Credit Scores and College Investment

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.