Pricing, Selection, and Welfare in the Student Loan Market: Evidence from Borrower Repayment Decisions

Advances in data-driven underwriting have both efficiency and equity implications for consumer lending markets where private and public credit options coexist. In the $1 trillion student loan market, private lenders now offer a growing distribution of risk-based interest rates, while the federally-run loan program sets a break-even, uniform interest rate. In this paper, I measure the overall gains in consumer surplus from such risk-based pricing and quantify the redistributional consequences of low-risk types refinancing out of the government pool into the private market. The empirical analysis is based on a unique applicant-level dataset from an online refinancing firm that contains information on loan terms, household balance sheets, and risk-based interest rates. I first leverage a series of firm-conducted interest rate changes to estimate the sensitivity of borrowers’ maturity and refinancing choices to interest rates. Using the maturity response, I then estimate a structural model of borrowers’ repayment preferences. Using the estimated model, I show that comprehensive risk-based pricing generates large absolute gains in welfare of $480 per borrower relative to a break-even uniform price, and $400 relative to a coarser method of FICO-based pricing. If the federal pool conducts breakeven pricing, these e ciency gains come at a direct equity cost – low risk surplus will increase on average by $2,300, while high risk surplus will fall by $2,100. In order to maintain access to the current uniform rate, the government would have to transition from break-even pricing to an average net subsidy of $2,080 per borrower.