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The Interplay Between Student Loans and Credit Cards: Implications for Default

Author

Listed:
  • Felicia Ionescu

    () (Colgate University)

  • Marius Ionescu

    () (Colgate University)

Abstract

We 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.

Suggested Citation

  • Felicia Ionescu & Marius Ionescu, 2012. "The Interplay Between Student Loans and Credit Cards: Implications for Default," Working Papers 2012-014, Human Capital and Economic Opportunity Working Group.
  • Handle: RePEc:hka:wpaper:2012-014
    Note: M
    as

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    File URL: http://humcap.uchicago.edu/RePEc/hka/wpaper/Ionescu_Ionescu_2012_interplay-student-loans-credit.pdf
    File Function: First version, 7/13/2012
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    References listed on IDEAS

    as
    1. Athreya, Kartik & Tam, Xuan S. & Young, Eric R., 2009. "Unsecured credit markets are not insurance markets," Journal of Monetary Economics, Elsevier, vol. 56(1), pages 83-103, January.
    2. Igor Livshits & James MacGee & Michèle Tertilt, 2007. "Consumer Bankruptcy: A Fresh Start," American Economic Review, American Economic Association, vol. 97(1), pages 402-418, March.
    3. S. Rao Aiyagari, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 109(3), pages 659-684.
    4. Satyajit Chatterjee & Dean Corbae & Makoto Nakajima & José-Víctor Ríos-Rull, 2007. "A Quantitative Theory of Unsecured Consumer Credit with Risk of Default," Econometrica, Econometric Society, vol. 75(6), pages 1525-1589, November.
    5. Nicole Simpson & Felicia Ionescu, 2010. "Credit Scores and College Investment," 2010 Meeting Papers 666, Society for Economic Dynamics.
    6. Chatterjee, Satyajit & Corbae, Dean & Ríos-Rull, José-Víctor, 2008. "A finite-life private-information theory of unsecured consumer debt," Journal of Economic Theory, Elsevier, vol. 142(1), pages 149-177, September.
    7. Athreya, Kartik B., 2002. "Welfare implications of the Bankruptcy Reform Act of 1999," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1567-1595, November.
    8. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Default; Student Loans; Credit Cards;

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • I22 - Health, Education, and Welfare - - Education - - - Educational Finance; Financial Aid

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