How Do Income-Driven Repayment Plans Benefit Student Debt Borrowers?
71 Pages Posted: 30 Oct 2024
There are 2 versions of this paper
How Do Income-Driven Repayment Plans Benefit Student Debt Borrowers?
How Do Income-Driven Repayment Plans Benefit Student Debt Borrowers?
Date Written: October 07, 2024
Abstract
The rapid rise in student loan balances has raised concerns among economists and policymakers. Using administrative credit bureau data, we find that nearly half of the increase in balances from 2000 to 2020 is due to deferred payments, largely driven by the expansion of income-driven repayment (IDR) plans, which link payments to income. These plans help borrowers by smoothing consumption, insuring against labor income risk, and reducing the present value of future payments. We build a life-cycle model to quantify the welfare gains from this payment deferment and the channels through which borrower welfare increases. New, more generous IDR rules increase this transfers from taxpayers to borrowers without yielding net welfare gains. By lowering the average marginal cost of undergraduate debt to less than 50 cents per dollar, these rules may also incentivize excessive borrowing. We demonstrate that an optimally calibrated IDR plan can achieve similar welfare gains for borrowers at a much lower cost to taxpayers, and without encouraging additional borrowing, primarily through maturity extension.
Suggested Citation: Suggested Citation