America's total student loan balance has topped $1.5 trillion, according to recent Federal Reserve data. Default rates on student loans are at 11%. While the job market has improved for recent graduates, many are struggling with excessive debt (over $39,000 at graduation on average) and entry-level jobs that make repayment difficult.
Enter an alternative approach to paying for college – the Income Share Agreement (ISA). Schools that offer an ISA program provide the funding to get your degree in return for a percentage of your post-graduation income over a set number of years. In essence, the school is investing in you and expecting that return to pay off in a direct income stream – bypassing the student loan system entirely.
The repayment percentage varies depending on the chosen major/profession and starting salaries, following the advice of Adam Carroll, Founder and Chief Education Officer of National Financial Educators. "We need to make borrowing commensurate with what starting salaries are in that major," says Carroll. "Just by doing that I think we would cut back significantly on the amount of borrowing that's happening in society."
ISAs don't charge interest, nor are they open-ended commitments. Graduates are protected against unemployment or low-paying jobs by a minimum income threshold to trigger repayment. Conversely, the maximum payment is capped at some multiplier of the original funding amount. This prevents high earners from paying far more than they would have based on a traditional student loan.
Schools use historical data and projections to set repayment periods and percentages. They strive for a balance that brings in enough money from successful graduates to provide a safety net for graduates that are struggling. Think of an ISA as a form of tuition insurance.
ISAs do not replace student aid programs, and graduates may have a mixture of student loans and ISA obligations. Most schools that provide ISAs view them as supplementary to other forms of need-based financing. However, it's easy to see how ISAs could start to replace government-backed student loans in the future.
Universities like the income element – if you've assessed risk correctly, you have a near-guaranteed stream of income. Policymakers like the concept because the risks and costs associated with default are shifted to individual universities and donors instead of taxpayers. Students like the security of a safety net without the strings associated with federal income-based repayment programs.
What's the downside? Aside from possibly paying more than you would with a traditional student loan – especially if you land a high-paying job that would allow you to pay ahead or refinance to a better rate – the main downside is that ISAs are not regulated like student loans.
How are delinquencies/defaults handled? What happens if you don't graduate or you transfer? What are the rules on deferment? Is there a check on discriminatory practices? Each school sets their own rules to this point.
The answers will be covered in the ISA contract – so make sure you fully understand the program and what happens in case of unexpected consequences. Ask questions to clarify anything that isn't clear to you or that isn't addressed in the contract.
Tuition assistance in return for future obligations is nothing new – colleges associated with the military have been offering that model for years. ISAs extend the same principle to other universities and trade schools.
Before committing to an ISA, be sure to review the ISA contract very carefully. Understand all commitments and obligations before signing, including best and worst cases. With few regulations in place, you're on your own if things don't go as planned.