The Interplay Between Student Loans and Credit Card Debt

This study analyzes the interactions between two different forms of unsecured credit and their implications for default behavior of young U.S. households. One type mimics credit cards in the U.S. and the default option resembles a bankruptcy filing under Chapter 7; the other type mimics student loans in the U.S. and the default option resembles Chapter 13. In the credit card market a financial intermediary offers a menu of interest rates based on individual default risk, which account...
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This study analyzes the interactions between two different forms of unsecured credit and their implications for default behavior of young U.S. households. One type mimics credit cards in the U.S. and the default option resembles a bankruptcy filing under Chapter 7; the other type mimics student loans in the U.S. and the default option resembles Chapter 13. In the credit card market a financial intermediary offers a menu of interest rates based on individual default risk, which account for borrowing and repayment behavior in both markets. In the student loan market, the government sets the interest rate and chooses a wage garnishment to pay for the cost associated with default. The authors prove the existence of a steady-state equilibrium and characterize the circumstances under which a household defaults on each of these loans. They demonstrate that the institutional differences between the two markets make borrowers prefer to default on student loans rather than on credit card debt. They find that the increase in student loan debt together with the expansion of the credit card market fully explains the increase in the default rate for student loans in recent normal years (2004-2007). An income contingent repayment plan for student loans completely eliminates the default risk in the credit card market and induces important redistribution effects. Figures and tables. This is a print on demand report.