Many people have difficulty borrowing as much money as they want, even if they a

Question

Many people have difficulty borrowing as much money as they want, even if they are confident that their incomes in the future will be high enough to easily pay back the borrowed funds. For example, many students in medical school will earn high incomes after they graduate and become physicians. if the could, they would probably borrow now in order to live more comfortably while in medical school and pay the loans back out of their higher future income. Unfortunately banks are reluctant to make loans to people who currently have low incomes, even if there is a good chance their incomes will be higher in the future. If people could always borrow as much as they want to, would you expect consumption to become more or less sensitive to current income? Please explain.

Explanation / Answer

If people could always borrow as much as they want to, it is expected that consumption would become less sensitive to current income.

Banks are reluctant to give out loans easily because there is always a chance of bad debt , when students avail loans banks feel that they may or may not return it because their jobs are not a fixed return.Most of such loans are always on collateral basis so that banks get a surity of return .SUcch bad debts are a cost to the bank ,also if banks give out loans easily people will become less sensitive to income because of availability of loan, they would not reduce coonsumption even with fall in come so MPC is high , they would not like to save much and be dependent on loans.

The bank must be able to identify a return. If the loan is supposed to be paid back over say 30 years, this may represent the entire career of a physician. If the borrower borrowed TOO much, their income may never be able to cover the payment and the interest rate. Furthermore, the risk would have to be mitigated with higher interest rates which may further weaken the ability of a borrower to pay back over time unless they maintained their income for a long period. Anything could eliminate the payback, death, accident, the bank has to insure the ability to repay so current pay would become a much bigger factor.

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