plus/minus epsilon

Income Share Agreements, or ISAs, are contracts where a borrower receives something of value, and in exchange they give the lender a percentage of their income every year for a fixed number of years. A lot of people have been proposing them as an alternative to traditional student loans.

Unlike loans, which are two dimensional (term and rate), ISAs typically have about five parameters:

1. Income Threshold. The yearly income under which you make no payments, and at/over which you must make monthly payments. Usually $50k.
2. Income Percent. The percent of income the payment must be equal to. Usually 10-20%.
3. Repayment Cap. The maximum amount of money that may be paid pack. Usually 1.5x prinicpal.
4. Payment Count. The number of monthly payments required. Usually 24 or 48.
5. Expiry Period. The amount of time after which the ISA expires regardless of repayment status. Usually 5 or 8 years.

As such, the contract ends when one of three events happens: the repayment cap is hit, the required number of payments has been made, or the contract expires. Lenders usually seem to want to maximize the likelihood of hitting the repayment cap, and they do this by setting fairly low income thresholds relative to the profession they’re training people to enter.

The benefit of an ISA over a traditional loan is that there’s less risk to the borrower because the structure of ISA payments minimizes the chance that they become a financial hardship. When a borrower makes less income, their ISA payment is less or nothing at all.

What’s worth considering though, is that professionally successful individuals would expect to pay much much more over the life of an ISA than they would with an equivalent loan. That’s because ISAs have all the same failure scenarios as a typical loan (the borrower dies, the borrower is unemployed), plus anything that could cause the borrower to make less money than expected, compounded by the fact that ISAs create no minimum obligation for the borrower. So if someone chooses a lower-paying career path after school, that’s already a failed investment, and in fact you’d expect more ISA borrowers to do this than those that received a traditional loan.

As a method of financing, ISAs disconnect the decision to receive debt from having any intention or ability to repay the debt, which encourages riskier behavior, which drives their price up, which drives away safer borrowers, and creates a negative feedback loop. As an investment vehicle, ISAs have completely unpredictable returns that can only be measured historically, and they more tightly couple the labor market with the financial market which are already prone to their own negative feedback loops.