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Thursday, August 13, 2015

Should I Finance College with An Income Share Agreement?

This is my 200th post!  Reaching this milestone was nothing easy, let me tell you.  I did have some help along the way courtesy of great guest authors.  I hope I can continue to be a part of your life, my loyal visitor, as I endeavor to educate and entertain on all matters financial literacy.  Thanks for being here, and here's to the next 200!

Before I get started on today's topic, I'd also like to thank Jeremy Biberdorf, blogger at the excellent personal finance blog, Modest Money.com, for allowing me to guest post.  If you like to read about personal victories where someone overcomes an addiction, and takes a bunch of money back from the hands of the future, this is your article.  Enjoy!

Now onto Income Share Agreements, or ISAs for short.  These are basically private loans where an entity, such as a university, a non-profit, or a private company, agree to fund an individual's education for a portion of their future earnings.  They're all the rage right now, as the college loan industry is getting worked like anyone who steps in the ring with UFC Champ, Ronda Rousey.




I went on Google and found several articles that explain ISAs and give perspective from people involved, e.g., college professors, CEOs, politicians pushing the agenda for more ISA clarity, etc:

Slate.com: "Because You're Worth It," by Alison Griswold

Deseretnews.com: "Income Share Agreements: A Better Way to Fund Higher Education?" by Jan Miller

Forbes.com: "Income Share Agreements, and their Role in Making Higher Education More Affordable," by Richard Vedder

Income Share Agreement (Wikipedia)  This one is the most informative in my estimation.


Though not new--the idea of an investor taking a fractional interest position in someone else's earnings prospects has been around since the 1950's--it's just now that students have taken to consuming ISA contracts, and those who were early on the scene (2010-2013) have not yet been asked to provide their review on the deal they got.  They may have, but I couldn't find any first person reviews.

ISAs are in my opinion a last source of funding.  Future college students must first exhaust what they can get, if anything, from FAFSA, relatives, work study, and lastly, low-interest private loans.


Source

The claim is that ISAs will provide students from disadvantaged backgrounds who do not qualify for low-interest private loans, a better alternative.  Let's think about this.  If I don't qualify for low-interest private loans, it usually means that I'm not considered the "cream of the crop" by lenders.  In other words, I'm considered risky.

The terms, if qualified for an ISA, would not be favorable; either they'd stick it to me by virtue of, making me pay from my earnings for an extended period (15 - 30 years), OR, making me pay a high interest rate (10% or more) on my loan.  Be mindful that "risky" in the case of an ISA for investors is defined as a graduate who does not make more than $18K a year, basically, a deadbeat.  Graduates don't have to pay a single penny back of their loan if they earn less than $18K!  So if you're a college student who graduates, and procures a great career, you're stuck with a private loan that, unless it allows for prepayment (with penalty no doubt), will cost way more than what your education was actually worth!

So like any other loan, if you choose the option to fund a part of your college education with an ISA, be smart at the beginning prior to signing anything, and try to get the best terms you can.  Look for things such as:

1.  A prepayment penalty clause.  What will it cost you to pay your balance in full before the life of the loan is due to expire?

2.  Is refinancing an option.  Say you sign an ISA prior to the start of your sophmore year (maybe you didn't get awarded enough in Federal Aid this time out or something) and in the middle of the year, you decide you want to change majors from Sociology to Engineering.  It happens!  Can you go back to your borrowing institution and refinance your original ISA upon proof of being accepted to the College of Engineering?  If you had reported Engineering as your major from the get-go, you would've undoubtedly been given better borrowing terms.  Are you stuck now?  Ask, Ask, Ask, kid!  Before you sign on the dotted line.

Now I want to show you why not all ISAs are equal with a visual:

"An Income Share Agreement (or “ISA”) is a financial vehicle in which an individual or organization gives a fixed amount of money to a recipient who, in exchange, agrees to pay back a percentage of his/her income for a fixed number of years."  From Wikipedia.  The key words here being, "fixed number of years."


Hypothetical Private Loan Company A Offering the Same ISA Contract to Everyone

Amount being Borrowed
For fixed length of time of,
At a rate on future earnings of,


$10,000
10 years
10%







Scenario 1
Bank Teller (underemployed Psychology graduate)



Salary
Monthly Net Earnings
Monthly Loan Payment
Annual Payment Total
At 10 years
$25,000
$1,750
$175
$2,100
$21,000





Scenario 2
Teacher



$40,000
$2750
$275
$3,300
$33,000





Scenario 3
Software Engineer



$95,000
$6,500
$650
$7,800
$78,000


 In each of these three scenarios, the investors make money.  Of course, we are talking a static situation where there are a) no changes in earnings for ten years and b) no changes in work profession or time on the job.  This won't happen because people usually get raises over time, they are promoted, demoted, or fired = unemployed.  From this data table, you can see that the best possible ISA outcome for students going to college would come from:

1.  Working with an entity that provides you the best terms.  If you apply with one that lets you measure yourself, i.e., allows you to submit your credit score (if any), work history (if any), grade point average, SAT scores, prospective major, etc., and find your interest rate is still over 10% for a ten year fixed term loan (using our example above), then going with "Company A," may be a good thing for you.  Upstart.com uses an algorithm by using data points such as the ones I mentioned here, to compute your rate.

2.  If you're an "elite" kid, you will want to stay away from places like "Company A."  You'll want your established credit, sources of income, SAT scores, etc., to count.  So working with an entity that works like an insurance company (good driver discount, etc.) when letting you borrow money, is where you want to head.

ISAs turn out to be more like indentured servitude, far worse than any private loan can be, as interest rates and time commitments climb.  As a high school graduate, entering your first year of college, the picture of your career future out of college is still very fuzzy.  I would not recommend anyone apply for an ISA, unless they have no other way to finance a college education, until they have started their upper division coursework.


Source

Better yet use an ISA, if you have to, to fund grad school.  By then, you're intrinsic value as an earner has risen (you've held a job as an undergrad, you've used credit wisely, you've made the Dean's List, etc.) meaning you can command more favorable borrowing terms for yourself.

Should You Finance College with An Income Share Agreement?

Only if you have no other recourse.  That is it because there are no good reasons why you'd want to turn away better borrowing terms, for a fake "peace of mind," other than you not believing in your potential or having a sorry outlook of the future.  Your future!  

Think about this: even though you will be protected as a borrower in an ISA if you happen to land on dire straits after college, and don't break an income of $18K for 1, 2, maybe even 3 years, will your mind be truly at peace?  Will you be happy knowing that because you are under-employed, and your earnings have diminished, you will now have to pay back less money each month to your note holder?  Only losers would be happy about misfortunes like this.

Thanks for reading!  If you liked this post please share it with a friend.

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