The federal government’s standard option for student loan repayment plans may have a hand in driving more borrowers into default, according to a new study released this week.
To study the phenomenon, the researchers—James Cox and Daniel Kreisman of Georgia State University, and Susan Dynarski of the University of Michigan—created an exact replica of the Department of Education’s (ED) Student Loan Exit Counseling website and tested what role the existence of the default option, inaccurate information about future earnings, and information complexity play in borrowers’ decision-making. The study, published in the National Bureau of Economic Research, found that the 10-year standard repayment plan that federal student loan borrowers are automatically enrolled in “has a dominant effect on borrowers’ choices.”
The findings add to a body of research showing not only that income-driven repayment (IDR) plans are underutilized, but also that most defaulted borrowers met the criteria for enrolling in such a repayment plan. A 2012 study from the Department of the Treasury found that 70 percent of defaulted borrowers would have qualified to enroll in an IDR plan, and that the default rate among those in IDR plans was just 1 percent. By comparison, the most recent federal data on the national cohort default rate showed that 10.8 percent of borrowers who entered repayment in fiscal year 2015 defaulted within three years.
In their experiment, the researchers used the standard 10-year repayment plan as their baseline and changed the default option to the Revised Pay As You Earn (REPAYE) plan to determine whether simply changing the default option would lead borrowers to make different choices. They also changed the way information about future earnings is given to students for some subjects, and reduced the complexity of information for some subjects.
Overall, however, they found that the default repayment plan option had the strongest effect on borrowers’ choices, and that providing more clear information about future earnings, and reducing the complexity of information and choices had little effect on borrowers’ decision making.
They found that while 60 percent of borrowers in the baseline group chose the standard repayment plan, just 34 percent chose it when the default option was changed to an IDR plan.
“This suggests that the government has a very easy policy lever to pull if it wants to increase uptake of income-driven repayment plans,” they wrote.
They also found that reframing the way IDR plans are explained to borrowers—from a plan that could lengthen repayment time to one that provides protection for times of low earnings or unemployment—leads to increased enrollment.
The researchers argued the findings could speak to the value of higher education at a time when many claim there is a growing student loan crisis and the return on investment for a college degree might not be worth the cost.
“Part of this is simply due to high variability in earnings in early careers, even for college graduates; and part of it is due to the fact that returns to schooling accrue over a lifetime, not immediately after graduation,” they wrote. “Hence, offering flexible repayment plans that vary with earnings makes sense, both for borrowers and lenders. The problem then is not that these programs are not offered, but rather that [they] are not utilized.”
While some might argue that automatically placing borrowers in the standard 10-year repayment plan might be beneficial in reducing their overall repayment time and possibly the cumulative amount repaid, the authors argue that may not be the case.
“Given these facts, it appears that there is potential to reduce default rates simply through a change in the default option,” they wrote. “From a policy perspective, this need not be controversial. … Legislative efforts in the U.S. to shift to an income based repayment scheme have gained little traction. Past efforts to nudge borrowers into income driven plans has seen limited success. But none of these reform policies has shifted the default option.”
Publication Date: 11/21/2018