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, eligibility conditions on student loans from the private market are based on the credit history of the student and the parents, who often serve as cosigners. In addition, interest rates on private loans vary significantly with credit scores (from 7.4 to 15.4 percent). 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 better credit scores invest in more college education. The effect of credit scores on college investment is largest for students with low parental contributions for college and medium levels of ability. The importance of credit scores varies across alternative credit market arrangements: an increase in eligibility conditions in the private market for student loans induces a 5.2 percent decline in college investment, whereas a relaxation in borrowing limits for government student loans leads to a 5.1 percent increase in college investment, with most of the changes coming from students with low and medium credit scores.