The Interplay Between Student Loans and Credit Cards: Implications for Default
AbstractWe analyze, theoretically and quantitatively, the interactions between two different forms of unsecured credit and their implications for default behavior of young U.S. households. One type of credit mimics credit cards in the U.S. and the default option resembles a bankruptcy filing under Chapter 7 and the other type of credit mimics student loans in the U.S. and the default option resembles Chapter 13 of the U.S. Bankruptcy Code. In the credit card market financial intermediary offers a menu of interest rates based on individual default risk, whereas in the student loan market the government sets a fix interest rate. We prove the existence of a steady-state equilibrium and characterize the circumstances under which a household defaults on each of these loans. We demonstrate that the institutional differences between the two markets make borrowers prefer default on student loans rather than on credit card debt. Our quantitative analysis shows that the increase in college debt together with the changes in the credit card market fully explain the increase in the default rate for student loans in recent years. While having credit card debt increases student loan default, loose credit card markets help borrowers with large student loans smooth out consumption and reduce student loan default. We find that the recent 2010 reform on income-based repayment on student loans is justified on welfare grounds, and in particular, in an economy with tight credit card markets.
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Bibliographic InfoPaper provided by Human Capital and Economic Opportunity Working Group in its series Working Papers with number 2012-014.
Date of creation: Jul 2012
Date of revision:
Default; Student Loans; Credit Cards;
Find related papers by JEL classification:
- D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
- I22 - Health, Education, and Welfare - - Education - - - Educational Finance
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