• Jason Flurry, CFP

Exploring a new way to pay for college through Income Share Agreements

Everything you need to know to see if this new option is right for you

An increasing number of colleges are offering a new way to help pay for college, but it is based on a pretty old idea.

You may remember hearing back in 1997 that the musical legend David Bowie wanted to raise money for himself. And the special thing about his capital-raising strategy was that he pledged his future earnings to do it.

By this point in his life, David Bowie had been a rock star for something like 30 years. He had this huge catalog of hits. And, every time somebody bought one of his albums or played one of his songs on the radio, Bowie got a little money in the form of royalty payments. That’s how a lot of artists make their money and over time it can be very lucrative for a mega star like Michael Jackson or the Beetles.

David Bowie decided that instead of getting a little money every year, he wanted a lot of money now. So he said to investors - if you give me a lot of money now, I will give you a chunk of my royalties for the next 10 years.

And it worked. Investors gave Bowie $55 million. And in return, they got a nice steady stream of income for the next decade.

Bowie Bonds for college Colleges are now beginning to make a similar arrangement with talented, highly capable students who can’t pay for college but who have promising futures. The arrangement is called an Income Share Agreement, or an ISA. And it was first introduced by the famous economist Milton Friedman in his book Capitalism and Freedom. He said that we should have a way you can give a student money in exchange for a cut of his or her future earnings, and now colleges and private companies are experimenting with different ways to do exactly this.

See, if you're a company and you need money, you basically have two options.

Option #1 is debt - get a loan or sell a bond. If you do this, you have to pay back everything you borrowed plus interest.

Option #2 is to sell an equity stake in your business. That’s basically where you sell stock to investors. If you do this, your investors give you money and you get to keep it. It is not a loan. You don't have to pay it back. But the people who gave you the money when they invested in you get a share of your future profits, just like investors in publicly traded companies like Microsoft, Amazon, and The Home Depot do.

This equity arrangement centers around one very important principle. The more money you make as a company the more money you have to give your investors. And as the business owner, that’s the tradeoff you make to get the capital needed to grow your business. Pretty straightforward, right?

Well, ordinary people who are trying to improve their future results don't have this choice. If you're a regular person and you need money, all you get is option #1. You can borrow money if somebody is willing to lend it to you. If you don't want to borrow money or if there is nobody who is willing to lend you money, you're out of luck.

That’s why, to combat the burden of student loan debt, or so it may seem, colleges and universities are starting to offer these Income Share Agreements that provide students with money up front in exchange for a cut of their future earnings. The arrangement looks a lot like an equity stake in a student’s future, and to some degree it is. But, when you really look at how the arrangement is structured, it actually acts more like a bond, which is just another form of debt. Let me explain.

What is an Income Share Agreement? An Income Share Agreement is a contract agreement between a student and their school. The student agrees to receive borrowed money from the university to fund their education. In exchange, they agree to pay the university a set percentage of their salary after graduation for some period of years after they begin working.

Although the percentage a student has to pay is usually fixed, the college is betting that a student who graduates from their university and goes out in the world to use their newly earned degree will actually see their income rise in the first few years out of college. If and when that happens, the dollars the college receives as a return on their investment increases, even though the percentage of their payout stays the same. That’s great for the college, but it can be a bad arrangement for a student trying to get their life and career off the ground quickly.

With each increase they earn, their Income Share Agreement kicks in and takes away a bigger and bigger chunk of their income. Of course, we know that usually with more income also comes more taxes. So you can see where an ambitious, upwardly mobile professional 3-5 years out of college could easily feel a pinch financially in a situation like this. And that’s assuming they have no other college debt, which many students actually do.

There are some good aspects of income share agreements though, and in the right situations, they can be very beneficial. After all, the university is the one taking all the risk up front. At a time when the cost of college continues to feel out of reach for many students, schools and forward thinking entrepreneurs are beginning to think of new ways to finance the cost of tuition - even knowing that if the student isn’t successful in landing good paying job, they pay back nothing, or at least far less than they received to get their degree.

Finding Income Share Agreements at work Historically, Income Share Agreement have been used by programs referred to as “coding boot camps” where someone can learn a specific skill, like a new computer coding language, in a much shorter amount of time, say 9-24 months, instead of several years at a traditional college. Many of these programs are designed to help someone who is already out of college and working at a job add a new skill to their repertoire.

So basically, the reason people take these kinds of classes is to help them become more qualified, which ultimately helps them earn more money. If things don't pan out for someone after completing the program and they don't earn as much as they had hoped, well the school "failed" because they won't get much in return for providing the education. But, if the student does well and lands a high paying job after graduation, the school could earn a nice reward.

Mainstream ISA’s Other more mainstream colleges are also offering income share agreements, but in most cases they are a complement to scholarships, grants, and student loans, rather than being an arrangement to cover the full cost of college.

One of the most notable colleges using income share agreements is Purdue University in Indiana. Unlike other colleges who restrict Income Share Agreements to STEM related majors, like engineering or medicine, Purdue opens their “Back a Boiler” Income Share Agreements to all students and all majors starting in their sophomore year of college. Naturally, different majors lead to different careers and those different careers have different levels of compensation. So, to account for that, Purdue has different percentages in different time frames allotted for each major in their agreements.

For example, a history major borrowing the maximum amount available of $10,000/year would have an income share percentage rate of 4.52% over the next 112 months after graduation (or a little over nine years). A chemical engineer, on the other hand, would be obligated for 2.81% for 88 months (or just over seven years). These percentages can range between 1.73% and 5% and the duration of payments can last up to 10 years depending on the major.

If a student is successful and their income increases faster than the college anticipated, there is a cap on how much that student has to pay to satisfy their income share agreement. The maximum amount any student has to pay is 2.5X the ISA amount that student received from the school.

How do income share agreements impact you? At first glance, an Income Share Agreement might sound like a saving grace for a broke college student who’s fed up with student loans and looking for an alternative. They learn about a new Income Share Agreement that sounds like an alternative to student loan debt. Plus, there’s no interest! It sounds too good to be true, right? That’s because it is.

Income Share Agreement terms vary from school to school and as I mentioned the annual percentage rate you’ll pay depends on your major, how much you borrow, the length of your term, and the payment cap. And most programs do not allow a student to access the full amount don’t need to pay for college. That means that in addition to an Income Share Agreement, it’s likely that most students will also have student loan payments to manage after college, as well.

ISAs do have several benefits that can be helpful:

  • You only pay when you have income from employment (if you voluntarily leave your employment, the ISA goes on "pause" and resumes when you're working again)

  • Most ISAs do have a minimum income requirement, so if you only are working minimum wage, you may not be required to make payments

  • If you hit the end of your repayment term and your income was low enough, you could theoretically pay back less than you borrowed - but that would be rare

While all of this sounds interesting, at the end of the day you have to wonder if an Income Share Agreement is just putting a different kind of bandage on the same gaping wound of $1.5 trillion of student loan debt that’s already out there today. Many ISAs advertise that students do not have to pay interest, but this is not the case in practice, since students will usually pay more than the original amount borrowed. Call that difference whatever you like, but it serves the same purpose as interest.

Investors who fund ISAs aren’t lending money out of the goodness of their hearts. They’re doing it to make money! And, if your salary rises enough, that 2.5x cap could make you repay $25,000 in total to borrow just $10,000. That's effectively a 22.25% APR on your loan. That's expensive! Paying 7% on a regular student loan doesn’t look so bad in comparison, does it?

And here’s one more thing. There can be pretty severe consequences for not following through on an Income Share Agreement. At Purdue University’s Back a Boiler program, for example, breaking an agreement could result in a demand for immediate payment up to the payment cap, seizure of state tax refunds and legal action. So in a way, Income Share Agreements are just like taxes. They reduce your take-home pay and bind you to a lopsided contract that gives you few options other than to follow through on your end of the deal.

ISAs are also not regulated like federal student loans are and they may not offer the same advantages as student loans (forbearance, hardship deferments, etc.). They also often require the use of arbitration hearings to resolve disputes, instead of jury trials or class action lawsuits. But, unlike student loans, if you declare bankruptcy, your ISA can be dismissed in court. Hopefully your kids will never have to go through that...

There is a better way The good news about paying for college is you don’t have to use income share agreements, or even student loans of any kind, to make college affordable. Between scholarships, grants and good, old-fashioned work, you can design a plan to cash-flow college.

Remember, a degree is a degree. Look at all of your options and educate yourself, or find a College Planning Specialist you can work with who knows how to beat the colleges at their own game. That way you can find a combination of opportunity AND value that fits your budget. And just as importantly, your kids don’t have to sell out their future income to make going to the college of their dreams possible.

Paying for college with cash flow is hard work unless you have a proven game plan in place before you start. ISAs are just another tool in the toolbox, which is why I wanted to tell you about them. But, as I hope you can see, they aren’t for everyone. It all depends on the terms offered by the ISA program and your student’s individual situation. The lower the income share rate and terms, the better the ISA deal. But always calculate out total payback against student loans to get an accurate comparison and explore other options before letting your kids agree to share their future earnings potential with anyone. Having Uncle Sam in their pocketbook once they start working will be more than enough!


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