Working Paper

Default Risk and Private Student Loans: Implications for Higher Education Policies

Abstract: The private market for student loans has become an important source of college financing in the United States. Unlike government student loans, the terms on student loans in the private market are based on credit status. We quantify the importance of the private market for student loans and of credit status for college investment in a general equilibrium heterogeneous life-cycle economy. We find that students with good credit status invest in more college education (compared to those with bad credit status) and that this effect is more pronounced for low-income students. Furthermore, results suggest that the relationship between credit status and college investment has important policy implications. Specifically, when borrowing limits in the government student loan program are relaxed (as implemented in 2008), college investment increases, but so does the riskiness of the pool of borrowers, leading to higher default rates in the private market for student loans. When general equilibrium effects are accounted for, the welfare gains experienced from a more generous government student loan program are negated. This compares to budget-neutral tuition subsidies that increase college investment and welfare.

Keywords: College investment; credit status; student loans; default;

JEL Classification: D53; E21; J22; J28;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2015-01-29

Number: 2014-66

Pages: 60 pages