American Student Loans: Repayment and Valuation
19 Pages Posted: 23 Oct 2020 Last revised: 26 Oct 2020
Date Written: October 7, 2020
American student loans are fixed-rate debt contracts that may be repaid in full by a certain maturity. Alternatively, income-based schemes give borrowers the option to make payments proportional to their income above subsistence for a number of years, after which the remaining balance is forgiven but taxed as ordinary income. The repayment strategy that minimizes the present value of future payments takes two possible forms: For a small loan balance, it is optimal to make maximum payments until the loan is fully repaid, forgoing both income-based schemes and loan forgiveness. For a large balance, enrolling in income-based schemes is optimal either immediately or after a period of maximum payments. Overall, the benefits of income-based schemes are substantial for large loan balances but negligible for small loans.
Keywords: student loans, repayment, valuation, loan forgiveness
JEL Classification: G12, I22
Suggested Citation: Suggested Citation