Document Type

Working Paper

Publication Date

Summer 8-4-2010

JEL Codes

E21, E24, I22, I28

Working Paper Number

2010-07

Abstract

The private market of student loans has become an important source of college financing in the U.S. Unlike government student loans, the terms on private student loans (i.e., credit limits and interest rates) are based on credit scores We quantify the effects of credit scores on college investment in a heterogeneous life-cycle economy that exhibits a government and private market for student loans. We find that students with higher credit scores invest in more college education. Furthermore, we find that the relationship between credit scores and college investment has important policy implications. For example, when government borrowing limits are relaxed, college investment increases but so does the riskiness of the pool of borrowers, leading to higher default rates in the private market. If private creditors react to the government policy (by adjusting loan terms to minimize default risk), college investment is offset, with poor students experiencing the largest reductions. The effects of credit scores on college investment are more pronounced when taking into account the recent drop in financial wealth for U.S. households.

Acknowledgements

The authors would like to thank seminar participants at Fordham University, the Federal Reserve Banks of Atlanta, Minneapolis and Richmond, the University of Iowa, the University of Pennsylvania, the University of Virginia, the Cornell/Penn State Macro Workshop, the 2009 Midwest Macroeconomic Meetings, and the 2010 SEDMeetings. Special thanks to Kartik Athreya,Marina Azzimonti, Satyajit Chatterjee, Flavio Cunha, Jonathan Heathcote, Dirk Krueger, Lance Lochner, Alex Monge-Naranjo, Makoto Nakajima, B. Ravikumar, Victor Rios-Rull, Viktor Tsyrennikov, Juan Sanchez, Eric Smith, Gianluca Violante, Tom Wise, Eric Young, Christian Zimmermann and to several people in various financial aid offices and private credit institutions who provided us with valuable insight. All errors are are own.

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Economics Commons

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