P2P Student Loans and Income Sharing Agreements and other Predatory Passive Income Streams.
In our Financial Mastery series, creating passive income stream analysis, we recently looked at Peer-to-Peer (P2P) lending. And, I passed negative judgement on the passive income created by loaning capital to a student through peer-to-peer lending for funding education.
There Are Two Ways An Investor Can Profit From Student Loans:
- Pure P2P Student Loan; and,
- P2P Student Loan through an Income Sharing Agreement.
A P2P Loan given to a student to fund their education would provide a return on investment of capital in the range of 1.25% to 12.99%. These types of loans may be beneficial for a student who may be seeking education that would not normally be funded by federal or other private student loans.
Examples of this would include enrolling in an unaccredited school, or funding for an international student.
First conceptualized in 1955 by Milton Friedman, a student loan attached to an Income Sharing Agreement (ISA) is a form of equity investment.
This is a financial agreement where an investor provides fixed amount of capital to a student who will use the loaned money to pay for their education needs.
The student obtains the loan by agreeing to repay the loan over a predetermined payment term and, by committing a percentage of their future income to this debt repayment.
Typical terms of repayment would be payments of 5% to 7% of income per year for 10 years.
The ISA is believed to benefit the student because carries lower risk than a traditional student loan.
With a traditional student loan repayment is due after completion of education regardless of employment status or income level. Conversely, an ISA, it is argued, provides protection to the student who completes their education and obtains employment with low earnings.
The repayment amount is based on their earnings and repayment starts once their earnings reach a certain income threshold.
How Much Would An Investors ROI Be?
How much would your return on investment be? 14% to 22% without any protection of capital investment.
For-profit higher education is today a booming industry, feeding on the student loans handed out to the desperate.
Thomas Frank
Student(s), Are You Paying Attention?
That ISA is benefiting the lender in the range of 14% to 22%.
The root of this issue is for-profit education. Additionally, ongoing increases in costs of education and student loan debt.
Rather than create ways for private investors to benefit from this disaster these core issues must be addressed.
Relevant Facts:
Student Loan Debt continues to be at an all-time high.
In Canada, total Student Loan Debt in 2020 is unknown, in 2012 it had reached $28.3 Billion.
In the US, student loan debt in 2020 has reached $1.6 Trillion Dollars. And, carried by 45 Million Borrowers. US student loan debt was $902 Billion in 2012.
Evidence In The Headlines
Multiple provinces and states report statistics such as “1 in 6 insolvencies due to student loan debt”, “Student Loan Default Rate, 90+ Days, 10.8%” and “in 2008 18% of insolvency filings involved student loan debt”.
Contributing Factors In Student Loan Default
First, student not completing their education leading to low earnings. Secondly, students finish school but get stuck in low-income employment after graduating.
The larger implication of these issues is the development of habits.
We teach students how to borrow. Then, we allow them to struggle to repay debt. And, our system offers them ongoing relief through other debt opportunities. As a consequence, we have let that student down. Furthermore, we have likely lead them into a debt habit.
They have learned habits on how to survive when they can not make ends meet. And debt is their relief. This sets them on a path that limits future choices and prevents them from achieving financial independence.
To Students
Make choices that create options.
Hoyes-Michalos Bankruptcy Study “Who’s Filing Insolvency & Why” issued in 2019 states “a staggering number of insolvent student debtors use payday loans,”.
Debt becomes relief. A habit was born and I argue that the student did not really have a choice.
How might we help students while we create financial independence? How might you make a difference?
Financial Mastery Rule 11
Refer to Financial Mastery Rule 11: You Give.
If we take someone who is advanced in their career and is in late stages of creating financial independence their income will expose them to very high income-taxes. All individuals earning employment income must pay their taxes, and in achieving financial mastery these individuals will learn a variety of options for creating tax credits and use of tax deductions.
In Canada, a high-income earner like me on the West Coast will pay a marginal tax rate of 49.8%. In the US a high-income earner like me on the West Coast will pay a total income tax rate of 36.29%.
I pay my taxes and I don’t know where my tax dollars go. When an individual uses a tax strategy to create tax credits this allows that individual to have a vote in where their money is directed. A democratic choice if you will.
I investigated the option of supporting students through creation of a bursary, scholarship or grant and I found promising news.
In Canada I can create a Tax Credit: Up to 33% of the amount donated at the federal level and up to an additional 24% of the amount donated depending on province of residence
In the US an individual can create such a grant and it qualifies as a prize or award that is excludable from gross income under IRA Code section 74(B).
When done according to the rules these bursaries/scholarship/grants are not taxable for the student.
Speak to a tax professional when you set yours up.
Student(s): This Bridges Two Components of Financial Independence
Financial Mastery Rule 11: You Give
And
Avoiding the Great Destroyers of Wealth, Failure to Plan: have a tax strategy.
This is a thing of beauty in my opinion, it is truly win-win.
The Numbers?
In Canada if a high-income earner creates a $13,000 grant it would net a $5,633.72 tax credit. That’s $7,633.28 out of pocket to help a student avoid debt and it prevents $5,633.72 in loss to income taxes.
If each of the ultra-high net worth individuals in Canada (10,395) and the US (81,340) contributed $10,000 USD to student grants this could provide over $917 Million USD per year in REAL aid for students, and significant tax savings for these ultra-earners.
If each of the wealthy individuals in Canada (764,033) contributed $10,000 USD to student grants this could provide over $7.6 Billion USD per year in REAL AID for students, and significant tax savings for these wealthy individuals. (Ultra-High Net Worth and Wealthy Source: WealthX.com)
Create a Scholarship for students, this solidifies your achievement of Financial Mastery and it helps you avoid one of the great destroyers of wealth by forming part of your tax strategy.
Enjoy your tax savings, more importantly, if you choose to do this you have made a difference for a student.
If you know someone with strong employment income, ask them to read this.
Additionally, all of our posts in the Personal Finance Series can be found here.
Finally, more great content can be discovered on our Youtube channel.
