The Pros and Cons of Using Income Share Agreements for Personal Loans
You may have heard this term floating around: income share agreement.
Most likely — if you’ve heard of it — you’ve heard of income share agreements as an alternative way to pay for college.
More likely? You haven’t heard of them at all. And there’s a lot to learn.
Income share agreements have gained popularity in recent years as a way to avoid massive student loan debt.
Students can make an agreement with funders to cover the cost of their education. In exchange, students agree to pay a fixed percentage of their income after graduation for a number of years.
In this form, borrowers and lenders are basically gambling on the success of the borrower’s education.
But it’s not just for student loans: Income share agreements for personal loans are making their way into the market.
Align is a company that offers income share agreements in Georgia, Illinois, New Mexico and Utah for anything from consolidating debt to paying a medical bill to planning your wedding and describes them like this:
“An Income Share Agreement (ISA) allows you to receive money in exchange for a percentage of your future income, for a set period of time.
“It’s similar to a personal loan, but your payments, since they are pegged to your income, are more flexible and can go all the way to zero if you become unemployed.”
How Income Share Agreements Work
Unlike a loan, your ISA payments to a lender aren’t based on repaying a principal (the original amount borrowed). Instead, you pay the agreed percentage of your income for the agreed number of years — and the lender earns their money back (plus some) or not.
For students signing up for an ISA to pay for school, the agreement can be risky or beneficial for both the borrower and lender.
If the borrower gets a high-paying job after graduation, they’ll pay a lot back. It could cost more than traditional student loans. In the student’s favor, though, if they remain unemployed or earn very little, they’ll pay less back — maybe even less than the amount of the loan.
Income share agreements for personal loans are significantly less risky on both sides.
The scale and terms of these agreements make them less dramatic than those that pay for college. The max you can borrow through Align, for example, is $12,500. The most you can pay is 10% of your income (usually less) and the longest term is five years.
The other major difference is you have to be employed full-time to qualify for an ISA with Align. You’re not gambling on unknown future earnings. You’re working with what you have now — and leaving room for surprises in the future.
And of course, you can use the money you borrow for anything, not just school.
How Much Do Income Share Agreements Cost?
Unlike a traditional loan, you’re not paying interest. The amount of money a lender makes off your income share agreement is based on how your income fluctuates over time.
A Purdue University program launched last year for students caps payments at 2.5 times the initial loan amount. Even if you make a hefty salary, you’d stop paying once you hit that mark.
For its personal loans, Align says the percentage you’ll pledge “will vary based on factors like the amount of money you need, the length of your contract, your income level and your creditworthiness.”
Align’s loans don’t come with a cap, but borrowers can buy out their contract for a fixed lump sum any time. It’s a safeguard to keep you from drastically overpaying if your income significantly increases. The buyout starts less than the loan amount and is reduced each month as you keep making payments.
For example, say you borrow $5,000 from Align to buy a new (used) car.
If you work full-time for a $40,000 salary, and you pledge 5% of your income for three years, you’d pay $6,000 — $167 a month.
But maybe after two years (you’ve paid $4,000), you get a new job with a $60,000 salary.
You could keep your ISA, pay $250 a month and fork over a total of $7,000 — $2,000 more than your original loan!
Or you could buy it outright for the lump sum and pay less.
Benefits of Income Share Agreements
Depending on your credit history, qualifying for an income share agreement might be easier than qualifying for a traditional loan. It could also be cheaper long term and/or more affordable in the short term.
Whether you borrow to pay for tuition or want to take out a personal loan for something else, your future income determines whether an ISA is right for you.
If you’re employed full-time at a local newspaper, for example, an ISA could be more attractive than a traditional loan.
The instability of the industry could mean frequent job (and salary) shifts for you in the near future — and maybe even an unexpected layoff. Your payments would fluctuate with your changing salary, so they’d be easier to keep up with than traditional loan payments.
If you’re an engineer and have decent credit, you’ll probably get a better deal with a traditional loan. The high demand and high salaries in your field mean you probably won’t have to worry about affording monthly loan payments.
Either option is subject to a ton of variables, so run some scenarios for your own situation before making any decisions.
One benefit of income share agreements you won’t get from traditional lenders is their investment in your success.
Referring to ISAs that pay for college, Investopedia explains, “Because lenders have a vested interest in the student's future, ISAs will offer mentoring and advising services throughout and after school.”
Align makes a similar commitment to personal loan customers who become unemployed. “We have a financial stake in your success, so we have a variety of services to help you get back on your feet, including resume review and career search assistance.”
With Align, borrowers who become unemployed don't have to make payments during those months without a job, and they're never required to make up the payments, either.
Traditional lenders don’t give a hoot what happens to your job, so this investment is a welcome relief!
Drawbacks of Income Share Agreements
“The skeptics of income sharing often compare the concept to indentured servitude,” Investopedia says of students betting on future income.
That’s an extreme criticism, but the worry is valid: You run the risk of forfeiting a lot of unnecessary money if your income increases quickly.
But some safeguards are in place to make it far less binding than being an indentured servant.
Purdue’s 250% repayment cap isn’t amazing, but at least it exists to protect graduates. Align’s option to buy out a contract for a lump sum means if your income increases, you can end your agreement and keep your shiny new salary for yourself.
Income share agreements are a relatively new practice in the U.S., so skeptics are keeping an eye on their development.
In the meantime, we’re happy to see a new option for borrowers.
As finance writer James Surowiecki wrote in “The New Yorker” in 2013, when lender Upstart had just started making income share agreements for small business startups:
"The old way of borrowing was predicated on a world in which the job market was stable and everyone had a steady income. That world of work is changing. The way we finance it needs to change, too.”
Your Turn: Would you apply for an income share agreement instead of a traditional loan?
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Dana Sitar (@danasitar) is a senior writer at The Penny Hoarder. She’s written for Huffington Post, Entrepreneur.com, Writer’s Digest and more, attempting humor wherever it’s allowed (and sometimes where it’s not).