How Do Income-Driven Repayment Plans Benefit Student Debt Borrowers?

71 Pages Posted: 30 Oct 2024

See all articles by Sylvain Catherine

Sylvain Catherine

University of Pennsylvania - Finance Department

Mehran Ebrahimian

Stockholm School of Economics - Finance Department

Constantine Yannelis

University of Chicago

Multiple version iconThere are 2 versions of this paper

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

Catherine, Sylvain and Ebrahimian, Mehran and Yannelis, Constantine, How Do Income-Driven Repayment Plans Benefit Student Debt Borrowers? (October 07, 2024). The Wharton School Research Paper, Available at SSRN: https://ssrn.com/abstract=4980610 or http://dx.doi.org/10.2139/ssrn.4980610

Sylvain Catherine

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

Mehran Ebrahimian (Contact Author)

Stockholm School of Economics - Finance Department ( email )

Sveavägen 65
Stockholm, 11383
Sweden

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

Constantine Yannelis

University of Chicago ( email )

1101 East 58th Street
Chicago, IL 60637
United States

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