Income-share agreements are emerging as a popular alternative to student debt.
The idea is more common in other countries but quickly gaining traction in the United States.
Rather than borrowing a traditional student loan, income-share students agree to pay a portion of their income for a set period of time. The goal behind this approach is to protect graduates who struggle to find jobs and to incentivize schools and lenders to help students find quality employment.
Ideally, an income-share agreement aligns the interests of the borrowers with the schools and lenders. The more money the borrower earns after graduation, the more money the lender gets paid.
That being said, not all income-share agreements are created equal. Some will be excellent deals for borrowers while others end up being worse than traditional student loans.
Ultimately, the quality of an income-share agreement will depend upon the terms of the contract. Because borrowers are literally signing away future income, it is critical to read and understand the agreement in full.
Borrowers should pay special attention to the following terms.
Payment Length and Timeframe
All income-share agreements will require participants to pay a certain percentage of their income, for a certain period of time.
That time period may only be a couple of years or it could last much longer. The length of the contract will make a huge difference in the total cost.
Income-share borrowers should run through the numbers in a few different ways. First, look at how much would have to be paid if the student ends up earning an average salary. Run the numbers again for best-case scenarios and worst-case scenarios to get an idea of the range of possible costs.
Additionally, it is important to look at the repayment timeframe. For some agreements, it will start immediately after completing school. Others will not start the clock until the borrower starts earning an income. For example, the income-sharing may only last two years, but that two-year window might start four years after finishing school.
What Income is Going to be Shared?
One of the more critical numbers to look at is the percentage of income being shared. Unfortunately, it isn’t as simple as just saying 10% of income.
Is that income before tax or after tax?
How are bonuses or overtime handled?
Is the income based on adjusted gross income on taxes?
Who is responsible for determining income? How does the process work?
Does marriage have any consequences? What happens if the income-share spouse stays home with the kids?
All of these questions should make one point very clear: income determination can get complicated very quickly. Income-share participants should understand exactly how the calculations are made before signing any agreement.
Is there an Income Floor?
Most income share agreements contain an income floor. This is the part of the income where borrowers keep 100%.
As an example, one income-share agreement calls for borrowers to pay 17% of their income above $50,000. If a borrower earns $40,000 per year, they won’t have to make any income-share payments. If they make $60,000, they will only have to pay 17% of $10,000.
Other income share agreements may not have a floor at all.
In some circumstances, a higher percentage payment with a high floor may be preferable to an income-share that requires payment starting with the first dollar earned.
Payment Maximums or Caps
A critical term for all borrowers will be the cap on total payments.
The cap is the maximum that a borrower will ever have to pay on an income-share agreement.
Without a cap in place, a borrower could end up paying a fortune for a small amount borrowed.
What if the student doesn’t find a job in their field of study?
One area where income-share agreements are becoming popular is coding academies.
Students attend these coding academies with the idea of becoming a computer programmer or working in a related field.
Suppose the student finishes school and is unable to find a job using their degree. Needing an income, the unemployed graduate takes a job in a completely unrelated field.
Does that graduate still have to make payments on the income-share agreement?
Starting a Business
Starting a business is notoriously difficult.
Many small business owners do not turn a profit for years.
An income-share agreement could be a great deal for someone who aspires to start a business because the income-sharing may only apply to the early years where the business isn’t generating much of a profit.
However, the lender in the income-share may want to protect themselves and create a term in the agreement that either extends the income-share for small business owners or gives the lender ownership of a portion o the business.
Here again, things can get complicated very quickly. This is yet another example of why it is critical to read the income share prior to signing.
Cost of Tuition vs. Value of Degree
Some programs may say that students can either pay $25,000 for classes or sign an income-share agreement.
When prospective students do their analysis, they may compare expected income-share spending against the $25,000 they either pay or borrow in a traditional student loan.
Unfortunately, the analysis cannot stop here.
How much is the program really worth? If the classes are all online, the school may only be spending $500 per student.
For this reason, traditional school evaluation is still important even if there is an income-share agreement. Students considering the program should ask questions like:
- What percentage of graduates get jobs in the field?
- What is the average salary?
- How many employees work full-time helping students find jobs?
- What percentage of students find jobs through the career development office?
The important takeaway is that an income-share agreement doesn’t automatically mean the school will do a good job helping graduates find jobs. Schools may choose to maximize income by focusing on student recruiting pumping out as many graduates as possible. Even if half the students don’t get good jobs, they will make a fortune on the half that finds jobs on their own.
Anyone considering an income-share agreement will have some serious homework to do.
Not only will they have to do the traditional school analysis that all prospective students must do, but they will also have to carefully read and consider the terms and conditions of the income-share agreement. There are major pros and cons to consider.
In some cases, the income-share agreement could be a great deal. In others, it might be worse than a typical student loan.