At an average cost of $35,331 per year, a college education might be one of the most expensive purchases you make in your life.
Most people borrow money to pay for some or all of that expense. In fact, 70% of bachelor’s degree graduates have educational debt by the time they graduate, according to the Urban Institute. Those wanting to avoid student loans may be drawn to an alternative option that has been gaining popularity in recent years: income share agreements (ISAs), which are credit products that base borrowers’ payments on their income.
For some borrowers, an ISA can be a lower-risk option that potentially reduces interest costs. However, experts recommend maxing out your federal student loans and other financial aid before turning to any private option, including ISAs. For those considering an ISA over a private student loan, be sure to read the contract’s fine print and crunch the numbers yourself. Depending on your income after you graduate, an ISA could save you money or it could end up costing you more in the long run. Here’s what to know.
Income Share Agreements Explained
An ISA is a credit product offered through a student’s university where the lender gives students the money needed to pay for their education. In return, the student agrees to repay the amount borrowed, plus a premium. Unlike with a student loan, however, your monthly payment isn’t set in stone. Instead, it’s a pre-agreed percentage of your income.
ISAs have been becoming more prevalent as an extra financial aid tool that helps bridge the ever-increasing cost of college, says Jessica Thompson, vice president of The Institute for College Access & Success.
“Some higher-cost colleges have a lot of students with financial aid gaps between the cost of school and what their loans and financial aid will cover,” says Thompson. “There is an incentive or interest for colleges to find ways to meet that gap.”
Before turning to ISAs, make sure you complete the Free Application for Federal Student Aid and, if required, the CSS profile. By submitting these applications, you could qualify for grants or work-study programs and reduce the need for loans or ISAs.
ISAs are attractive to borrowers since the borrower only makes payments once they’re employed. “You only have to repay once you get a job and reach a level of income, which can be comforting to some students,” says Andrew Pentis, a certified student loan counselor and senior writer with Student Loan Hero by LendingTree.
ISA companies look at your major, academic record, and other factors to calculate your earning potential. Based on that information, they will determine your eligibility for an ISA, what percentage of your income you have to repay, and how many payments you must make.
For example, you might receive $20,000 in an ISA, and have to pay 5% of your income for 120 months. Under those terms, this table shows how your payments could vary depending on your annual salary:
|$50,000 Salary||$60,000 Salary|
|Number of Payments||120||120|
How Do Income Share Agreements Work?
While ISAs are often advertised as alternatives to student loan debt, they are still credit products and must be repaid. In many cases, ISAs make repayment more confusing than loans, which can be straightforward to calculate based on the amount you borrowed and your interest rate.
“The terms are often fuzzy or misleading, making ISAs seem like they’re not loans,” says Thompson. “But ISAs are loans, and you have a financial obligation to repay them. In a lot of cases, it can be difficult to figure out what your obligation is in terms of the total repayment cost.”
ISAs are issued by individual companies, so terms can vary a great deal. In general, payments are usually 5% to 18% of your income, and repayment terms range from 24 to 160 months. Under the ISA terms, borrowers usually have to submit proof of income every year.
Some ISA companies have caps on your total repayment. Once you reach the cap listed on your disclosure agreement, the ISA is considered paid in full and you no longer have to make payments.
ISAs may also have minimum income requirements; if you don’t meet the income threshold, you aren’t required to make payments.
Income Share Agreements vs. Student Loans
While ISAs and student loans share some similarities, ISAs differ from student loans in the following ways:
- Varying terms: Federal student loans are carefully regulated, and all of the loans follow the same structure with the same repayment policies. But ISAs work differently. Because they’re issued by individual companies, terms and conditions can vary by issuer.
- Risk-based underwriting: While federal loans have the same rates and terms for all borrowers, ISAs use risk-based underwriting. Companies look at the borrower’s major, degree track, university, and academic record to determine their eligibility and terms. Lower-risk individuals can get more favorable terms — such as a lower percentage of their incomes going toward payments — than individuals deemed to pose a higher risk. Private student loans also use risk-based underwriting, but they look at a borrower’s (and their cosigner’s, if applicable) credit history and income to determine their eligibility and interest rate.
- Payments: Under an ISA, your payments are a percentage of your income. As your income increases, so do your payments. With student loans on standard repayment plans, the payment stays the same for the duration of the loan.
Will You Pay Less with an ISA or Student Loan?
If you’re trying to decide between student loans and ISAs, the best choice depends on your career path and expected income. Because repayment is based on a percentage of your salary, high earners end up paying a proportionally bigger sum every month.
“In some high-paying careers, ISAs aren’t as cost-effective,” says Pentis. “If you work as a doctor, for instance, student loans may be a better fit because you’ll pay much less than with an ISA.”
To compare, you can use the federal Loan Simulator tool to find out how much you’d repay with a student loan. For ISAs, use your expected income along with the income percentage and payment cap listed on your ISA agreement.
For example, we calculated the total repayment cost for ISAs and loans for students that borrow $20,000 and earn $55,260 per year — the average starting salary for bachelor’s degree graduates from the class of 2020, according to the National Association of Colleges and Employers (NACE).
For ISAs, we assumed 120 monthly payments. We calculated the payments using two hypothetical options: a 5% income percentage and a 10% income percentage. Some programs have total payment caps, so we considered a payment cap equal to 1.6 times the original amount. In this case, the payment cap would be $32,000.
For student loans, we calculated the totals based on a standard 10-year repayment plan. We assumed the borrower took out federal Direct Unsubsidized Undergraduate Loans with a 3.73% interest rate.
|ISA With 5% of Income||ISA With 10% of Income||Student Loan at 3.73% Interest|
|Number of Payments||120||120||120|
|Total Repaid||$27,630||$32,000 (repayment cap)||$23,992|
As you can see, you would pay less overall in this situation if you opted for a federal Direct Unsubsidized Loan instead of an ISA. However, if you earned a lower amount, an ISA could be more advantageous.
The raw numbers shouldn’t be your only consideration when choosing between an ISA and a student loan, especially if you qualify for federal student loans. “Federal loans, while there are many things I’d like to see improved, are the safest form of borrowing,” says Thompson. “They come with protections and a strong safety net which no private option, including ISAs, can match. And, they can be repaid based on income through income-driven repayment.”
What Are the Risks of an ISA?
When it comes to ISAs, there are some significant risks to keep in mind:
- No grace periods: Not all ISA issuers offer grace periods, so you may have to start making payments right after you graduate or leave school.
- Short repayment terms: Depending on the issuer, repayment terms can be quite short. A shorter term can mean a higher percentage of your income goes toward your payments.
- Lack of transparency: As ISAs are issued by individual companies, transparency is a major issue. It can be difficult to find clear information about ISA terms and conditions, such as late fees or penalties. Because of these issues, the Consumer Financial Protection Bureau (CFPB) took action against a major ISA issuer for misrepresenting its product in September 2021.
- Potentially require a substantial portion of income: Your payments are based on your income, but, unlike federal income-driven repayment plans, ISAs don’t take into consideration your family size or discretionary income. Your ISA payment can take up a significant portion of your salary — some charge as much as 18% of your income — making it difficult to make ends meet.
- Term extensions: Many borrowers don’t realize that their payment term can be extended under certain circumstances. For example, if you leave the labor force to care for a child or loved one, you won’t have to make payments, but your payment term is lengthened, so you may have to make payments once you return to the workforce.
- Potentially higher total repayment cost: Depending on your income, the amount you repay could be substantially more than you would have repaid with a student loan.
- Unpredictable payments: With an ISA, your payments are based on your income. As your income changes, the ISA issuer adjusts your payment amount. Because your payments aren’t fixed, it can be difficult to plan and budget for the future.
- Damaged credit: Just like regular loan payments, ISA payments are due by a specific date each month. If you miss a payment, your account can enter default, and the issuer can send your account to collections and report the activity to the credit bureaus, damaging your credit.
- No federal protections: Federal student loans offer income-based repayment plans, deferment and forbearance options, and other forms of protection such as the CARES Act student loan payment freeze during the COVID pandemic. An ISA won’t come with this flexibility.
Should You Consider an ISA over a Student Loan?
Although ISAs can be appealing, they are largely unregulated, and they could be quite expensive. “ISAs have very high payment caps,” says Pentis. In some cases, the caps can be two or three times the original amount borrowed, he says.
Because of this, most borrowers would be better off applying for other forms of financial aid, including scholarships, grants, and federal student loans, before turning to private options like ISAs.
“Maximize federal loans first,” says Thompson. “Talk to your financial aid contact if you still have a financial need that can’t be covered before turning to private debt, meaning either private loans or ISAs,” she adds. “In some cases, you may qualify for a higher level of federal education loans. There are situations where they can be adjusted. If not, the financial aid office might have some advice on private debt options, but private debt should be the last resort.”
ISAs may make sense if you’ve exhausted your federal financial aid options and are considering private student loans, but make sure you carefully consider all of your options and review the ISA terms and disclosures before moving forward.
Private loans and ISAs are more comparable to each other, and which one is best for you ultimately depends on what terms you can get and what you expect your future income to be. “Create a simple spreadsheet and project monthly and total payments to figure out which is better for you,” suggests Pentis.