America’s young people are drowning in student loan debt. According to a 2018 report from the Federal Reserve, 42% of all people who have attended college borrowed money to pay for it. The average American with outstanding student loans owes between $20,000 and $25,000 and makes payments of $200 to $300 per month. Worse still, many of those who owe money for student loans never finished college – so they have the debt without the degree to boost their earnings.
Some universities are taking a novel approach to this problem: letting students fund their college education through investment, rather than debt. Through deals called income sharing agreements (ISAs), students can pay for their education by promising the school a cut of their earnings once they graduate.
An ISA can be a great opportunity for students who can’t manage to fund their entire college education through scholarships or student loans. But for the average student, its value isn’t quite as clear.
How Income Sharing Agreements Work
To understand how ISAs work, think about how you’d get money to start a business. Assuming you couldn’t pay your startup costs out of your own pocket, you’d have two basic choices: debt or equity. You could borrow money to get your business off the ground and pay it back over time, or you could find investors who would pay your startup costs and get a share of your earnings if you succeed.
Typically, students who can’t cover all their college costs have to pay them through debt. ISAs let them use equity instead, essentially selling shares of themselves, with the school as an investor. In an interview with Freakonomics, Mitch Daniels – the president of Purdue University, one of the schools that offers an ISA – calls this “working your way through college after college.”
ISAs vs. Student Loans
When you take out a student loan, you borrow a specific amount of money, which you must then pay back with interest. After you graduate, you’ll have to pay a fixed amount each month toward your debt – and this amount doesn’t change based on what you earn. If your college degree helps you get a good job with a high salary, you’ll probably be able to make these payments easily. But if you can’t find a job that pays more than minimum wage despite your degree, you could find yourself struggling to make your payment each month.
With an ISA, your monthly payment isn’t fixed. Instead, you agree to pay a percentage of your income for a certain number of years. This amount can be anywhere from 2% to 20%, depending on your school and your major, and the repayment period is typically five to 10 years.
This means the total amount you pay back to the school varies depending on your income. If you’re stuck earning minimum wage, you pay less in total than you would with a traditional student loan. On the other hand, if you start a successful business and earn millions, you pay a lot more than you would have with a loan – but then, in that situation, you can easily afford it.
Details of ISA Agreements
Obviously, when a college enters into an ISA with a student, it wants to make sure it gets its money’s worth. However, students also want to make sure an ISA is going to be a reasonable deal for them before they sign up. Because of this, ISAs typically include a number of provisions to protect both the student and the school. These include:
- Variable Payback Terms. The percentage of your income you pay through an ISA is often lower and the payback time is shorter if you’re going into a more lucrative field. For instance, in exchange for $10,000 in aid, an engineering major at Purdue would pay around 3% of their income for close to eight years, while an English major would pay 4% for nearly 10 years. Since the engineering major will probably earn a higher salary, the school doesn’t need to collect as high a percentage of it to make its money back. Other schools charge the same percentage to all students, but only offer ISAs to students majoring in fields that are likely to be profitable.
- Cap on Payback Amounts. Many schools set a limit on the amount you have to pay back on your ISA. This cap can be anywhere from 100% to 250% of the amount you received through the program. That way, if you go on to start a billion-dollar business like Facebook, the school doesn’t get to claim a share of your massive windfall.
- No Limits on Career Choice. An ISA is clearly a better deal for the school if you take the highest-paying job you can get. However, if you prefer a job with lower pay that’s more satisfying in other ways, the school can’t force you to turn it down. As long as you’re paying a percentage of your income as agreed, you’re fulfilling the terms of your ISA.
- Pause for Nonworking Periods. Of course, you could easily exploit this deal by deliberately slacking off for the first few years after graduation. To avoid this problem, many ISA agreements include a clause that sets the deal on “pause” during periods when you’re not seeking employment. So if you take a year off right after college to go backpacking around Europe, your ISA won’t start until you return and start looking for work. However, if you spend that year after graduation looking for a job and can’t find one, the ISA clock keeps ticking.
- No Payments Below a Certain Income Level. Paying 5% of your income toward an ISA each month can be hard to manage when you’re barely making a living wage. Because of this, most ISAs come with a minimum salary, typically $20,000 to $30,000 per year. If you’re making less than this amount, you don’t have to make any payments at all, and your ISA doesn’t go on pause.
- Dollar Limits. Most schools set a limit on how much aid you can receive through an ISA. The typical maximum is $10,000 per year. According to The College Board, the average cost of a year’s tuition and fees at a four-year private college is more than twice this amount, so an ISA generally isn’t enough to cover the entire cost. However, the “net price” – what most students actually pay after grants and scholarships – is much lower, so an ISA could be enough to make up the difference.
How ISAs Developed
The idea of ISAs has been around for a while. Economist Milton Friedman proposed it in his 1962 book “Capitalism and Freedom,” and Yale University experimented with it in the 1970s. About 3,300 students enrolled in the school’s Tuition Postponement Option (TPO), which organized its participants into cohorts. Each member of a cohort agreed to pay the school 4% of their annual income for each $1,000 borrowed until the entire group’s debt had been paid off.
Unfortunately, Yale’s program didn’t work out as planned. The recessionary 1970s meant that many members of each cohort couldn’t find jobs, so those who were earning had to keep paying much longer than expected. Eventually, the wealthiest members of each cohort exercised an option to buy their way out of the TPO early by paying 150% of what they had borrowed, plus interest. That left the lower-income members to carry the burden of the remaining debt, which persisted until Yale finally ended the program in 1999.
Around the same time Yale’s program was ending, an economist named Miguel Palacio was toying with the idea of starting one in his native Colombia, where many talented students were dropping out of college because they couldn’t afford tuition. Together with entrepreneur Felipe Vergara, he founded a company called Lumni, which currently backs ISAs for around 10,000 students in Colombia, Peru, Mexico, and Chile. So far, it has provided a total of $50 million in funding, and it’s now preparing to break into the U.S. market.
The first U.S. university to adopt an ISA was Purdue, with its Back a Boiler program (named for the school’s mascot, the Boilermaker). It got its start in 2015, when Daniels, who had read about ISAs in Friedman’s book, mentioned them at a congressional hearing on higher education. Afterward, he told NPR he was “swarmed” with reporters wanting to know more about the idea, so he headed back to Purdue and put together a team to make the idea a reality. Since then, several other U.S. colleges and universities and some noncollege training programs have started ISAs of their own.
Which Schools Have ISAs
The list of schools that offer ISAs is ever-changing, as new schools either try out new ISA agreements or drop the ones they have. Some schools test out an ISA program for only a few years before canceling it, as Yale did in the 1970s. As of 2019, nine U.S. colleges and universities have ISAs:
- Purdue University. The Back a Boiler program was the first successful ISA in the country, and it’s still the biggest. Launched in 2016, it has provided over $10 million in funding to more than 850 students at the Indiana university. It offers aid of $5,000 to $10,000 per year to students who have completed their freshman year, have declared a major, and are meeting the school’s standards for “satisfactory academic progress” toward a degree. The payback percentages and terms vary based on the student’s major. Students can get a separate ISA agreement for each year they attend Purdue, adding together the total of the percentages for each agreement to determine how much they must pay when they graduate.
- Lackawanna College. This private college in Scranton, Pennsylvania offers its Lackawanna Shares ISA to students who have not been able to cover their full tuition through federal student loans. To qualify, students must have at least 12 credits toward a two-year or four-year degree in one of 17 specified programs and must maintain a GPA of at least 2.5. Students get a six-month grace period after graduation before payments begin, after which they must pay back a percentage of their income for the next five years. However, they only need to make payments in months when their income exceeds $1,666.67, equivalent to around $20,000 per year. Also, the total payback amount is capped at twice the amount students received in funding.
- Clarkson University. The Lewis Income Share Agreement (LISA) Program at this New York college is very selective, accepting only 20 students per year. It provides up to $10,000 per year to students in over 95 degree programs at any of the school’s three campuses. A student who borrowed the maximum amount, $40,000 over four years, would pay back 6.2% of their income for 10 years after graduation.
- Messiah College. This private Christian college in central Pennsylvania launched a pilot ISA program in June 2018. It designed the program with the help of with Vemo Education, a technology company that helps colleges develop and launch ISAs. The ISA is open to Messiah undergraduates and graduate students in occupational or physical therapy. Payback percentages range from 3% to 3.5% of income, with payments waived for students who earn less than $25,000 per year.
- University of Utah. The Invest in U program at the University of Utah is also in its pilot phase. It’s open only to undergrads who are within one year of completing a degree in one of 18 qualifying majors. These students can receive $3,000 to $10,000 to cover any funding gaps after grants and scholarships. After graduating, they pay back 2.85% of their income each month over a period of three to 10.5 years, depending on their major and the amount they received. Students can pause their payments while they’re pursuing a graduate degree, if they’re earning under $20,000 per year, or if they’re engaged in voluntary service.
- Norwich University. This Vermont school is the oldest private military college in the country. Because the school is expensive – over $60,000 for the 2019-20 academic year – 95% of its students receive financial aid. In 2018, the university launched an ISA with Vemo as part of its 10-year plan to eliminate upfront tuition for all students. Currently, the ISA provides assistance only to juniors, seniors, and fifth-year students who are at risk of dropping out due to expense.
- Colorado Mountain College. CMC is a private college with 11 campuses. It offers bachelor’s degrees in five fields – nursing, business, education, management, and sustainability – as well as associate degrees and one-year certificates. Its Fund Sueños (Spanish for “Dream Fund”), launched in 2018. It’s reserved specifically for students who have financial need but can’t receive federal financial assistance because they aren’t U.S. citizens. Financed by private donors, the fund provides these students with up to $3,000 per year – which is enough to cover the cost of tuition, student fees, and books at this inexpensive college. Students begin paying back these loans six months after graduation, but only when they have a job paying at least $30,000 per year. They pay 4% of their income for up to five years or as long as it takes to pay back the amount they received (with no interest).
- Make School. At Make School, a coding school in San Francisco with a bachelor’s degree program in applied computer science, a majority of the students fund their education through the school’s ISA. Instead of paying $70,000 upfront for tuition, they commit to paying the school 20% of their gross salary for 60 months after graduation. Or they can split the difference, paying $35,000 upfront plus 20% of their salary for 30 months. These payments don’t start until graduates have landed a job that pays at least $60,000 per year. The school also offers a living assistance ISA, which provides $1,500 per month for living expenses in exchange for an additional 5% to 7% of income for 10 years.
- Holberton School. This for-profit college of software engineering has campuses in California and Connecticut, as well as three in Colombia and one in Tunisia. Its ISA program allows students to defer their tuition until they graduate and find a job that pays at least $40,000 per year. At that point, they must pay the school 17% of their gross monthly earnings until they’ve paid off the full amount of their tuition. If a student doesn’t find a job over the salary threshold within two years after graduation, their ISA payments begin at a rate of $0 per month until they do. If they haven’t paid off the full amount after 42 months, the school forgives the difference.
ISA programs aren’t just for degree-granting institutions. For example, the UC San Diego Extension offers the San Diego Workforce Partnership ISA for students earning a certificate in front-end development, Java programming, digital marketing, or business intelligence analysis. Students at Lambda School, an online coding academy, can defer their $20,000 tuition until they’ve found a job paying at least $50,000 per year. After that, they pay 17% of their income for two years, up to a maximum of $30,000.
In some cases, it’s possible to sign up for an ISA even if your school doesn’t offer one. A company called Align Income Share Funding, previously known as Cumulus Funding, cuts ISA deals directly with students. The company can provide up to $12,500 in funding in exchange for up to 10% of your income over a period of two to six years. You can also use an Align ISA as an alternative to a loan for other types of financial needs, such as medical bills or home repairs.
Pros & Cons of ISAs
Although an ISA isn’t technically a loan, it’s still a financial obligation. You are receiving money from the school, and you have a commitment to pay it back. And while an ISA doesn’t technically involve interest, the amount you pay back is usually more than you borrowed, just as it would be with a loan.
The advantage is that you know your payments will stay in line with your income. If you graduate and can’t get a job for the next five years or you can only get a low-paying job, you won’t have to squeeze a $200 payment out of your meager budget month after month. And you won’t be in any danger of defaulting on your student loans and having the merciless federal bill collectors come after you.
Of course, the flip side of this is that if you get a really high-paying job, you’ll probably end up paying back a lot more than you would with a traditional student loan. On the other hand, if you’re earning a high salary, those higher payments won’t be as painful for you. And since most ISAs have a cap, you know you won’t have to pay millions of dollars. Plus, the fact that your school is rooting for you to get a high-paying job, since it makes more money that way, means it has a strong incentive to help you succeed in your career.
ISAs also aren’t as highly regulated as federal student loans. This means you can’t necessarily get the same kind of breaks on them, such as forbearance – a pause in your loan payments – if you suffer a hardship unless the ISA contract has this benefit built in.
A final downside is that most ISAs will only provide you with a limited amount of money. At most schools, you won’t be able to cover the entire cost of your tuition with one. So unless you can get a scholarship, you’ll probably still need some type of student loan to cover the rest of the bill. But there are exceptions, like CMC because its tuition is so low and the coding schools because their payback percentage is so high.
Comparing the Cost
So which is better: an ISA or a traditional loan? If you’re less concerned with making your monthly payments than which costs less money in total, it depends your payback terms and how much you earn after graduation.
For example, consider this hypothetical case: A Clarkson student borrows a total of $40,000 through the LISA program and has to pay back 6.2% of his income for 10 years. This student graduates and becomes a teacher, earning $40,000 per year. That means his payments for the first year are $2,480 per year, or $206.67 per month.
After five years, the student gets a raise to $45,000, so his payments go up to $2,790 a year ($232.50 per month). Over the full 10 years, he pays back a total of $26,350 – less than the $40,000 he actually received. For this student, the ISA was clearly a bargain. If he’d taken out a 10-year student loan at 6% instead, he’d have paid a total of $53,289, more than twice as much.
But now, look at the numbers for a Make School student who chooses to cover her full tuition with the ISA, paying 20% of her income for five years. When she graduates, she gets a job that pays $95,000 – the average starting salary Make School says its graduates receive. This salary rises to $100,000 after three years.
Over the course of five years, this student pays a total of $97,000 back to the ISA. If she’d taken out a five-year student loan at 6%, she would have paid back only $81,197, saving nearly $16,000. So for this student, a traditional student loan would have been a much better deal.
Many schools that offer ISAs, such as Purdue, provide a comparison calculator to help you estimate how much you can expect to pay with an ISA. Enter your major and year of graduation, and it shows you how much your payments are likely to be based on the average salary for people in that field. You can use this number to compare the costs of an ISA to a student loan for the same amount.
How to Decide
If you’re like most people, total cost isn’t your only concern. You also want to know whether an ISA makes sense for your particular situation. Ask yourself a few questions to figure out if an ISA is a good option for you.
- Where Are You Going to School? Right now, only a few U.S. colleges offer ISAs, though that could change in the future. If yours doesn’t have one, you can try to set one up through Align. However, you’ll need to pass a credit check and other tests to evaluate your likely future earnings.
- What Are Your Other Options? Obviously, the best possible way to finance your college education is through grants and scholarships, which don’t have to be paid back. And for many students, the next-best is federal student loans, which offer low interest rates and easy repayment terms. However, if you aren’t eligible for federal aid, an ISA is likely to be a more affordable alternative to an expensive private student loan. It’s often a good option for students eligible for the Deferred Action for Childhood Arrivals program, known as “Dreamers,” who can’t receive federal aid because of their citizenship status. It can also help you pay your way through an institution program that doesn’t qualify for federal loans, such as a trade school.
- How Much Do You Need? The $10,000 per year most ISAs can provide isn’t enough to cover the full cost of tuition at most schools that offer them. Most students need some combination of grants, loans, and scholarships in addition. However, if you’ve already squeezed all the aid you can out of these sources and it’s not enough to cover all your costs, an ISA can be a less expensive way to pay for the rest than a private student loan or a PLUS loan. And it’s certainly a better alternative than dropping out of school without a degree because you can’t afford to pay for your final year.
- What’s Your Major? At many schools, the payback percentage for an ISA varies depending on your major. Students in the STEM fields (science, technology, engineering, and math) can generally expect to pay a smaller percentage of their income for a shorter time. For them, an ISA can be a better deal than a loan. However, for lower-earning humanities and social sciences majors, the payback percentage is typically higher and the term is longer. For these students, a traditional loan is likely to be a better value. In fact, at some schools, the ISA isn’t even available to students in these fields, because it’s too hard for the school to make a profit on them.
- How Much Do You Expect to Earn? Although ISAs are better deals for majors with generally good career prospects, they’re a poor bargain for people with very high potential earnings. Since the amount you pay is simply a fixed percentage of your income, very high earners are likely to end up paying back quite a bit more than they borrowed Even though the total payback is usually capped, these people almost always pay more through an ISA than they would have with a traditional loan.
- How Debt-Averse Are You? There’s no way to be absolutely sure upfront whether an ISA will cost you more or less than a traditional student loan. Until you get your first job, you can’t know exactly what your salary is going to be. However, an ISA offers you one guarantee that a student loan can’t: Your monthly payments will never be higher than a certain percentage of your monthly paycheck. If you’re terrified at the prospect of finding yourself jobless and burdened with student debt you can’t afford to pay, choosing an ISA can ease your mind. And the fact that an ISA isn’t a loan makes it an appealing option for those whose religious beliefs prohibit charging or paying interest.
Even if you’re sure an ISA is the right choice for you, you probably can’t use it to cover all your college costs. So it’s still worth looking into other ways to keep your college costs low. Tax-advantaged savings, scholarships, earning extra credits to get your degree faster, or starting out at a community college can all help you keep the total bill down and reduce the amount you need to fund through an ISA.
What do you think of income-sharing agreements? Do they sound like a good deal for students or like a rip-off?