Student debt has become a serious problem in the United States. Income Share Agreements (ISA) are a promising alternative to personal student loans. Unlike traditional loans, they don’t accrue interest and there is no principle that is paid down.
An Income Share Agreement is a contract that a student enters into with their school (or some other institution) where the student promises to pay a certain percentage of their future income in exchange for deferred tuition. Plus, monthly ISA payments are only due when you’re employed — and in many cases, not until you’re earning an agreed upon salary.
By agreeing to pay a fixed percentage of one’s income, students can ensure that their student financing obligations will never exceed some predefined percentage of their total income in the future.
But, some federal student loans have a similar income-based component built in. It’s called an Income-driven repayment plan. On the surface, Income Share Agreements may look a lot like Income-driven repayment plans offered by the government. They both allow you to make payments based on a percentage of your income. However, if you dig a little deeper, you’ll notice that the two products can be vastly different. Which is why it’s a good idea to know the difference between them and which one will work the best for you. Keep reading to discover how ISAs differ from income-based repayment plans.
Income Share Agreement
With ISAs, which call for borrowers to make postgraduate payments, generally, only if they find a job, the protections are similar to income-driven repayments.
If you aren’t familiar with Income Share Agreements check out this guide, but here are some of the basic benefits Income Share Agreements have.
You could defer — or pause — repayment
With Income Share Agreements you are only in active repayment when you’re earning an agreed upon salary, so you could automatically postpone your monthly payments in cases of unemployment. The exact terms of the contract will vary, but check out this guide to repayment to learn the different ways your payments could be paused.
Your repayment won’t drag on forever
ISA contract terms create limits on the amount of money and time you would spend in repayment.
With an ISA, you pay back a percentage of your earnings each month for a set number of months. Each of these payments is considered one of your Required Payments. Once you pay all the required payments your ISA is completed.
For example, let’s say that outlined in your ISA, you are to pay 10% of your income for 24 monthly payments. (this is the number of Required Monthly Payments)
So, based on your income, you pay $500 per month to your ISA. If your income doesn’t change for 24 months and you make each of those $500 payments every month, your ISA is over.
As you can see, there is no amount of money that you’re hacking away at. Just make each of those required monthly payments based on a percentage of your income.
With an ISA you’ll always know the exact amount of money you could potentially pay back. The Payment Cap is the most you could ever pay on your ISA. Thanks to the Payment Cap, you’ll repay only a set multiple of your original ISA balance — and no more. If your $5,000 ISA has a 1.5 cap for example, the max amount you would ever pay would be $7,500. If your payments add up to this 1.5 times cap, even if you haven’t made all your required payments, your ISA is finished!
Income Share Agreement Disadvantages
Income Share Agreements can not be a great fit for everyone, depending on your career you could potentially be paying more than you would with a regular federal student loan. Although Income Share Agreements are increasing in popularity because they are a newer alternative to federal student loans, since they are newer there are no federal regulations. There are state regulations but it’s important to know exactly what your ISA contract says and how much you could potentially be paying back.
Direct Federal student loans also generally give students access to various “Income-driven repayment plans,” which would reduce one’s payment but can also increase their repayment term.
The federal government offers four income-driven repayment plans that can lower your monthly bills based on your income and family size. Switching to one of these plans can be right for you if:
- You have high debt and a low income
- You can’t afford your current payments
- You qualify for Public Service Loan Forgiveness.
Here’s what to know about the different income-driven plans before you sign up.
All income-driven repayment plans share some similarities: Each caps payments to between 10% and 20% of your discretionary income and forgives your remaining loan balance after 20 or 25 years of payments. There are 4 different plans:
Income-Based Repayment (IBR) is an Income-driven repayment plan that caps your monthly federal student loan payment at either 10% or 15% of your monthly discretionary income, which is the amount by which adjusted gross income exceeds 150% of the poverty line, depending when you borrowed your federal student loans.
Generally 10 percent of your discretionary income if you’re a new borrower on or after July 1, 2014*, but never more than the 10-year Standard Repayment Plan amount
Generally 15 percent of your discretionary income if you’re not a new borrower on or after July 1, 2014, but never more than the 10-year Standard Repayment Plan amount
Pay As You Earn
To qualify for PAYE, you must demonstrate financial need. You must also be a fairly recent borrower. Pay As You Earn offers the lowest payment amount for all eligible borrowers. This Income-driven repayment plan is best for you if you have graduate loans and have low earning potential.
Revised Pay As You Earn
Best for you if you don’t have graduate loans and have high earning potential. Revised Pay As You Earn (REPAYE), which became available in December 2015, is the newest Income-driven repayment plan.
This plan is similar to PAYE, with a few key differences. The most notable difference is the fact that you’re eligible regardless of when you took out your first federal student loan. You also don’t have to demonstrate financial need. The payment amount is generally, 10% of your discretionary income, and the repayment period is typically 20 to 25 years. Use this calculator to estimate your monthly payments with REPAYE.
Income-Contingent Repayment is an Income-driven repayment plan that caps your monthly federal student loan payment at either 20% of your discretionary income, or you would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to your income. Whichever is equal to less money over the years.
Since monthly payments are capped at 20% of discretionary income, ICR is considered to be more expensive than other Income-driven repayment plans. After 25 years of payments, you can receive student loan forgiveness on your remaining federal student loan balance.
Before enrolling in any Income-driven plan, plug your loan information into Federal Student Aid’s Loan Simulator. This will give a good idea of your monthly bills, overall costs and forgiveness amounts under each plan.
While Income-driven repayment options can make monthly student loan payments more affordable, these programs do have some potential disadvantages.
You can end up paying more interest. An income-driven repayment plan won’t change your student loan interest rate. Switching to an IDR plan can lower the amount you’re required to pay each month, but it won’t impact your interest rate. Income-driven plans could potentially extend your repayment term from the standard 10 years to 20 or 25 years. Since you’ll be repaying your loan for longer, more interest will accrue on your loans. Interest will be assessed and charged in the same way it was before you enrolled in the plan. Plus, the lower monthly payments on an IDR plan won’t reduce your balance as quickly as a standard repayment plan. You’ll be charged interest on a balance that’s higher than it would be if you followed the traditional 10-year repayment schedule.
That means you may pay more under these plans — even if you qualify for forgiveness. You also have to pay off your loan before forgiveness kicks in. But if you have a balance left at the end of the repayment term, the forgiven amount will be taxed as income unless you qualify for Public Service Loan Forgiveness. You can apply for Income-driven repayment at studentloans.gov or by sending your student loan servicer a paper request form.
Comparison of ISAS VS. Income Driven Repayment Plans
ISA and IBR programs both have payments based on income, but after that, they both look very different. Even though IBR payments are based on income, there is still an underlying traditional loan with interest. If you aren’t able to cover the interest building up with your payment, you will start seeing your balance grow over time.
IBR is more like a traditional loan, so if you fulfill the requirements and you have the rest of your loan forgiven, you still have to pay taxes on the amount forgiven. Even though this is favorable to paying off the whole loan, it can cause a large one-time payment that you may not be ready for. This could cause you an even bigger headache during tax time.
Income-based repayment plans are also part of federal funding loans, therefore they have limits on how much one can borrow. For undergraduates, students are only able to borrow up to $57,500 over the course of their studies. This includes yearly limits of up to $12,500. But sometimes this still isn’t enough to cover education costs.
On the other hand, Income Share Agreements don’t currently have a limit on how much you can use. Some schools do limit the amount that a student can borrow, but this is all at the school level. Still, the annual limits for some of these programs are larger than the annual traditional loan limit from the federal government.
While IBR programs have some downfalls, these federal loans can still be potentially less costly due to their low interest rate. Federal loans also have protections that other private loans don’t have, such as deferment and forbearance that allow you to pause payments.
On the other hand, Income Share Agreements don’t have a balance or interest. This means that you don’t have an original amount that you will have to pay back. You just make your payments as a percentage of your income and once you complete your term, you’re finished. Regardless of whether you paid back the original balance or not. An ISA is completely dependent on your situation.
Both Income Share Agreements and Income-driven repayment plans are useful when used in the right circumstances. Be sure to do your research and talk to your school advisors to determine which one is best for your situation. Check out the Meratas blog if you’re interested in learning more about Income Share Agreements!
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