they would under a student loan," says Kantrowitz.
He also points out that, unlike student loans, ISAs are not regulated. This means individuals considering this type of agreement will have to dig deeply into the fine print so they understand exactly how much they'll have to pay back, under what conditions, and the total costs of using the ISA.
While Bacon is happy with how his ISA situation turned out, he also points out that ISAs offer less flexibility in terms of repayment. Specifically, he disliked the fact you have to keep paying for a set number of years and you cannot typically pay down your ISA faster.
Who Should Consider An ISA?
Taking out student loans to pursue higher education isn't the end of the world, but would an ISA leave most people better off? That really depends on the individual and what their goals are, says John Ross, CEO of Test Prep Insight.
Ross says that students who land a well-paying job post-graduation, such as an electrical engineer making more than $100,000/year, may end up writing a significant check to their university each year — potentially more than they would have if they had opted to borrow the money.
The key is for students to do their research on what they can expect to earn in the first five to ten years post-graduation, and look at the terms of both financing models, says Ross.
"If a student stands to make a significant sum post-graduation because they work in a lucrative field like engineering, medicine, or law, straight student loans, particularly federal loans, may be preferable."
With that being said, Ross says income share agreements may be a great financing strategy for students who don't expect to make a significant amount of money post-graduation. If you are pursuing a career in a field that you love but it may not pay a lot, for example, you may ultimately end up paying less with an ISA than you would with student loans.
Tayne also says students who aren’t sure if the career they’re pursuing is right for them can be a good fit for an ISA.
"If they don’t find a high paying enough job, or decide that the field isn’t right for them, they might not have to make payments," she says.
The Bottom Line
Only you can decide if an ISA is worth exploring, or if you would prefer to borrow for college the old fashioned way. Whatever you do, run the numbers for each scenario so you'll know how much your degree will cost in the end.
While ISAs may be growing in popularity, they have the potential to cost students more in the long run. Student loans aren't perfect either, so do some research and pick your poison accordingly.
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