American Student Loans: Repayment and Valuation

19 Pages Posted: 23 Oct 2020 Last revised: 26 Oct 2020

See all articles by Paolo Guasoni

Paolo Guasoni

Dublin City University - School of Mathematical Sciences; Boston University - Department of Mathematics and Statistics

Yu-Jui Huang

University of Colorado at Boulder - Department of Applied Mathematics

Saeed Khalili

University of Colorado Boulder

Date Written: October 7, 2020

Abstract

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

Guasoni, Paolo and Huang, Yu-Jui and Khalili, Saeed, American Student Loans: Repayment and Valuation (October 7, 2020). Michael J. Brennan Irish Finance Working Paper Series Research Paper No. 20-11, Available at SSRN: https://ssrn.com/abstract=3707118 or http://dx.doi.org/10.2139/ssrn.3707118

Paolo Guasoni (Contact Author)

Dublin City University - School of Mathematical Sciences ( email )

Dublin
Ireland

HOME PAGE: http://www.guasoni.com

Boston University - Department of Mathematics and Statistics ( email )

Boston, MA 02215
United States

Yu-Jui Huang

University of Colorado at Boulder - Department of Applied Mathematics ( email )

Boulder, CO 80309
United States

HOME PAGE: http://www.yujui-huang.com

Saeed Khalili

University of Colorado Boulder ( email )

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