A New Way To Pay For College Tuition?
Income Sharing Agreements (“ISAs”) are relatively new college tuition financing vehicles being introduced at several universities across the country. ISAs provide students with funds for a college in exchange for a percentage of the student’s earnings over a specified number of years after graduation.
Important terms to the ISA are (using traditional student loan terms for ease of discussion):
a) Total amount of the “loan,”
b) The percentage of the “borrowers” monthly income the “lender” will receive,
c) The duration of the payback period,
d) The repayment amount cap (typically a multiple of the amount “borrowed”) and
e) The borrower’s minimum income threshold required to paying back the “loan”.
Depending upon the crystal ball, ouija board or magic 8 ball used to determine the unknown variables, borrowers can try to compare these ISAs to traditional student loan terms to determine which one is more cost-effective.
As if that is not challenging enough, given the unique nature of these ISAs, there are additional questions that potential users of these agreements should ask. Eight of these are listed below:
Can the ISA be securitized or otherwise sold?
A borrower may have originated their ISA with an esteemed university, but does the university have the ability to sell the agreement to a third party? Borrowers may feel comfortable owing money to their alma mater. Would they feel differently if they owed money to Vinnie-The-Thumb-Breaker’s Collection Agency?
What happens if a borrower does not graduate?
What recourse does a lender have if the borrower does not graduate? Do all of the terms remain intact, or are penalty/acceleration clauses triggered?
How will credit reporting agencies report this type of agreement?
Is an ISA a debt instrument, or is it something else? Regulators will need to address this question. If they determine it is not debt, how will credit agencies disclose the ISAs on the borrower’s credit report? Will disclosure of an existing ISA be required on a borrower’s future apartment, credit card or home mortgage applications?
Are periods of under/unemployment added to the payback period?
If so, what is the maximum length of time that an ISA can remain enforceable? One of the advertised benefits of the ISA is the fact that no payments are required unless a minimum income threshold amount is met by the borrower. But how are those non-payment periods treated? Are they tacked back on to the end of the initial period?
Is there a limit to the harassment borrowers will receive during periods of unemployment?
What recourse will borrowers have against abusive collection tactics? Who else can the lender contact in order to seek repayment?
Will a borrower be required to take a job outside of the discipline for which they received a degree?
A quick review of prevailing terms of these loans states a borrower will not be required to make a payment if earnings are below $20-30K per year. That translates to a rate between $9.62 and $14.42 per hour. Several states have a minimum wage within that range. Is the expectation that a borrower will need to pay the loan back even if they are making a minimum wage?
Does payback require notification to the borrower’s employer?
Does the ISA require the borrower’s employer to send ISA payments directly to the lender? Should borrowers be concerned with employers knowing this? Should a borrower be concerned that this knowledge may advantage employers during promotions or salary negotiations? If this is a concern, borrowers should ask the question to make sure that the mechanics around the repayment are completely understood.
What are the income tax consequences?
Borrowers are able to deduct on their taxes student loan interest paid during the year if they are below certain income thresholds. Will any portion of these ISA payments be classified as interest allowing for this deduction? Additionally, there is a concept of loan forgiveness being treated as taxable income to a borrower.
If the borrowed amounts are not fully repaid, will the borrower have taxable income for the amount that was effectively forgiven?
There are a lot of unanswered questions regarding ISAs. Given the novelty and complexity, borrowers need to understand all of the terms and related risks of an ISA prior to entering into one.
About the author:
JP Geisbauer is a Certified Public Accountant and a Certified Financial Planner ®. He is the founder of Centerpoint Financial Management, LLC, a retirement planning, investment management, and tax planning firm located in Irvine, CA. If you have specific questions regarding your situation, please schedule a complimentary 30-minute call here.
Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, please consult with your financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.