The decision to freeze student loan payments in 2020 as part of the response to COVID-19 may have actually led some households to take on more debt.
That’s the paradoxical conclusion of researchers from the National Bureau of Economic Research, according to a working paper published this month.
In 2020, at the peak of uncertainty over the pandemic, the federal government paused student loan payments, collection and interest.
The move was intended to provide economic security to American’s paying down student loan debt during a period of economic turmoil.
But the working paper suggests that those who benefited from the pause actually went out and took on more debt.
Researchers Michael Dinerstein, Constantine Yannelis, and Ching-Tse Chen found that the policy significantly increased short-term consumption and overall long-term debt among borrowers.
The study analyzed the effects of this policy using administrative credit panel data. They compared borrowers who had their federal loan payments frozen to those who were still required to pay private student loans.
The researchers found a sharp drop in student loan payments and delinquencies for those subject to the debt moratorium. Credit scores also increased for this group.
The study’s findings suggest that the payment freeze led to a significant rise in borrowing on credit cards, mortgages, and auto loans, indicating an immediate increase in consumption. The results imply that borrowers used the new liquidity to increase borrowing rather than avoid delinquencies.
Interestingly, the study found that these effects were concentrated among borrowers without prior delinquencies, who likely saw no change in their credit supply. This suggests that these borrowers’ demand for credit increased as they had more liquidity, highlighting a complementarity between liquidity and credit.
Despite the immediate increase in consumption, the study found that household leverage rose as borrowers made higher payments on other loans. This led to an overall increase in debt, with household leverage excluding student loans rising by 3% for households subject to the payment pause.
The study also analyzed the impact of a policy proposal by the Biden Administration in August 2022, which sought to cancel between $10,000 and $20,000 in student loan debt. The researchers found no significant impact on borrowers’ use of credit following this announcement.