Income Share Agreements and TILA's Ban on Prepayment Penalties

Abstract

This memo explores how the Truth in Lending Act’s (TILA) consumer protections prohibit a prominent feature of Income Share Agreements (ISAs) known as a “prepayment penalty”—a lending industry practice that forces borrowers to pay an extra sum if they want to pay off a debt early. Despite a federal ban on prepayment penalties in private student loan contracts, the authors find that these penalties to be common in ISA contracts. By blocking borrowers from prepaying or refinancing, ISA providers are able to trap borrowers in high-cost credit for years. This mirrors the same harmful practices often used by subprime mortgage lenders in the run up to the financial crisis more than a decade ago. The authors demonstrate that a typical ISA is a “private education loan” as defined by the TILA, and therefore ISAs should be subject to the federal ban on prepayment penalties. Based on this analysis, this memo offers recommendations for the Consumer Financial Protection Bureau, state regulators and law enforcement, and the Department of Education to take immediate action to protect students who use ISAs.