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

61 Pages Posted: 20 Sep 2014

See all articles by Anamaria Felicia Ionescu

Anamaria Felicia Ionescu

Board of Governors of the Federal Reserve System

Nicole B. Simpson

Colgate University - Economics Department

Date Written: December 15, 2015

Abstract

In recent years, the proportion of students facing a binding constraint on government student loans has grown. This has led to substantially increased use of private loans as a supplementary source of finance for households’ higher education investment. A critical aspect of the private market for student loans is that loan terms must reflect students’ risk of default. College investment will therefore differ from a world in which government student loans, whose terms are not sensitive to credit risk, are expanded to no longer bind. Moreover, beyond simply crowding out private lending, expansions of the government student loan program will feed back into default risk on private loans. The goal of this paper is to provide a quantitative assessment of the likely effects of the private market for student loans on college enrollment. We build a model of college investment that reflects uninsured idiosyncratic risk and a well-defined life-cycle that is consistent with observed borrowing and default behavior across family income and college preparedness. We find that higher government borrowing limits increase college investment but lead to more default in the private market for student loans, while tuition subsides increase college investment and reduce default rates in the private market. Consequently, higher limits on government student loans have small negative welfare effects, while tuition subsidies increase aggregate welfare.

Keywords: College investment, credit risk, student loans, default

JEL Classification: D53, E21, I22, I28

Suggested Citation

Ionescu, Anamaria Felicia and Simpson, Nicole, Default Risk and Private Student Loans: Implications for Higher Education Policies (December 15, 2015). FEDS Working Paper No. 2014-66, Available at SSRN: https://ssrn.com/abstract=2498073 or http://dx.doi.org/10.2139/ssrn.2498073

Anamaria Felicia Ionescu (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Nicole Simpson

Colgate University - Economics Department ( email )

13 Oak Drive
Hamilton, NY 13346
United States
315-228-7991 (Phone)

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