ISAs 101: Understanding and Investing in Income Share Agreements

Income Share Agreements (“ISAs”) are a fast growing alternative to private student loans. A properly structured ISA aligns the interests of the student, the school and potential investors. We believe that ISAs provide a more affordable and flexible way to finance education when compared to private student loans. By investing in ISAs and further promoting the development of school ISA programs, edly believes that ISAs can fill the education funding gap (the difference between the cost of higher education and the amount of federal student loans and grants available to students). This number is large as confirmed by the $119 billion in private student loans outstanding (source: Measure One Private Student Loan Report, Q3 2018).  

How ISAs work

Instead of taking out a loan, students agree to pay a fixed percentage of their earnings for a fixed number of months, which customarily ranges from  36 to 120 months (but can be more or less). Students are obligated to make a monthly payment only if they are working in that month and earning more than a specified minimum salary, which typically ranges from $25,000 to $60,000

For example, a student may have to pay 10% of their earnings each month for 48 months, but only if they earn over $45,000 per year. Payments are also subject to a total cap on payments– for example, the student won’t need to pay more than 1.4 times the tuition (sometimes caps are higher or lower than that multiplier). There is also a payment obligation window after which the student no longer has any obligation to make further payments, regardless of the number or amount of payments made.

The two charts below illustrate the cumulative payments made overtime by the student under a private student loan vs a $40,000 ISA salary (Graph A) and a private student loan vs a $60,000 ISA salary (Graph B). In both cases the private student loan requires the student to start paying earlier than an ISA and results in payments over a longer period of time. In contrast the ISA delays payments until the student starts earning the minimum income threshold and caps the student at a total number of payments and a total payment amount. Graph A represents a student earning $40,000 and demonstrates how the student benefits greatly compared to the payments it would have owed under a private student loan. ISA payments were not required until the student’s salary met the minimum income threshold and no further payments were due after the 60 month payment window. Graph B depicts the cashflows for a student earning above the minimum income threshold at the start. The student pays up to the cap in month 49 and no longer owes payments under the ISA.

Sample ISA Terms

edly believes that ISAs, in many circumstances, are the more affordable and flexible option when compared to private student loans . To prove this to schools and students, edly provides schools with analytic tools to compare private loans with ISAs.

Based on our analysis, those who pay the maximum capped amount would often pay about the same as they would under a private student loan, but they benefit from the flexibility of an ISA.  In effect, they get an “insurance” policy in case they cannot find a job or lose their job. However the average earner (and certainly low earners) with an ISA pay less than they would pay with private student loans. This analysis assumes that there is no co-signer. Depending on student circumstances (and especially if a parent co-signs a private student loan) a student may pay less in repayment of a loan than he or she would pay in the aggregate for an ISA.

School skin in the game

An important feature of ISAs is their ability to align the interests of schools, students and investors. Because the school is the party best able to influence student outcomes (through admissions, education, and job placement) edly has structured its ISA platform so that returns for schools and investors are directly aligned with the success of the students (“skin in the game”).

edly uses a variety of methods to achieve this goal, including delaying payments to schools until after investors have met their IRR target. For example, edly may advance tuition to a school as follows:

70% of total tuition payment deferred by the student upfront, and then,

a share of remaining amounts of payments made by students after investors achieve their target returns. Those returns will be influenced by a variety of factors such as graduation rates, employment rates, time to employment, and defaults.

Understanding ISA Investments:

The benefits of ISAs to students are clear, but how can investors earn an attractive return at the same time?

The key driver of an ISA investment is the employment outcome of the students. Because investors are getting a share of the students’ earnings, they earn greater returns if students have good employment outcomes. A key difference between student loan investments and ISA investments is that student earnings drive ISA investment returns more than any other single factor. Loan returns are primarily affected by repayment defaults.

Starting salary is the most important driver of investment earnings. Other drivers include salary increases, time before starting employment and any cause of non-payment (salary under the minimum at which the student obligor is required to make a payment, interruption in employment for illness or other personal reasons, or missed payments).

edly makes available to investors tools to help analyze ISA investments. Evaluating schools’ historical outcomes is essential. These outcomes give important clues for future performance (although past performance is no guarantee of future returns). Historical outcomes are provided by schools and are available on the edly website.   Investors should review information provided by edly about the schools, some of which have been graduating students for several years and some of which are relatively new.

edly has developed an ISA Analytical Calculator we call “ISAAC”. ISAAC allows users to evaluate any ISA investment using common metrics, which allows an investor to make comparisons between different pools of ISAs from different schools, fields of study, geographic location and other factors. Investors can input their own assumptions to see the impact of varying assumptions on projected investment returns.

Attractive Investment Features

1) High Expected Yield – most ISA investments compare favorably with other alternative fixed income investments. For example, a recent ICE /BofAML U.S. High Yield Master effective yield was 5.62% (Federal Reserve Bank of St. Louis, 9/27/19).

2) Monthly Cash Flows – edly ISA investments make distributions on the 25th day of every month. Even in early years of an ISA investment (when a student is still in school) edly ISAs pay a monthly return from a reserve account.

3) Diversification – edly investors can make small investments but still benefit from diversification of large pools of ISAs across many students, schools, and fields of study.

4) Tax Reporting – investors do not receive K-1’s as they should not be considered “partners” for tax purposes under the edly investment structure. Instead, edly provides 1099’s to investors.

5) Possible tax advantages – investors should consult their tax advisors to determine if they can enjoy certain tax advantages inherent in this type of investment including deferral of income recognition until payments received with respect to an ISA exceed the amount invested in such ISA.

6) Short Maturity – edly provides a series of optional calls and clean up calls designed to shorten the duration of the investments. Each ISA investment has specific call and maturity features listed.  (Note: While an investor’s investment will be terminated at the Maturity Date, there can be no assurance that all of the initial investment will be returned by that date).

7) Investment Reporting & Monitoring: edly makes reporting available to investors monthly on the edly site in investors’ accounts.

Ways to invest on edly

edly currently offers three ways to invest in ISAs:

1) Featured Investment – edly will regularly offer investments in several ISA pools bundled together and describe them in a single investment offering. This option is for those investors who want to make a small investment but want to be diversified across multiple ISA pools.

2) Custom Investment – Investors may browse the inventory of all ISA investments on the edly platform and choose ISA pools based on the characteristics important to them (e.g., yield, school type, academic or training program).

3) Indication – Investors can tell edly what they want their investment to look like and edly will search existing inventory of investments as well as future ISA pools which will be available. When the ISAs are available, edly will notify investors that an investment is available and investors can then make the decision to invest.