As a student loan consultant, one of the biggest challenges I face is helping borrowers of various student loan portfolios and economic needs to navigate — and survive — their student loan repayment.
But with the growing cost of college and the consequent greater potential for student debt, students are nervously looking for alternative options to fund their schooling — and to avoid the student loan crisis altogether.
Some are asking for funds on social media, while others are using peer-to-peer loan websites. Others still are working through school to acquire as little debt as possible.
An option that has been recently growing in popularity is Income-Share Agreements (ISA). Although this financing option has been around since the 1950s, it wasn’t until recently that it’s come into serious consideration on a national scale.
Here come the Income Share Agreements
With Income Share Agreements, students can essentially borrow money from investors in exchange for a share of their future earnings. So although, technically, ISAs are private loans, they are an entirely different beast.
Typically, in this type of an arrangement, the investor pays for the student’s schooling and then is entitled to a specified percentage of the student’s income for a specified length of time, but only after the borrower makes a minimum income.
For example, the borrower might receive $10,000 a year to pay for school and then will be required to pay back 10 percent of his earnings for 10 years once he makes at least $18,000 per year. If this sounds similar to the federal income-driven programs, indeed, it has many similarities.
In both types of programs, the monthly payment is determined by income. Your payment is zero if your income is below $18,000 and the loan is satisfied at the end of the term — no matter how much you have contributed.
There are many key differences, however. Let’s look at a comparison between the federal Pay As You Earn program (PAYE), without Public Service Loan Forgiveness eligibility and the above Income Share Agreement.
PAYE vs. ISA
The payment calculation under the ISA is a flat 10 percent of the borrower’s gross income. As a result, once the borrower makes $30,000 a year ($2,500 a month), the 10 percent payment would be equal to $250 a month.
However, the 10 percent calculation under the PAYE program is based on the borrower’s “discretionary” income. Under the U.S. Department of Education’s definition of discretionary income for the PAYE program, it takes your adjusted gross income and subtracts 150 percent of the poverty line in your state (for single borrowers, this is equal to $17,505). So, if you make $30,000 per year under the PAYE program, your payment would be approximately $105 a month.
Also, it should be noted that with the PAYE program, you must include your spouse's income to determine the qualified payment if you file jointly. Whereas the income share agreement will likely base the payment off of the student’s income only, in all cases.
Another difference is that the remaining balance left on the loan under the PAYE program is taxable as income based on current tax law. As a result, you may owe a considerable lump sum to the IRS after the Pay As You Earn program is complete. With an Income Share Agreement, though, there is no actual loan accruing interest.
Once you satisfy the term under the agreement, the 10 percent share simply stops. Both programs provide a certain level of protection from career disaster in the future, but the premium you have to pay for this protection is quite different.
With PAYE, the premium may lie within the additional interest you accrue over the 20-year program or more likely the income tax you may have to pay on the amount forgiven. With an ISA, the premium is going to already be included with the terms. You can bet that the lender has done the math and taken into account the risks involved with this type of loan.
Yet another difference is the flexibility of the programs once you are done with school. At any time during your repayment, you can chuck the PAYE program and accelerate your payments, use forbearance when needed, or even pay the loan in full. You still have the full assortment of federal repayment programs at your command. However, with an ISA, once you are working, you are going to be paying under the original terms until they are satisfied. There is no changing it.
The verdict on ISAs
All things considered, while it’s nice to see creative options for financing higher education springing up, Income Share Agreements are still less desirable than traditional student loans for the majority of borrowers.
Federal loan programs offer greater flexibility, lower payments and less commitment. Traditional private loans are going to be more desirable to most seeking higher-paying jobs since they are going to be considerably cheaper in most cases.
For a small group of people who don’t qualify for enough help through the FAFSA, don’t have quite good enough credit for low-rate private student loans but do need funding for an education that leads to a high income career path, this might be a good alternative, or more likely an addition to their financial aid.
It should be mentioned that these income sharing products are still relatively new and as they evolve they may become more and more attractive to borrowers. However, I don’t expect ISAs to revolutionize the student loan industry anytime soon.
Jan Miller is a student loan consultant and president of Miller Student Loan Consulting. He creates customized student loan repayment strategies that fit each borrower’s unique budget and life. EMAIL: firstname.lastname@example.org