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Legal Complexities of Income Share Agreement Programs

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The most recent Federal Reserve statistics show student loan debt topping $1.5 trillion, and this represents a substantial increase since the end of 2006.[1] While most people agree student loan debt is a problem, and everyone would be better off if higher education could be paid for without having to obtain any type of third-party funding, the reality is that simply isn’t possible for most people. As state spending on higher education has dropped, public universities have increased tuition and other costs.[2] Even with student loan debt topping $1.5 trillion, there are still an increasing number of students who experience a gap in funding, either because the student’s particular program or school is not eligible for existing types of federally funded student financial aid or the student has exceeded the borrowing limits under those programs.[3] The percent of higher education costs covered by the annual federal student loan limits has been cut in half since 1994-1995, because the federal student loan limit increases have not kept pace with cost increases.[4]

What is an Income Share Agreement?

As the demand for student financial aid has outpaced existing student loan options, income share agreement (ISA) programs have emerged as a new option for funding higher education. With an ISA, a student contractually agrees to pay a set percentage of his or her income over a set period of time. The total amount the student pays will vary depending on a number of factors, including the income share percentage, the length of the contract term, and the student’s income. The student’s obligation to pay varies based on income, such that the student’s overall payment obligation on the contract term may be more or less than the initial funding amount. On the other hand, the student’s obligation on a student loan doesn’t change, regardless of what happens during the student’s life or career after college. Absent a loan forgiveness by the lender and excluding temporary deferrals during which interest typically continues to accrue, the student remains obligated for the loan amount funded, plus interest.

How does an ISA compare to a loan?

One of the most common questions about ISA programs is whether they are really different from loans. The answer: it depends on how the ISA is structured. Is it possible to structure an ISA program that is really just a student loan under a different name? Absolutely, and that is one of the most dangerous pitfalls of creating an ISA program. People are accustomed to loan structures and terminology. Even the most seasoned finance professionals can fall into the trap of calling a program an ISA but then referring to an “APR” or a “principal balance.” A true ISA does not use either concept, and the amount funded under the ISA isn’t even a variable in the monthly payment calculation. The biggest difference between a student loan and an ISA is that in a well-structured ISA program, the ISA funder shares in the risk. Under a loan, the obligation to pay does not change and will always be principal plus interest. With a well-structured ISA, if the student is laid off or if the student is self-employed and the business has a bad year, the amount the student is obligated to pay actually decreases.

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One criticism of ISA programs has been that if the amount paid varies with income, the student is guaranteed to pay more over the life of the ISA contract. This criticism is based on an outdated assumption that people enter the workforce after college and experience steady increases in salary throughout their careers. The reality today is people often enter and exit the workforce for different reasons due to corporate lay-offs, illness and disability, child rearing, returning to school or starting a business.[5] A properly structured ISA offers a certain amount of downside protection not available with a student loan. A cap on the maximum amount payable on an ISA also offers upside protection. Universities benefit from having an ISA program by raising retention and graduation rates and by increasing access to higher education which may otherwise be hindered by debt aversion. [6]

What are the legal issues unique to structuring an ISA program?

Most existing education and consumer finance laws and regulations are structured around loan concepts such as principal balances, interest rates, and APRs. ISA programs don’t use those concepts, so the threshold questions for structuring ISA programs are: (1) whether a particular law or regulation applies to ISA programs and, (2) if it does apply, how to fit the “square peg into the round hole” given the differences in ISA concepts versus student loan concepts. Additionally, there are usually multiple layers of regulation involved at the federal, state, and school levels, so figuring out how those layers intersect and conflict is essential in structuring a successful ISA program.

Two pieces of ISA legislation have been introduced in Congress: (1) the Investing in Student Success Act (S. 268), introduced by Senators Marco Rubio and Todd Young, and (2) the Investing in Student Achievement Act (H.R. 3145), introduced by Representatives Luke Messer and Jared Polis, along with other supporters. While both bills are still under committee review, the Investing in Student Achievement Act, in particular, has gained substantial bipartisan support.[7] In addition, California Assembly Member Randy Voepel introduced Assembly Bill 154 creating a postsecondary education ISA pilot program in January of this year, which is still under consideration by California legislators. The California legislation provides for an appropriation of funds to create a pilot ISA program at California State University and the University of California, subject to certain parameters provided in the bill. Each of the proposed bills includes, among other requirements, a minimum income threshold (below which a student would not be obligated to pay); caps on the duration, total payments, and total percentage of income that can be contracted; and disclosure requirements. The proposed federal legislation also covers conflicts with state law (such as usury law), bankruptcy treatment, and federal tax treatment.

ISA programs can be a useful tool for schools and universities that need to close the gap between student demand for education financing and traditional student loan options. A properly structured ISA program has the advantage of offering downside protection for students who experience fluctuations in income outside of their control. While the regulatory landscape around ISA programs is still evolving, proposed legislation offers insight into the aspects lawmakers consider the most crucial underpinnings of a compliant ISA program. Time will tell if ISA programs create a more sustainable education finance market, but the current market is definitely not sustainable.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.
[1] https://www.federalreserve.gov/releases/g19/HIST/cc_hist_memo_levels.html.
[2] https://www.cbpp.org/research/state-budget-and-tax/a-lost-decade-in-higher-education-funding.
[3] https://www.nasfaa.org/issue_brief_loan_limits.
[4] id.
[5] https://www.usnews.com/news/the-report/articles/2015/07/16/unemployment-is-low-but-more-workers-are-leaving-the-workforce.
[6] https://cepa.stanford.edu/sites/default/files/wp16-15-v201608.pdf; https://unews.utah.edu/u-announces-innovative-financing-program-to-help-students-finish-degrees/.
[7] https://www.forbes.com/sites/prestoncooper2/2018/11/06/income-share-agreements-gain-bipartisan-support/#6ea5097e155d.

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