Borrow Now, Pay Even Later: A Quantitative Analysis of Student Debt Payment Plans
47 Pages Posted: 19 Oct 2022 Last revised: 17 Jan 2023
Date Written: October 12, 2022
In the U.S. student debt currently represents the second largest component of consumer debt, just after mortgage loans. Repayment of those loans reduces disposable income early in their life cycle when marginal utility is particularly high, and limits households' ability to build a buffer stock of wealth to insure against background risks. In this paper we study alternative student debt contracts, which offer a 10-year deferral period. During this period individuals either make interest payments only ("Principal Payment Deferral", PPD) or make no payments at all ("Full Payment Deferral", FPD) with the missed interest payments added to the value of the debt outstanding. We first calibrate an equilibrium with the current contracts, and then solve for counterfactual equilibria with the PPD or FPD contracts. We find that both alternatives generate economically large welfare gains, which are robust to different assumptions about the behavior of the lenders and borrower preferences. We decompose the gains into the percentages resulting from loan repricing and from the deferral of debt repayments.
Keywords: Student debt, household finance
JEL Classification: G51, H31
Suggested Citation: Suggested Citation