New form of debt is a risky gamble for college students
Income-sharing agreements could put students at risk, the Iowa Attorney General’s office and Iowa College Aid warn
Students and families seeking to avoid student loan debt might be tempted by creative alternatives. One idea growing in popularity at schools in other states is income-sharing agreements (ISAs).
The hook: Give up a certain percentage of your future earnings to cover the cost of your education. The amount repaid is linked to the amount you earn after graduation. If your degree fails to pay off, you may end up repaying less. If your income grows, however, so will the amount you repay. The funder of your agreement makes more return when you make more money.
The catch: ISAs are still debt, and with repayment linked to earnings, students could end up repaying much more than they would if they borrowed traditional student loans. ISAs also don’t offer the same repayment protections offered to borrowers of federal student loans.
The Iowa Attorney General and Iowa College Aid urge students to avoid income-sharing agreements and caution educational institutions and policymakers to steer away from embracing the tools.
ISAs are still rare, although institutions ranging from Purdue University to small coding boot camps offer them. The arrangements could be poised to grow quickly, however. The U.S. Department of Education plans to pursue an experiment to offer ISAs to students. Bills in Congress could also spur growth in ISAs and provide a framework for more colleges to adopt them.
Supporters say legislation would provide more choices for students and more oversight for the product. Consumer advocates warn that the proposed bills are a mistake, in part because they could undermine existing protections for students who incur debt.
In Iowa, income-sharing agreements are regulated by the Iowa Consumer Credit Code, and the terms of most ISAs would violate the law’s limits on interest rates, late fees, grace periods, and more, if they were offered to Iowa students. However, Iowans attending out-of-state schools may be presented ISAs as part of their financial aid packages and should be aware of the costs and risks of ISAs, as well as other states’ laws that apply to those agreements.
Some important points to consider:
Actual rates could be exorbitant: Here’s an example provided by Mark Kantrowitz, financial aid expert and publisher of SavingForCollege.com:
A student signs a $30,000 ISA contract promising to pay 12% of her income a year for 10 years. Assuming she makes $50,000 a year — the average starting salary for someone with a bachelor’s degree, according to the National Association of Colleges and Employers — and saw a 2% raise each year, the student would end up paying back $65,700. This equates to an interest rate of 18.4%, or more than $6,000 a year on a pre-tax income of $50,000. For comparison, federal student loans currently have interest rates around 5%, with a $318 monthly payment and total payment of $38,184 over 10 years.
Your major matters: Students who plan to enter lucrative fields, such as engineering or computer science, are likely to get the best repayment terms. Education and liberal arts majors are considered riskier and will pay higher percentage rates.
If the bill collector comes: Julie Margetta Morgan, a fellow at the Roosevelt Institute think tank, warns that students who sign ISA contracts often waive their rights to jury trials and lawsuits. Instead, they must resolve disputes through binding arbitration, which can exploit consumers. Some funders can collect the money owed directly from students’ state tax refunds.
Iowa College Aid and the Iowa Attorney General recommend that before students consider ISAs, they exhaust other ways to pay for their education. Every college-bound student should file the FAFSA (Free Application for Federal Student Aid) to qualify for federal and state grants and scholarships, federal work-study, and federal student loans.
Federal student loans are always the better option for student borrowers, as they provide flexible repayment options and have lower interest rates. Private loans can also fill gaps in financing; for more information, see August’s Consumer Focus newsletter.
The window to file the FAFSA for the 2020-21 school year will open Oct. 1; for more information, go to IowaCollegeAid.gov/FAFSA.