As the realization that student loan debt has become a serious issue in the United States spreads, the number of different solutions proposed to resolve or at least alleviate the burden on the debtholders has increased as well. Two of the newest and probably most misunderstood are the Income Share Agreement and the Income-Based Repayment Plan.
In this post, we will attempt to highlight some of the more important features that make the two concepts different.
Income Share Agreements
Income Share Agreements (ISAs) are rather straightforward. For our example, we will assume that the two parties entering the agreement are a financial institution and a student. The student has applied to the financial institution for funds to pay for their tuition. In an ISA, the financial institution will provide the funds in exchange for the student’s promise to share some percentage of her future income for a specific period.
ISAs typically include some additional beneficial features. For example, if the student post-graduation experiences a period of unemployment, no repayment is usually due. This is because the student is only in active repayment while employed and earning a salary to share. That salary sharing may also only kick in after reaching a certain level as well. Of course, this provision does not “forgive” those payments and the amount must be returned eventually. In this case, the final payment month is just pushed out to a later date without adding to the total balance owed.
Additionally, the percentage of the student’s future monthly income is set. With traditional lending, the payment amount is set and will vary as a percentage of monthly income as that income varies. However, this creates another interesting feature of ISAs: ISAs will normally contain a provision “capping” the total amount repaid, unlike traditional loans where the longer one takes to repay, the more interest that accrues and the greater the total repaid.
Income-Based Repayment Plans
On the other hand, Income-Based Repayment Plans (IBRs) could be considered “mean-tested” plans. This means that someone who holds student debt would have to qualify based on certain conditions. IBRs will normally limit the monthly payment to a certain percentage of monthly income based on the debtholder’s discretionary monthly income. On the surface, this sounds like a good deal. On the surface, it sounds like the same deal offered by ISAs.
The Difference
ISAs fix the term of repayment based on the percentage of monthly income required – this in turn sets the total amount repaid in subject to a repayment cap. IBRs offer no such protection. Lowering the monthly payment to a set percentage of income will indeed lower the monthly payment. However, this does nothing to the amount owed and does not stop the “clock” causing interest to accrue. If the new, lower payments cannot cover interest payments and reduce the principal, the balance can actually increase!
Knowing the differences between ISAs and IBRs can help borrowers trying to choose the two avoid additional financial duress.
