The Interplay Between Student Loans and Credit Card Debt: Implications for Default Behavior∗

Student loans and credit card loans represent important components of young households’ portfolios in the United States. While default rates on credit card debt are at historically low levels, default rates on student loans have increased significantly in recent years. There are important institutional differences between bankruptcy arrangements and default consequences in the two markets, which may affect default incentives. We theoretically and quantitatively analyze the interactions between these two forms of unsecured credit and the implications of their financial arrangements for default behavior of young U.S. households. We document important facts about the interaction between student loans, credit card debt, and default on both types of loans and build a general equilibrium model to explain the observed facts. We theoretically characterize the circumstances under which a household defaults on each of these loans and demonstrate that the institutional differences between the two credit markets make borrowers prefer to default on student loans rather than on credit card debt. Our quantitative analysis shows that the increase in student loan debt during recent years contributed about half of the increase in default rates, whereas worse labor outcomes for young borrowers during the Great Recession significantly amplified student loan default. At the same time, the credit card market contraction during this period helped reduce this effect. An income contingent repayment plan for student loans completely eliminates the default risk in the credit card market and induces important redistribution effects. This policy is beneficial (in a welfare improving sense) during the Great Recession, but not during normal times. JEL Codes: D91; I22; G19;