Income Share Agreements–The Solution to Paying for Medical School?

I recently learned about Income Share Agreements (ISA). These are sometimes touted as an alternative to student loans and are being used as such. However, in my view, they are something completely different and an option I would like to see expand at medical schools across the country–for the students, for the schools, and for potential investors.

Income Share Agreements: Debt and Equity

Perhaps the best way to look at an ISA is to consider the corporate model. When a for-profit company needs to raise money, it has two options. The first is to borrow. This is where corporate bonds come from. The company gets the money it needs at a known cost and the investor gets a relatively safe fixed income investment backed by the profits and value of the company. The second option is to issue stock, where the investor actually owns a small chunk of the company and her share of any profits the company generates. That share can, of course, be sold to other investors at a higher or lower price in the future.

Student loans are like corporate bonds. An ISA is like buying corporate stock. Rather than being guaranteed fixed future payments, the payments the investor receives are dependent on the income of the person who takes money in exchange for signing an ISA. Whoa! Is that a crazy idea or what?

These are not necessarily new. Some schools have been experimenting with them for a long time; Yale had a program in the 1970s. Purdue launched its program in 2016. Even my local state university, The University of Utah, has a pilot program going. The appeal of the programs is pretty easy to see. It lowers the risk of a student being caught in a never-ending cycle of debt due to a low income to debt ratio.

If the school is backing the program, it incentivizes them to make sure that program participants are actually being prepared for high-earning employment. For an investor, the appeal is a higher equity return rather than a lower debt return. Investors are also really only interested in a chunk of your earnings when you make a lot, so there is plenty of incentive to pause payments for unemployment, underemployment, disability etc. Investors are also incentivized to help you negotiate the best contract/job possible.

Muslims and others who are opposed to debt have another option to pay for school (and to invest.) It's not debt, it's equity.

Criticisms of Income Share Agreements

What's not to like? Well, it turns out there is plenty. Radio show host Dave Ramsey likens them to a new form of student loans.

Although it’s being flaunted as an affordable, smart alternative to student loans, it’s still just debt stealing from your income—literally….At first glance, an income share agreement might sound like a saving grace for a broke college student. You’re fed up with student loans and looking for an alternative . . . and in walks an income share agreement. It’s new, shiny and presented differently than student loan debt! Plus, there’s no interest! It sounds too good to be true, right? That’s because it is…..

He goes on to explain how in some situations, a student could end up paying MORE under an ISA than under student loans. Well, duh. Why do you think investors are interested? He fails to mention the protection for the student who DOESN'T get a high earning job. In fact, a study from the Manhattan Institute suggests that the average ISA user currently pays back LESS than they would under a student loan.

Another criticism is that it incentivizes graduates NOT to earn as much as they can. However, given that most of these programs only require payment of 2-17% of your income for a limited number of years (usually 10 or less) that seems like a pretty minor disincentive to me. Tax rates of 2-17% don't seem to keep people from working and earning as near as I can tell.

Yet another criticism is that this is a form of indentured servitude, like the near-slavery of Europeans brought to the New World centuries ago. Also, complaints that it is a regressive form of charging for school since those from disadvantaged backgrounds end up paying more for school than the privileged. Frankly, I don't see that as being any different than student loans. This sort of program is taking the place of student loans, not scholarships and grants.

The Devil Is In the Details

Of course, for both the student and the investor (whether the school or the private investor), the devil is in the details. It is entirely possible that this is a better deal for the student than borrowing money. It is also entirely possible that this is a better deal for the investor than loaning money. And vice versa. It is simply a different deal.

It's like the military HPSP scholarship where you are basically trading time for money. It's a contract. You agree to go through the military match, probably make less money as an attending than you would in the civilian world, and do what the military tells you to do for a few years in exchange for tuition, fees, books, and a monthly living stipend for four years.

Is that better or worse than student loans? Well, it depend on a lot of things, like your the cost of tuition, your specialty, your feelings about debt, your ability to artificially restrain your spending in order to Live Like a Resident for a few years, your desire to serve in the military, and your competitiveness under the military match system.

Income Share Agreement for Medical School?

Likewise, a medical school ISA could be a much better deal than student loans for a pediatrician who goes part-time to go on the “parent track” and a much worse deal for a financially successful full-time spine surgeon.

Which revenue stream would you like to purchase as an investor if they both cost the same? How do you know who to invest in as an MS1? Do you base it on what they think they will be interested in? Will you look at their grades and MCAT scores to try to decide how likely they are to match into their chosen field? Wait until they finish step 1? You can't wait until they match, they don't need the money then.

Will you simply pick an “average” number that makes sense if the average medical student/doctor signs the agreement? That may not work well. Just like unhealthy people are more likely to buy low deductible health insurance, medical students who are less likely to match at all or interested in low paying specialties are more likely to sign up for an ISA.

Do you base the percentage of income paid back on the specialty they match into? Do pediatricians pay 12% and orthopedists 6%? Do the payments start during residency/fellowship when income is low, or as an attending when income is high? Does the percentage decrease upon completing training and if so, how is a resident going to afford the higher percentage? That's the opposite of government IDR programs which provide lower payments during training. Are there caps on the amount paid? If so, how is that fair to the investor? The investor is willing to lose their entire investment if this person is unemployable, but their return is capped at only 2X the amount given to the student? How is income defined? Is it Adjusted Gross Income? Well, that incentivizes graduates to max out retirement accounts and other AGI lowering activities. Is it taxable income? That incentivizes graduates to give to charity and get a big fat mortgage.

Current Undergrad Programs

What do the programs currently in place really look like? Well, let's take a look at the pilot program at the University of Utah. Utah students, many of whom are Mormons, have serious debt aversion. This partially explains why tuition at the colleges in the state is so darn low. But many students tend to drop out of school or go part-time in order to avoid taking out student loans, so you can see the reason the school is interested.

The Utah program will give students $6-20K a year and requires payments of 2.85% of income for a period of 3 to 10.5 years. The lower-paying your field, the longer you would have to make payments. A teacher would pay for 10.5 years and an engineer would pay for 6.5 years. The total amount paid is capped at 2X the amount given and you don't make any payments if you aren't making at least $20K a year. You have to be within 32 hours of graduation and only 18 majors are permitted. (No Underwater Basketweaving majors apparently.) There is not yet an option for medical students.

Purdue's Back a Boiler program will provide up to $10K per year with a variable amount of income that must be paid back for a period of up to 10 years, ranging from 1.73-5% of income for 88-116 months depending on major. The total amount paid back is capped 2.5X the amount given. All majors are eligible and you must be a sophomore with a declared major to enroll. (Not sure what happens if you change majors.)

Several other schools have similar programs. Heck, there are even commercial companies (Leif, GS2) that help schools implement a program. I was unable to find a way to INVEST in the future earnings of students, but how long can it be before an enterprising person on Wall Street figures out a way to securitize these agreements?

Should You Use an ISA?

So here's where the rubber meets the road. I'm not opposed to these agreements any more than I am opposed to student loans. If getting help paying for an education that you otherwise could not get allows you to complete the education and dramatically increase your income (even after paying for that help) then it is a good deal.

I feel similarly about practice loans. My general rule is that borrowing 1X future annual earnings in student loans is a good deal. But since nobody is offering ISAs for medical school or dental school (and certainly not for practice loans), and since I believe nearly EVERYONE can complete an undergraduate education debt-free, I'm not really seeing a reason to sign an ISA currently. You should choose a less expensive school, work in the summers and during the school year, and apply for scholarships and grants. But if you are choosing between loans and an ISA, well, the devil is in the details.

In general, I like the idea behind ISAs and am fully supportive of expansion and development of these programs, both for students and investors. Sometimes the best move is to borrow money, but many times, the best move for everyone involved is to issue stock.

What do you think? Do you know anyone who has used an ISA? Would you use one if available for medical/dental school? Would you invest in one? Would you use a similar product for a practice loan? Comment below!