ECONOMIC REPORT OF THE PRESIDENT

alone would supply an inefficiently low amount of credit for the purpose of
financing education.
From an individual’s perspective, attending college makes financial
sense whenever the present value of the benefits outweighs the present value
of the costs, when both are discounted based on preferences for current outcomes
versus future outcomes. But while the benefits of attending college are
spread out over a long future, most of the costs—including both the direct
cost of tuition and fees and the foregone earnings while in school—must be
paid up front. While some students are able to finance their college educations
through savings or help from their families, many need to borrow to
make the investment.
A major function of the Federal student loan system is to ease the
credit constraints caused by imperfections in the private loan market,
thereby ensuring broad access to affordable college loans and a means to
invest in one’s future earnings potential.5 However, while the student loan
system has helped to alleviate credit constraints at the time of college enrollment,
the traditional standard repayment plan’s 10-year repayment period,
with equal payments due each month, does not account for income volatility
or dynamics once the student has left school. As a result, this standard
plan—in which students are enrolled by default—may adversely affect some
students’ investment decisions and hinder others from successfully managing
their debt.
The constraint imposed by the 10-year repayment plan is illustrated
in Figure 5-4, which shows the lifetime earnings trajectory of a typical
bachelor’s degree recipient working full-time and year-round from age 25
to retirement. As the Figure shows, there is a strong positive relationship
between age and earnings. This relationship is especially strong for those
with a bachelor’s degree and it persists for at least 15 to 20 years after many
students graduate from college. In short, a college investment pays off over
several decades, and a 10-year repayment window forces borrowers to pay
the costs at a time when only a small share of the benefits have been realized.
Indeed, the discounted values for the earnings levels used in Figure 5-4
suggest that less than a third of the earnings gains over a 40-year career are
realized during the standard repayment window.
5 Although a private loan market exists, the loans typically require a co-signer and often do not
come with the consumer protections that Federal loans have, including discharge in instances of
death or permanent disability. Today the private market constitutes only a small share of student
loans—in 2012, 6 percent of undergraduates used private loans to finance their education
(NPSAS 2012, CEA tabulations). In the 2000s, private student loans accounted for a larger share
of student loans; see CFPB (2012) for a detailed analysis about how and why the private market
for student loans has changed over the last decade.
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