Borrow Now, Pay Even Later: A Quantitative Analysis of Student Debt Payment Plans

47 Pages Posted: 19 Oct 2022 Last revised: 17 Jan 2023

See all articles by Michael Boutros

Michael Boutros

Government of Canada - Bank of Canada

Nuno Clara

London Business School; Duke University - Finance

Francisco Gomes

London Business School

Date Written: October 12, 2022

Abstract

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

Boutros, Michael and Clara, Nuno and Clara, Nuno and Gomes, Francisco, Borrow Now, Pay Even Later: A Quantitative Analysis of Student Debt Payment Plans (October 12, 2022). Available at SSRN: https://ssrn.com/abstract=4245812 or http://dx.doi.org/10.2139/ssrn.4245812

Michael Boutros

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

Nuno Clara (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Duke University - Finance ( email )

Durham, NC 27708-0120
United States

HOME PAGE: http://www.nunoclara.com

Francisco Gomes

London Business School ( email )

Finance Department
Sussex Place - Regent's Park
London NW1 4SA
United Kingdom

HOME PAGE: http://sites.google.com/view/francisco-gomes/home

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