Paper Studies Effects of Default Option on Student Loan Repayment

Title: Designed to Fail: Effects of the Default Option and Information Complexity on Student Loan Repayment

Authors: James C. Cox, Daniel Kreisman, and Susan Dynarski

Source: National Bureau of Economic Research (NBER)

Findings from a recent NBER working paper suggest that as many as one in four student borrowers are enrolled in the federal standard repayment plan—and exposed to the risk of loan default—because it is the default repayment option.

The paper, by James C. Cox and Daniel Kreisman (Georgia State University) and Susan Dynarski (University of Michigan), reports the results of an experimental study that assesses how information complexity, uncertainty about future earnings, and default repayment options affect borrowers’ choice of loan repayment plans.

The researchers asked 542 undergraduates to navigate through a facsimile of the federal government’s Student Loan Exit Counseling website, where student borrowers learn about repayment options and choose a repayment plan. All students with federal loans are required to complete exit counseling, where the standard repayment plan is pre-selected as the default repayment option. It is also the default repayment option for students who do not complete exit counseling.

In the experiment, the researchers randomly varied the default repayment plan and the complexity of plan information presented to subjects, as well as whether subjects were presented with information about early post-graduate earnings of U.S. college graduates.

The researchers found that the default option played a dominant role in students’ choice of repayment plan. When the standard repayment plan was pre-selected as the default option, 63 percent of subjects chose it, while only a quarter (25 percent) chose an income-driven repayment plan—about the same rates at which borrowers choose each type of plan in practice.

But when the income-driven Revised Pay as You Earn (REPAYE) plan was pre-selected, the share of subjects choosing standard repayment fell by 45 percent (or 28 percentage points) while the share choosing REPAYE quadrupled (a 24 percentage point increase).

The results suggest that roughly a quarter of federal borrowers are enrolled in the standard repayment plan simply because it is the default option.

—Sam Imlay