In the wake of the ongoing student loan crisis, an old idea gaining new popularity is the concept of income-share agreements. Income-share agreements may look like student loans, but they come with unique pros and cons.
The way an income-share agreement works is relatively straightforward.
Suppose a student needs $5,000 to pay for school. Rather than borrowing a $5,000 student loan, the student enters into an income-share agreement. Per the agreement, the student agrees to pay a portion of their income to repay the debt.
This approach has some obvious benefits, but it comes with a few not-so-obvious drawbacks.
Income-Share Agreements in Action
Typically an income-share agreement lasts no more than ten years. Students usually get to keep their first $20,000 of income each year. After that first 20k, borrowers pay a set percentage of their income to the lender.
Additionally, payments under income share agreements are normally capped at 1.5 to 2.5 times the amount of the original amount borrowed for school.
Purdue University, one of the schools leading the income-share agreements trend, also dictates that students cannot sign away more than 15% of their future income per these agreements.
Presently, the market for income-share agreements is about $20 million a year. In the future, income-share agreements could be a billion-dollar industry.
Pros of Income-Share Agreements
The big advantage of an income-share agreement is that the debt will be affordable. Underpaid or unemployed graduates won’t have to deal with student loans they cannot afford.
Graduates on income-share agreements can behave as though they are in a slightly higher tax bracket. Instead of keeping 70% percent of their earnings as “take-home pay,” the percentage will be lower.
Qualifying for an income-share agreement works much differently than a traditional student loan. Credit checks eliminate borrowers with a severe negative history, but lenders don’t focus on credit scores. Additionally, there are no cosigners required. Income-share lenders care more about the school attended and the major of the borrower.
Another advantage of these agreements is the incentives created. If an investor or lender provides funds for school, and that student does not get a job, they are out of luck. If the lenders and investors can help that student find a job, they will make money. Instead of negative credit reporting and collection calls, we would have job placement assistance and career counseling.
Income-Share Agreement Cons
The problem with an income share agreement is that a student is betting against himself or herself. The investor or lender expects to make a profit on the deal. The student takes the deal because they are worried that they might not be able to pay back the amount in full.
If, at the time of the signing of an income-share agreement, a student knew for sure that they would be able to pay back the money, they would be much better off just getting a standard student loan. In many ways, an income-share agreement is a student’s way of protecting themselves against unemployment and underemployment.
From a big picture perspective, income-share agreements are unlikely to solve the student debt crisis. The student loan crisis can be blamed in part on the ever-increasing cost of college. If income-share agreements enter the equation, it just provides another means for students to afford increasingly unreasonable tuition prices. More borrowing means more debt, which means the crisis continues.
Finally, because income-share agreements are less common and more complicated than student loans, understanding the agreement’s exact terms becomes incredibly important.
Reading the Fine Print
Ultimately the quality of these agreements comes down to the exact terms and conditions. Just as some student loan terms are great, and some are awful, income-share agreement quality could vary greatly.
Students considering an income-share agreement should look very closely at the cap in payments. If the cap is too high or the length of the share is too long, it could result in very unfair terms to the student. Already, some are calling income-share agreements a modern-day form of indentured servitude.
Before signing an income-share agreement, it is critical to understand all of the terms and conditions.
Because we are talking about long-term financial agreements involving sophisticated parties such as lenders and investors, it will be critical that the interests of the students who enter these agreements are protected.
One of the big issues with student loans has been the lack of consumer protections in the marketplace. If income-sharing agreements are to be part of the solution to the student loan crisis, it would be wise for schools and regulators to set clear boundaries early on so that the industry has a chance to grow in a way that benefits all involved.
They may sound simple in theory, but the contract has the potential to get very complicated, very quickly. If done properly, it can be a great system. If abused, graduates could be unfairly forced to fork over a ton of money.
As a student borrower advocate, I find income-share agreements to be a bit scary, but they also have the potential to help many students.