Income Sharing Agreement: An Answer to Student Debt?

American students have been burdened with student debt. Much has been read and written about the mountains of debt that American students face. These decisions are made by students, who are young adults and do not really have the financial knowledge required to make such an important decision. Several of these students ended up being trapped in student loans for decades. A lot of these loans are backed by the government which means just about anyone can get them. Also, these loans cannot be discharged under bankruptcy. This means that the student does not have any way to get rid of them in the future.

The concept of income sharing agreements is the new financial innovation which is gaining popularity amidst the ensuing student loan crisis. In this article, we will have a closer look at the pros and cons of income sharing agreements.

What is an Income Sharing Agreement?

Income sharing agreements are an alternate way for American students to finance their college education. Instead of taking a student loan to finance their college education, they could opt for equity funding. Income sharing agreements are, therefore, a way for college students to transfer their risks to the lenders.

The cash flow remains the same. If the student needs $10,000 to fund their college education, they can obtain the same from investors. However, they do not have to pay fixed payments to repay that loan. In fact, it isn’t a loan at all. The investors are buying a percentage of the future earnings that the student will generate by undertaking the course. Typically students are allowed to keep the first $20,000 that they make for personal expenses. If they make more than $20,000, they are expected to pay 7% of their income to the lenders. The terms of this agreement may vary, but most agreements are drawn for a period of 10 years.

If the student earns a good amount of money, so do the investors. Otherwise, they make a loss too! However, there is a cap for the max amount that students will pay back to investors. Hence, high flying students who grow very fast in their career will not end up paying through their nose when they become part of an income sharing agreement.

Advantages of Income Sharing Agreements:

• Transfer of Risk: The biggest advantage of income sharing agreement is that the students can transfer their risks to investors. This ensures that the incentives of the investors, as well as the students, are aligned. This is the reasons why investors only offer income sharing agreements to vocational courses such as nursing, computer programming, plumbing, etc. This is because the probability of getting a job can be easily guessed in such fields.
• Funding Only To Good Institutes: Income sharing agreements put an end to universities who are peddling useless degrees that have no commercial value. Investors will only put their money on students they know have a decent chance of earning a good income in the later part of their lives. Colleges which sell overpriced degrees in fields which do not have much commercial application will not be able to obtain funds. Over a period of time, this will lead to a reduction in the number of such institutions.
• Better Returns: Investors are fairly confident that they will be adequately compensated for the risks that the take by funding income sharing agreements. Also, investors are confident that they will be able to earn this better return without doing anything which is against the interest of society as a whole.

Disadvantages of Income Sharing Agreements

• More Expensive: Income sharing agreements do alleviate the students from the risks of not getting a job. They also cover risks such as unemployment or underemployment in the future. However, all these risks are covered at a cost. Sometimes this cost can prove to be too expensive. Financial analysts have concluded that if a student is fairly certain about the probability of finding a job once they finish a course, they are better off taking a student loan. Income sharing arrangements are expensive when compared to loans. They are only useful because they cover risks and allow students to go scot-free if they lose their jobs. In effect, they are a very expensive insurance cover.
• The Possibility of Abuse: At the present moment, the industry is at a nascent stage. This is the reason why abuse related to income sharing arrangements has not been reported. At the present moment, investors are taking only a small portion of the salary of students. Also, the duration of the agreement is not very long.

However, it must be understood that this agreement is not regulated by the government. Hence, once the acceptability of these agreements increase and more students opt for this arrangement, investors might start entering fine print into these agreements. Analysts have warned that, if left unregulated, income sharing agreements have the potential to become the indentured slavery of today.

In conclusion, income sharing agreements are better than student loans in many aspects. However, the market is at a relatively nascent stage. Only a handful of universities have started adopting this model of financing as of now. Once the use of income sharing agreements becomes more widespread, it would become possible to ascertain their advantages and disadvantages more accurately.

Authorship/Referencing - About the Author(s)

The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.