Dynarski’s research shows default options key to student loan repayment

February 13, 2021

Susan Dynarski’s recent research, “Designed to fail: Effects of the default option and information complexity on student loan repayment,” shows the powerful effects of default options and how making an income driven repayment (IDR) plan the default or only option can help borrowers avoid student loan default. 

The research was motivated by the high incidence of student loan defaults within five years of leaving school “despite options that provide protection against involuntary default through income driven repayment plans.” IDR plans function like a low cost insurance against default. Repayments make up a percentage (typically 10-15%) of discretionary income above a threshold (usually 150% of the poverty line). Often, after 25 years loans are also forgiven outright. So it was perplexing for the authors why nearly 70% of those who had defaulted were eligible for IDR and could have avoided defaulting, according to a 2012 U.S. Treasury study. 

Through a series of simulations with 524 undergraduate students, the authors found why borrowers do not select IDR plans: they chose the default repayment plan that was presented to them. In practice, this means student borrowers often end up in the Standard Plan without the flexibility and advantages of an IDR plan. In other iterations, the simulation showed that providing just recent grad earnings information had only a negligible effect, but that providing information and switching the default option from Standard to an IDR option had the biggest impact on reducing possible default. 

The report summarizes, “The default option plays an outsized role in borrowers’ choice of repayment plan, driving them in many cases to a suboptimal choice. Yet, many borrowers choose the Standard plan even when the default option is changed to an IDR option. Thus, while changing the default option may be in aggregate welfare enhancing, the optimal strategy may be to follow the policy lead in Australia, New Zealand, the UK, Canada, South Africa and others, and do away with the menu of choices, leaving IDR as the only option.”

Read the research:

James C. Cox, Daniel Kreisman, Susan Dynarski. “Designed to fail: Effects of the default option and information complexity on student loan repayment.Journal of Public Economics, Volume 192, 2020.