Why Do Federal Loans Crowd out the Private Market? Evidence from Graduate Plus Loans

Abstract

I investigate why federal student loans crowd out the private market by exploiting the introduction of graduate PLUS loans, which relaxed the federal borrowing limit on graduate students. After the expansion, students replaced private with PLUS loans nearly one-for-one, but did not increase borrowing. I use credit bureau data to compare private and federal loans, and show that most graduate students could receive private interest rates below the federal rates. Modeling students expected utilities, I find that the insurance provided by the federal income-based repayment option can rationalize most borrowers decisions to take out the higher interest federal loans.

JEL Classification: H, I22, I28, I26