Research has shown how looming student loan debt can be associated with negative decisions later in life — borrowers may put off saving for retirement, buying a home, or starting a family, some studies have claimed. But a new working paper suggests the availability of more flexible repayment plans could increase the likelihood that borrowers make riskier — but potentially higher paying — career choices.
The working paper, published this week by the National Bureau of Economic Research, studies the effects of different student loan repayment plans on borrowers' career choices. The researchers — Katharine Abraham, Emel Filiz-Ozbay, Erkut Ozbay, and Lesley Turner of the University of Maryland — present situations that are particularly relevant in the current higher education landscape.
In studying the effects of different repayment plans, they set up three situations for borrowers: one in which income-driven repayment (IDR) and the 10-year standard repayment plans are both available, one in which some borrowers can choose between the two and others must choose IDR, and one in which IDR is the only available plan. Other countries — such as Australia, New Zealand, South Africa, and the United Kingdom — have moved toward a solely income-driven system for repaying student loans, and the same has been proposed in the United States. The second situation in the new study would represent the transition period from several repayment plan options to one.
"On one hand, by linking payments to income, IDR reduces the expected relative return to choosing a high paying career," the authors wrote. "On the other hand, by reducing downside risk, IDR could increase the likelihood that borrowers pursue higher-paying careers that involve much more uncertainty and/or require a longer period of job search."
The authors examined the issue theoretically before setting up an experiment in which borrowers, depending on the setting, are presented with a choice of repayment plan (or a lack of choice) and a choice between easy and difficult tasks for which they would earn money. For a borrower in the standard repayment plan, choosing the easy task would be the safe choice, whereas the difficult task would be a riskier choice should the borrower fail to perform the task — or job — successfully.
The "borrowers" in the experiment would receive a set amount for successfully completing an easy or difficult task, and would make that decision based on the loan repayment amount or percentage of earnings.
The authors found that overall those who enrolled in IDR were more likely to choose the difficult task. The flexible repayment plan can make that choice particularly attractive to borrowers with moderate skill levels, they said.
"Currently available fixed student loan repayment plans put borrowers at the risk of default during periods of low income," they wrote. "For moderately-skilled borrowers, the desire to avoid this risk may lead them to avoid risky but high return career paths."
Interestingly, the authors also showed that the availability of different repayment plans can affect borrowers' choices even when they don't have access to both plans. The "anticipation of regret," they said, could lead borrowers to choose the easy job even if their only option was to enroll in an IDR plan simply because they knew others had the option of enrolling in a standard plan. This could diminish the value of an IDR plan for those borrowers.
"Our findings highlight the fact that the set of available loan repayment plans in the market should be considered not only from an expected return perspective but also from a behavioral perspective," they wrote. "Student borrowers who are relatively new to making financial decisions may be most likely to anticipate regret over their labor market choices once uncertainty is resolved."
Publication Date: 7/18/2018