In search of alternatives to burdensome student loans, universities, companies and policymakers are increasingly drawn toward the concept of risk-sharing between students and universities. The concept is simple: if a school has a financial stake in the future of its students, it has a greater incentive to prepare those students for rewarding and successful careers.
Getting students to graduate and find meaningful work is critical to enhancing an institution’s reputation and fulfilling its mission. The goal of risk-sharing is to encourage further investment in student retention and success—salient issues from a finance perspective, given that most people who default on their loans have not completed their degree.
Most recently, Income Share Agreements (ISAs)—a concept first pioneered in the 1950’s—have captured the imagination of a growing number of institutions. Purdue’s “Back a Boiler” program, perhaps the best-known example, now allows students to share a portion of future income in exchange for tuition assistance today. In February, federal legislation was introduced to help create a legal framework for ISAs.
But how do Income Share Agreements really work?
In principle, ISAs present a more straightforward approach to student finance, at a time when half of incoming freshmen can’t accurately identify how much they are paying for college within $5,000. But like so many education buzzwords, ISAs are at once seemingly ubiquitous and poorly understood.
This brief glossary is meant to demystify Income Share Agreement terminology. Here’s what you need to know, and why it matters.
Income Share Agreement (ISA)
An ISA (Income Share Agreement) is a contract in which a person agrees to pay a fixed percentage of their income for a defined length of time, in exchange for up-front funding or services. In higher education, this contract is typically between a student and an institution.
An ISA differs from a loan in how the amount owed is calculated: In a loan, the individual makes payments based on an interest rate until their principal balance is reduced to zero. With an ISA, the individual pays a percent of income for a set period of time, regardless of the total amount paid. There is no outstanding “balance.”
Why it Matters: ISAs are being used by institutions to replace high-cost private education loans or PLUS loans to give students and their families greater flexibility after graduation.
Deferment (or Tolling)
A period of time during which a student is not required to pay the income share, even though the payment term continues to count down.
ISAs typically include a variety of reasons why a student may be eligible for deferment, including: involuntary unemployment, returning to school, raising a family, taking care of a relative, or leaving the labor force for other reasons. In some situations, the payment term continues to count down during the deferment. In other situations, the payment term is paused while the student is in deferment.
Why it Matters: Deferment means that students pay when they receive sufficient income. Unlike a loan, there is no accumulation of interest during approved nonpayment periods.
Income
An individual’s total earnings as reported to the IRS. ISAs typically exclude non-earned income (such as lottery, inheritance and capital gains).
ISA providers disclose exactly how they calculate income. The methods are typically similar to those used to calculate federal income-based repayment for student loans.
Why it Matters: ISAs are designed to align the amount a student pays with the impact of her education. Early career earnings are strongly linked to an individual’s education, whereas windfalls are unrelated.
Payment Term
The total number of months that an individual is required to make payments. Defined upfront, the number of months varies by institution. Typical payment terms range from three years for accelerated learning programs, and up to nine or 10 years at some colleges and universities.
In some cases, the payment term allows for periods of nonpayment, that don’t necessarily trigger deferment, such as a voluntary departure from the workforce, or life events that cause an individual to fall below the income threshold.
Why it Matters: Student obligations to pay under ISAs end when the term concludes, regardless of the amount actually paid.
Income Share Rate
The defined percentage of income that an individual will need to pay each month of the payment term, established at the outset of an ISA. ISAs typically use a percentage (generally 5 to 15 percent) of gross income, as opposed to taxable income, so that individuals are treated equally regardless of unrelated tax benefits (like the home mortgage interest deduction, which is unavailable to renters).
Why it Matters: The ability to adjust the rate allows institutions to design ISAs that reflect an individual’s ability to pay so that monthly payments are predictable and affordable.
Income Threshold
The level of income below which an individual has no payment obligation. As long as an individual is earning above the income threshold, he or she would make payments according to the terms of the ISA.
Why it Matters: ISAs are designed to help institutions make college more affordable. The Income Threshold is in place to protect those who, because of their income status, might struggle to afford even a small payment.
Grace Period
Period of time after leaving school, but before the Payment Term begins, when an individual is not expected to make payments.
ISA grace periods typically last 3-6 months immediately following graduation, when individuals would otherwise be expected to land a job and enter payment status. The length of the grace period is defined in the Agreement.
Why it Matters: In an ISA, the grace period gives individuals time to obtain employment (and often relocate) before entering a payment status.
Non-interference
ISAs stipulate that schools or ISA backers cannot influence an individual’s career or education choices. An ISA is an individual’s promise to make payments from income, not to work in any particular field or capacity.
The terms of Purdue’s program are, for example, academic program-specific. Education majors, for example, may pay a smaller percentage of income but for a longer period of time than the engineers who pay a higher percent of income for a shorter period of time. Under an ISA, engineers or pharmacists who chose to work in public service, will pay less on their ISA contract. In essence, ISAs can offer more flexibility in choice of fields of study and early career decisions than do student loans.
Why it Matters: Non-interference is an important consumer protection, rooted in (among other things) the 13th Amendment, and one where ISAs differ from loans for some individuals. An often-cited drawback of student loans is that they exert undue influence on individuals’ early career and family decisions.
Payment Cap
Maximum cumulative amount that an individual will ever have to pay.
Defined upfront, and varies according to the institution. Typical payment caps range from 1.0x to 2.5x the value of initial funding.
Why it Matters: Higher-earning individuals (who reach the payment cap sooner) are able to end their ISAs, rather than having to finish out a full payment term. High-paying students may also pay substantially more, however, than they might with accelerated repayment on a traditional loan.
