Central European Business Review 2016, 5(2):37-46 | DOI: 10.18267/j.cebr.150

Income Contingent Repayments How Can We Get into a Debt Trap?

Edina Berlinger¹, György Walter²

¹ Dr. Edina Berlinger, Associate Professor, Head of Department of Finance, Corvinus University of Budapest, H-1093 Budapest, Fővám tér 8., edina.berlinger@uni-corvinus.hu

² Dr. György Walter, Associate Professor, Corvinus University of Budapest, H-1093 Budapest, Fővám tér 8., gyorgy.walter@uni-corvinus.hu

Income contingent schemes have been widely used in student lending in the last few decades. Recently, in the aftermath of the crisis of 2007-2008, several authors argued that income contingent loans have much better risk profiles than traditional fixed loans, and they proposed to extend their scope to other areas of retail lending, too. Hence, understanding this scheme can be relevant from the point of view of both human resource management and financial engineering. In this paper we analyzed the unusual characteristics of income contingent repayments, and derived closed formulas for stability, success and shape. We concluded that humped debt paths can be frightening; however, if the growth rate of the debt is lower than the growth rate of the income, then it is not a debt trap, but a natural consequence of this patient and flexible scheme, which requires new methods of communication, risk management, financing and administration.

Keywords: income contingent repayment; student loan scheme; retail lending; debt trap

JEL classification: G01, G21, I22

Received: January 10, 2016; Revised: April 18, 2016; Published: June 30, 2016  Show citation