Liquidity and Insurance in Student Loan Contracts: The Effects of Income-Driven Repayment on Default and Consumption
Thursday, November 8, 2018
McKinley - Mezz Level (Marriott Wardman Park)
*Names in bold indicate Presenter
Enrollment in income-driven repayment (IDR) plans for student debt has tripled in the past five years, yet little is known of its effects on borrower welfare. By aligning student debt payments with borrower income, IDR may prevent default and improve financial well-being among credit-constrained borrowers but carries a potential cost to social welfare through moral hazard. In this paper, I estimate the causal impact of IDR on repayment rates, balances, homeownership, and consumption proxies using a novel dataset linking the first administrative panel of federal student loan payments to credit bureau records for over one million student borrowers. My research design uses two complementary identification strategies: a difference-in-differences design comparing borrowers with differential IDR take-up following delinquency calls from their loan servicer, and an instrumental variables design exploiting variation in the tendency of randomly-assigned servicing agents to enroll borrowers in IDR. Within seven months of take up, IDR enrollees are 21 percentage points less likely to fall delinquent and pay down $90 more student debt each month compared to those who remain on standard repayment plans. IDR enrollees have credit scores that are 7.5 points higher, hold 0.1 more credit cards, and carry $240 higher credit card balances than non-enrollees one year after the servicing call, implying increased short-term consumption out of liquidity. IDR enrollees are also 2 percentage points more likely to hold a mortgage, suggesting a positive effect of IDR on homeownership. Minimum monthly payments decrease by an average of $140 following IDR take up, but return to standard levels within one year of enrollment, minimizing the potential impact of moral hazard through loan forgiveness. My results suggest IDR improves borrower welfare by correcting for a market failure in human capital financing, allowing financially distressed graduates to borrow against future income when they lack the credit or collateral to do so through private lending markets.