The New Student Financing Vehicle Everyone Is Talking About: Income-Share Agreements From A Parent’s View
By: John Pelka
Background
Paying for college is difficult and it is becoming even harder as tuition and other costs increase. Please remember, tuition, room and board, fees, and books are not the total funds you need — there is travel, outside activities, school events, etc. that also must be considered. According to the US News and World Report, over the last twenty years, average tuition and fees at private National Universities have jumped 157 percent, out-of-state tuition and fees at public National Universities have risen 194 percent, and In-state tuition and fees at public National Universities have grown the most, increasing 237 percent. Please note though, the cost for an in-state school is still much less expensive than a private school. In 2017–18 the average cost of an in-state university is approximately $11,000 while a private university costs over $42,000, with the highly selective universities are in excess of $60,000.
The unfortunate fact is that student debt now totals more than $1.5 Trillion, having doubled in 10 years and is forecasted to continue to grow at 8% per year. The impact on students and their families is enormous and harms the economy and overall society. There are 43 million students who owe an average of $27,000 each, with many students/parents owing in excess of $100,000. In almost all cases, these student loans are not dischargeable, even in bankruptcies. Importantly, a majority of private student loans have a co-signer, so the co-signer (parents) are ultimately responsible if the student defaults.
Our Story
My wife and I raised two children who were fortunate to have been accepted to 2 top private universities in Pennsylvania and California. We had saved money for both of them as they were growing up but when it came time to enroll we were woefully short. Both children worked very hard in high school and as a result they both had significant scholarships to pay for a portion of school. We were still short. My wife, who had worked at the high school guidance center, had become an expert on student aid and how to fill out the FAFSA form. She went to work and we received another cash infusion from the schools in the form of grants — great if you can get them. However, we were still short. We applied for other scholarships and grants but we were not successful. Our daughter was able to get a small government loan that was at a low rate (~5% in 2001) but it was still not enough to meet the total need.
At that point we looked at private loans but we found that they were very expensive (often in excess of 10% APR) plus you were required to pay interest while you were still in school and we would be required to co-sign for the loan. As a result, we decided to take out a home equity line of credit to pay for the final amounts needed. While a good alternative, it placed the financial burden on us — and we continue to pay to this day. Unfortunately, at the time, we were not aware of a new alternative funding vehicle, the Income Sharing Agreement (ISA) which has only recently been promoted by several universities, including Purdue University and a number of private companies, including Paytronage.
What is an ISA
Income Sharing Agreements (ISA’s) are a new alternative method to finance a college education (either underygraduate or graduate school). ISA’s can be used to replace or supplement student loans and they can also be used to consolidate and pay off an existing college loan. An ISA is an up-front equity investment in a student where she agrees to pay back a fixed percentage of her future salary for a set period of time. The time frame for an ISA is typically from 7 to 15 years so they are comparable to the time frame of most government or private loans. The percentage of future income and the number of payments are fixed and do not change — and it is interest free and the total amount paid is capped. The percentage of income and the length of the payment period will vary based upon the expectation of a students future income. For example, an engineer will pay a lower percentage rate for fewer years than person who is a teacher or an English major.
What are the good points of an ISA
Perhaps the best feature of an ISA is that it is viewed as an investment in a student and is not a loan. People who fund an ISA have a stake in the student being successful which can lead to more positive long term support. An ISA is forward looking and positive while loans are based on the past and do not consider the future success of the student. Loans are usually only based on the student’s parent’s ability to pay based on their financial history. Another positive is that most ISA’s do not require a co-signer to receive the investment which reduces the risk for parents. The onus to succeed and payback the investment is with the person who was invested in which can leads to more self-reliance and career success. Also, ISA’s can be tailored to give support to a certain group of students who may need more help, resulting in lower costs to the student. For example, a non-profit, like the Girl Scouts of America (or any other cohesive group) can set up an ISA for certain women who want to pursue a STEM program in college. They can offer the ISA with no or a minimal return, reducing the cost to the student to pay back only the principal. This would extend their reach and have a positive social impact by allowing more women to pursue a STEM degree than a pure grant or scholarship.
ISA’s also offer an additional source of funding for students who have exhausted all other forms of financing and my have to drop out of school because they don’t have the “last mile” of funding. A good real-life example is a student at an Ivy League Business School who needed $34,000 to complete his senior year. He did not have a co-signer and his FICO score was low because of outstanding debt. He had maxed out on Stafford Loans and was disqualified from the Parent PLUS loan option. Several banks and college loan companies did not accept his loan request. In the end, he was offered a Sallie Mae Loan for 15 years at 10.8% which he accepted. Given that he was at a very selective school with a strong major it is likely he could have gotten an ISA for 15 years at less than 4% of his income and saved a significant amout of money — unfortunately an ISA was not available at his school at his time of need.
ISA’s have additional features that differentiate them from normal student loans. First, there is a Minimum Income Threshold (MIT) that the student must earn before they are required to begin to pay back the investment. For example, an ISA can be set up where the person must be making at least 1–1/2 times the poverty level (for example, $30,000) before beginning to pay. Graduates who are below the MIT or who decide to pursue higher education can defer the payback for an agreed upon number of months, at no added interest cost. ISA’s also have a Maximum Payback Cap (MPC) which is an agreed upon maximum cumulative payment amount compared to the initial investment received. For example, if $10,000 is received as an initial investment then the negotiated MPC might be $25,000, or two and a half times the original investment. ISA terms also allow an individual to terminate an ISA obligation by paying a set buyout amount equal to their MPC less total repayments made to date. In either case, the student will pay more when he is making a higher income and therefore, its more likely she will repay the investment.
What are issues with ISA’s
There are parents and students that have concerns about ISA’s. There is a concern that ISA’s are a form of “indentured servitude”. This is not the case because students are only committing to pay a percentage of future earnings and not committing to providing future services. The commitment is no different than a student loan and can be considered less restrictive, especially if the loan is difficult to discharge from bankruptcy.
There is a concern that ISA’s discriminate against students who are not focused on economic success. Students who graduate with degrees that are in lower paying careers often need to come up with various financial vehicles to fund their education. They need to decide if they are willing to take a lower financial return on their education investment. Loans will be taken out and grants and scholarships will be pursued. ISA’s will add one more option to these students.
There is also a concern that ISA’s would discriminate against low income students, women and minorities. The laws of the U.S. very clearly prevent discrimination against any group based on race or gender and ISA’s will follow the law. In fact, the loan process can be viewed at unfair based on differences in income between two applicants. And, since ISA’s are forward looking rather than based on the past, they can be considered less discriminatory and fairer.
Finally, the ISA space is very new and unregulated and many students and parents are not aware of what an ISA really is and how they make a final decision. The Federal Government has sevral bills that are in the process of being discussed. There should be a priority placed on getting the rules and regulations defined and agreed upon so that ISA’s can become another viable alternative for education funding. In fact, millennials have identified student debt as their number one concern and ISA’s are a new option that can help to resolve and reduce this huge issue
Conclusion
ISA’s are an interesting new method to fund a college education. ISA’s put the responsibility for repayment with the student and offer many ways to make the repayment easier and more likely. I wish that ISA’s had been promoted and available when we were looking at alternative ways to fund our children’s education. ISA’s would have been part of our funding portfolio because they would have provided our children with more responsibility for their own future success.
Originally published at medium.com.
Originally published at medium.com.
