Should You Be Selling a Piece of Your Future?
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Student debt is a big problem for many post-graduates who either can't afford the payments or can't invest in other assets because they're still paying back their student loans. As a result, many students are considering selling a piece of their future, aka signing an Income Share Agreement to fund their education.
What is an ISA, and should you be selling a piece of your future?
Find out what it all means below.
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Selling a Piece of Your Future
It sounds ominous selling a piece of your future, right? What it means is you share a part of your future income, aka post-grad income, to pay for college. You aren't sharing all the money you earn, but a percentage of it to get through college.
It's supposed to be an alternative to student debt, helping post-grads enjoy their lives after graduation rather than feeling burdened by large student loan payments.
While it is an alternative, it's one with many pros and cons that you must understand and consider. Unfortunately, every college doesn't offer this option yet. However, about 100 colleges, including Purdue, the University of Utah, and Colorado Mountain College, provide the opportunity to promise a percentage of your future earnings or the earnings you expect to make so you can pay for school.
Each college and major has different agreements, as the agreement depends on the potential future value of the graduate's day job income. Many investors have a minimum threshold they require to provide the funds. In some cases, it can be lower than the interest rates on student loans, but not always.
Income Share Agreements
Essentially, an income share agreement is a student loan. No, you don't have an interest rate or write monthly checks to a bank, but you promise a percentage of your income for a set term to the fund. It's a big personal finance decision that you shouldn't take lightly.
Depending on the terms, you might pay more than you borrowed or less. It comes down to the percentage of the income you expect to make that you promised, how long you pay it, and what your career path looks like after graduation. It's important to see how it fits into your financial goals after graduation before choosing it.
How It Works
Currently, Income Share Agreements aren't regulated like student loans. Such a thing could change soon, though, because the Consumer Financial Protection Bureau has already come down on one provider, requiring them to call their ISA a loan, and they must disclose the interest rates and fees.
Because they are unregulated, each provider has its own requirements and terms. Therefore, it's important to read the fine print, so you understand the terms, how long you must pay back the funds, and what percentage of your future income you promised.
Here are the steps to get an ISA.
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Find an ISA Provider
Finding ISAs can be pretty challenging since they aren't popular yet. The easiest place to find a provider is your school. If they offer ISAs, you'll typically find the information on a school's financial aid page.
You may also find private lenders that primarily work with undergrads in their junior and senior years. These investors take a 'gamble' betting or investing in a student's future. They hope the graduate makes more cash than expected, putting more money in the investor's pockets since graduates pay a percentage of their income for a set period.
Income share Percentage
The income share percentage is the amount of your future salary you promise to the investor monthly. On average, investors request 2% - 10% of a graduate's salary. It varies based on your potential income, career, and the path most people in your major or line of business take.
The higher the percentage you pay, the more likely you'll pay more than you 'borrowed' for your college education.
For example, if you make $50,000 when you graduate and promise to pay 5% of your salary for the next ten years, you'd pay $5,000 a year or $50,000. If you borrowed more than $50,000, you come out ahead. However, if you borrowed less than $50,000, you would pay more than you would have with a loan.
This example doesn't take into consideration raises or promotions, either. Each time you make more money, your payment to the investment company increases.
Most ISAs have a salary floor. This is the minimum amount you must make for them to collect payment. This doesn't mean you won't owe the funds if you make less than the floor, though.
Yes, the payments stop temporarily, but most ISAs defer the payments. In other words, you'll make up the payments when your future salary increases above the floor.
If you must defer your payments, you'll be on the hook for paying your ISA longer, which isn't always a good thing.
A payment cap protects you from paying back more than you borrowed. This is one of the most helpful features of an ISA, so pay close attention to it. Any ISAs with a payment cap above 2X the amount you borrowed will likely leave you paying much more than necessary. Also, if an ISA doesn't state the payment cap, look elsewhere.
The repayment term is how long you're on the hook to pay the investment company back. It's a set term, and you can't pay it back earlier like you can a loan. The typical terms range from two to ten years. Read the fine print carefully, though. Some ISAs allow the months you were below the salary floor to count in your term, and others defer your payments, adding the months to the end of your term.
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ISA Model Student Loans Example
Let's look at a more complicated ISA student loan example.
You graduate college with a new job paying you $50,000 a year. Your ISA has a 6% income share percentage and a 7-year term. Throughout your career, you are lucky enough to stay employed the entire time and even get a promotion. In year 2, your income increases to $55,000; in year 5, you make $65,000. Finally, in year 7, you make $70,000.
When you first graduate, you pay back the investor 6% of your $50,000 or $250 a month. You pay this for the first year, but your payment increases to $275 for the next three years.
In year 5, when you get a promotion, your payment increases to $325; finally, in year 7, it goes up to $350.
In the end, you pay $24,900. If you borrow less than this amount, you come up short, and the investor 'wins.' But, if you borrow more than this amount, you come out on top of the situation.
It's hard to predict your future income, so it can be difficult to base your decision on future earnings. Looking at the average income of someone in your career, though, can give you an estimate of what you might earn and pay versus what you would pay on a student loan.
Providers of ISA Student Loans
Lumni strives to help students by offering Income Share Agreements instead of student loans. They take a percentage of your salary after you graduate rather than focusing on how much you can borrow and what you'll pay on your credit score.
Lumni offers college graduates many opportunities for support to help young people reach their career and financial goals.
Upstart, a company known for more flexible underwriting guidelines for short-term loans, offers Income Share Agreements too. To come up with your agreement, professionals predict your income over the next ten years.
Upstart promises its investors an eight to ten percent return, which is on the higher end.
Pave, like Upstart, predicts your future income to determine how much you will pay back to investors. They allow up to a 10 percent income share, but most investors earn a seven percent return on their investment in college students through Pave.
SoFi has a fund that investors buy into that helps students of the college the investor graduated from refinance their loans at more attractive rates.
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What Happens if You Lose Your Job?
Usually, if you lose your job, you can stop making payments to stay on top of your day-to-day operations. Read the fine print on the terms of your ISA, though. Some companies allow you to count these months toward your term, and others add the missed months to the end of the term.
What if You Change Majors?
Each ISA has its own agreements and requirements. Some only offer the agreement to juniors or seniors to avoid the risk of changing majors. Those that offer them to first- or second-year students have requirements based on majors and what you can and cannot do.
Is an ISA Right for Everyone?
Only consider an ISA after you've exhausted all federal loan options. Government loans usually have lower interest rates and will cost less. Plus, they have options for income-based repayment and loan forgiveness. If you don't qualify for government funding or don't get enough, make sure you understand the terms of an ISA before accepting it.
Should You Be Selling a Piece of Your Future: The Bottom Line
So should you be selling a piece of your future earnings? It depends on your life plans, the agreement's terms, and the value of what you get versus what you'd pay on a student loan. Don't jump at the first chance you get to get money for college, but look at the fine print to make sure it suits your personal finance goals now and in the future.