This paper studies the effects of available student loan repayment plans on borrowers’ career choices. By removing the risk of loan default, income driven repayment (IDR) plans make higher-paying but riskier jobs more attractive to those with moderate skill levels. The authors present experimental evidence that student loan recipients consider the repayment plans offered to them as well as the plans available to other borrowers as a reference in their evaluations of loans and careers. Emotions such as regret over a choice that turns out to be suboptimal ex post and relief at being unburdened from having to make a choice that could turn out badly play significant roles in borrowers’ career choices. Compared to giving borrowers a choice between a standard loan repayment plan that requires a fixed amount to be repaid over a shorter period and an IDR plan that protects borrowers from default by linking payments to income, offering only the IDR plan generates notable benefits. Removing the standard plan from borrowers’ choice sets makes remunerative but risky careers more appealing to borrowers and raises their expected net income. Moreover, these effects are strongest when borrowers holding different plans coexist in the population, as in this environment relief from the possibility of being exposed to a regret-triggering situation is most salient.
This paper examines how regret and avoidance of regret alters borrower choice- for example if a borrower is considering a “more remunerative but riskier career path” and IDR would likely result in higher total student loan repayment costs than a fixed 10-year repayment if the borrower is successful. Contrariwise, if that flounders in that career, the IDR is less expensive. This dilemma colors a student borrower’s willingness to undertake higher riskier but potentially more rewarding (for both the borrower and society) job options.
This paper assumes, however, that even a failed career path with income only resulting in a minimal or even no IDR payment is the only possible result without consideration of how bankruptcy, which was originally intended to encourage risk by merchants and entrepreneurs, could similarly provide an ability to try, fail and start fresh for student borrowers.