Income share agreements (ISAs) may not be a new concept, but they are gaining more popularity nowadays—both as a way for some students to pay for college and as an avenue for investors looking to make an impact. With student debt currently at $1.73 trillion and growing six times faster than the nation’s economy, ISAs for college funding offer a potentially more appealing path for students to finance their education and find a surer step forward after graduation.
What Is an Income Share Agreement?
An ISA is a contract between a student and school that provides financial aid in return for a fixed percentage of the student’s postgraduate salary. The total amount a student pays may be more or less than the amount received, depending on the terms of the particular ISA. This gives the school a vested interest in providing an education that will lead the student to a well-paying job, sharing some of the risk involved in financing the student’s education.
The concept comes from Nobel Prize winner Milton Friedman. He originally proposed the idea of ISAs via his 1955 essay “The Role of Government in Education,” in which he argued for a role in private finance for investing in human capital. ISAs had not gained much traction until the past few years, with the option available at more than 60 schools and growing.
Key terms to understand in connection with ISAs include:
- Income share percentage: The percentage of gross income the debtor will repay on a monthly basis. This is generally between 2% and 10%, according to the 2019 State of the Income Share Agreement Market report from Career Karma.
- Salary floor: The graduate’s minimum postgraduate salary required to initiate payments, which will reflect their expected income based on their school and major.
- Payment cap: The most that an indebted student will have to repay, including interest.
- Repayment term: The length of the ISA contract.
Benefits of ISAs
ISAs can also be more flexible than traditional education loans for many reasons.
- Shorter repayment periods compared with traditional loans (5 to 7 years versus up to 20 years) can minimize the interest due.
- Loan payments can be adjusted or discontinued in the event of underemployment or unemployment.
- Payments depend on achieving a minimum income threshold, meaning repayment only begins above a certain salary.
- A cap of the amount repaid, up to 2.5 times the amount borrowed, keeps repayment more achievable.
- Personal credit score is not factored into the application.
- A cosigner may not be required.
Limits of ISAs
Perhaps the biggest shortcoming of ISAs is that they only provide for a small amount of financing—usually up to $10,000 per student per year. Thus, they are better suited to filling in gaps between federal student aid and other funding sources, such as private loans, parent PLUS loans, and institutional aid.
Furthermore, an ISA with disadvantageous terms can actually be more expensive than alternate funding. For example, say a student receives $10,000 with an income share percentage of 5% for five years. If the student makes $80,000 after graduation, that equates to $4,000 per year for a total of $20,000. A lower-income share rate and repayment term generally spell a better ISA deal, making it important for students to calculate the total payback when evaluating against traditional, high-interest student loans.
Overall, ISAs could help ensure affordable education by arranging tuition payments to better match students’ ability to pay. This may be particularly helpful to students who earn low initial salaries or those with unpredictable income streams.
How Can Investors Use ISAs to Make an Impact?
The Aspen Institute issued a more in-depth report exploring the ability of ISAs to improve economic opportunity and equity. Among the potential benefits of ISAs outlined in the report is increased access to education for those who may not qualify for existing federal aid options, such as undocumented students or those who want to attend non-Title IV schools.
Additionally, focusing on a student’s potential success rather than factors such as their credit scores allows ISAs to help low-income students with poor or nonexistent credit histories access financing that leads to better job opportunities. As a result, serving these student populations may produce higher social-impact returns for ISA investors.
Given the relative infancy and small size of ISAs, not much of a track record exists for measuring their successes or failures. They remain mostly unregulated with the exception of California, which issued its first license in August 2021 to an ISA servicer. As ISAs gain in popularity, so too will the need for a more defined, shared framework and regulations.
The COVID-19 pandemic has caused many students to question the high cost of tuition to receive a remote education. Income share agreements allow colleges and universities to absorb some of the risk involved with educational funding and support more diverse student populations. The dividends for impact investors, therefore, can be exponential according to students’ success postgraduation.