ISAs and You
Have you heard about a relatively new way to finance a college education? It's called ISA or Income-share agreements. ISAs allow students to have private investors indirectly pay for their college tuition in exchange for a share of the student’s earnings over a set period of time after graduation.
While ISAs are just now gaining traction – perhaps due to the high profile debut of Purdue’s ISA program – they were first proposed by Nobel Prize winner Milton Friedman in 1955. The idea was to benefit both investors and students. Investors could potentially double their investment over a period of time while students wouldn’t be mounted with large debts immediately out of school.
What’s interesting about ISA’s is that they are tied to a student’s income. This means if the student is unemployed during their contract or earn a low salary, they could potentially save money over a traditional loan. Obviously this would be bad news for investors. However, students earning a significant amount of money out of school could be put at a disadvantage and end up spending more than a traditional loan. How do you know if an ISA is right for you? Let’s take a look at a few examples.
For example, we’ll use two students named Eric and Beth. Eric and Beth both sign the same ISA contract that stipulates they will be borrowing $15,000 and must pay 3% of their salary per month (post-graduation) for a period of 10 years.
After graduation, Eric goes out and gets a clerical job with an annual salary of $30,000 per year. Beth lucks out and gets a high paying engineering job starting at $60,000 per year. For simplicity’s sake, let’s assume neither gets a raise for the ten year contract period.
Based on the information above, Eric would pay about $75 per month towards the ISA. After ten years he would have paid about $9,000 back. The investors lost money on Eric but Eric definitely did better than a traditional loan.
Let’s see how Beth fares. Because of Beth’s high salary, she would be paying about $150 per month towards the ISA. After ten years, she would have paid about $18,000 back to the investors. (Remember, with student loans you are also paying interest rates, so the amount you pay back in the end will almost always be higher than the amount originally taken out).
Obviously this was a greatly simplified example, but you can get the gist of it – maybe Eric goes through a rough patch and is unemployed for a few months – he wouldn’t have to pay anything during this period. Maybe Beth gets huge raises and is over $100k after five years – she would definitely end up paying a lot more than a traditional loan.
What to Look For
Economists think that ISAs are going to take off in a big way over the next few years primarily because of the surge in student debt. Before you run out and sign up for an ISA, be sure to do your homework. What are the terms of the deal – what percentage will you be “sharing” with Investors? Is there a cap or maximum amount you would pay back – for example 2x – which could help protect you if you got a great paying job. What is the length of the term?
Although Purdue is the highest profile ISA today, many more will be joining in. You can read through Purdue’s “Back a Boiler” program to get more details and even a comparison tool so you can see how an ISA compares to traditional financing.
Although ISAs may not be for everyone, it is nice to have another finance “tool” in the toolbox to hopefully open up the opportunity of higher education to more students.
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