Student Loan Programs
Lower Interest Rates and Higher Loan Volume Have Increased Federal Consolidation Loan Costs Gao ID: GAO-04-568T March 17, 2004Consolidation loans, available under the Department of Education's (Education) two major student loan programs--the Federal Family Education Loan Program (FFELP) and the William D. Ford Direct Loan Program (FDLP)--help borrowers manage their student loan debt. By combining multiple loans into one loan and extending the repayment period, a consolidation loan reduces monthly repayments, which may lower default risk and, thereby, reduce federal costs of loan defaults. Consolidation loans also allow borrowers to lock in a fixed interest rate, an option not available for other student loans. Consolidation loans under FFELP and FDLP accounted for about 48 percent of the $87.4 billion in total new student loan dollars that originated during fiscal year 2003. Two main types of federal cost pertain to consolidation loans. One is "subsidy"--the net present value of cash flows to and from the government that result from providing these loans to borrowers. For FFELP consolidation loans, cash flows include, for example, fees paid by lenders to the government and a special allowance payment by the government to lenders to provide them a guaranteed rate of return on the student loans they make. For FDLP consolidation loans, cash flows include borrowers' repayment of loan principal and payments of interest to Education, and loan disbursements by the government to borrowers. The subsidy costs of FDLP consolidation loans are also affected by the interest Education must pay to the Department of Treasury (Treasury) to finance its lending activities. The second type of cost is administration, which includes such items as expenses related to originating and servicing direct loans. This testimony focuses on two key issues: (1) recent changes in interest rates and consolidation loan volume and (2) how these changes have affected federal costs for FFELP and FDLP consolidation loans.
Recent years have seen a drop in interest rates for student loan borrowers along with dramatic overall growth in consolidation loan volume. From July 2000 to June 2003, the interest rate for consolidation loans dropped by more than half, with consolidation loan borrowers obtaining rates as low as 3.50 percent as of July 1, 2003. From fiscal year 1998 through fiscal year 2003, the volume of consolidation loans made (or "originated") rose from $5.8 billion to over $41 billion. The dramatic growth in consolidation loan volume in recent years is due in part to declining interest rates that have made it attractive for many borrowers to consolidate their variable rate student loans at a low, fixed rate. Recent trends in interest rates and consolidation loan volume have affected the cost of the FFELP and FDLP consolidation loan programs in different ways, but in the aggregate, estimated subsidy and administration costs have increased. For FFELP consolidation loans, subsidy costs grew from $0.651 billion for loans made in fiscal year 2002 to $2.135 billion for loans made in fiscal year 2003. Both higher loan volumes and lower interest rates available to borrowers in fiscal year 2003 increased these costs. Lower interest rates increase these costs because FFELP consolidation loans carry a government-guaranteed rate of return to lenders that is projected to be higher than the fixed interest rate paid by consolidation loan borrowers. When the interest rate paid by borrowers does not provide the full guaranteed rate to lenders, the federal government must pay lenders the difference. FDLP consolidation loans are made by the government and thus carry no interest rate guarantee to lenders, but changing interest rates and loan volumes affected costs in this program as well. In both fiscal years 2002 and 2003, there was no net subsidy cost to the government because the interest rate paid by borrowers who consolidated their loans was greater than the interest rate Education must pay to the Treasury to finance its lending. However, the drop in loan volume and interest rates that occurred in fiscal year 2003, contributed to cutting the government's estimated net gain from $570 million in fiscal year 2002 to $543 million for loans made in fiscal year 2003. Administration costs are not specifically tracked for either consolidation loan program, but available evidence indicates that these costs have risen, primarily reflecting increased overall loan volumes.
GAO-04-568T, Student Loan Programs: Lower Interest Rates and Higher Loan Volume Have Increased Federal Consolidation Loan Costs
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Testimony:
Before the Committee on Education and the Workforce, House of
Representatives:
United States General Accounting Office:
GAO:
For Release on Delivery Expected at 10:30 a.m. EST:
Wednesday, March 17, 2004:
STUDENT LOAN PROGRAMS:
Lower Interest Rates and Higher Loan Volume Have Increased Federal
Consolidation Loan Costs:
Statement of Cornelia M. Ashby, Director Education, Workforce, and
Income Security Issues:
GAO-04-568T:
GAO Highlights:
Highlights of GAO-04-568T, a testimony for the Committee on Education
and the Workforce, House of Representatives:
Why GAO Did This Study:
The federal government makes consolidation loans available to help
borrowers manage their student loan debt. By combining loans into one
and extending the repayment period, a consolidation loan reduces
monthly repayments, which may lower default risk and, thereby, reduce
federal loan default costs. Consolidation loans also allow borrowers to
lock in a fixed interest rate--an option not available for other
student loans--and are available to borrowers regardless of financial
need. This testimony is based on GAO's October 2003 report and
addresses (1) recent changes in interest rates and consolidation loan
volume and (2) how these changes have affected federal costs.
What GAO Found:
Recent years have seen a drop in interest rates for student loan
borrowers along with dramatic overall growth in consolidation loan
volume. From July 2000 to June 2003, the interest rate for
consolidation loans dropped by more than half, with consolidation loan
borrowers obtaining rates as low as 3.50 percent as of July 1, 2003.
From fiscal year 1998 through fiscal year 2003, the volume of
consolidation loans made (or "originated") rose from $5.8 billion to
over $41 billion. The dramatic growth in consolidation loan volume in
recent years is due in part to declining interest rates that have made
it attractive for many borrowers to consolidate their variable rate
student loans at a low, fixed rate.
Recent trends in interest rates and consolidation loan volume have
affected the costs of the Federal Family Education Loan Program (FFELP)
and William D. Ford Federal Direct Loan Program (FDLP) in different
ways, but in the aggregate, estimated subsidy and administration costs
have increased. For FFELP consolidation loans, subsidy costs grew from
$0.651 billion for loans made in fiscal year 2002 to $2.135 billion for
loans made in fiscal year 2003. Both higher loan volumes and lower
interest rates available to borrowers in fiscal year 2003 increased
these costs. Lower interest rates increased these costs because FFELP
consolidation loans carry a government-guaranteed rate of return to
lenders that is projected to be higher than the fixed interest rate
paid by consolidation loan borrowers. When the interest rate paid by
borrowers does not provide the full guaranteed rate to lenders, the
federal government must pay lenders the difference. FDLP consolidation
loans are made by the government and thus carry no interest rate
guarantee to lenders, but changing interest rates and loan volumes
affected costs in this program as well. In both fiscal years 2002 and
2003, there was no net subsidy cost to the government because the
interest rate paid by borrowers who consolidated their loans was
greater than the interest rate the Department of Education must pay to
the Department of Treasury to finance its lending. However, the drop in
loan volume and interest rates that occurred in fiscal year 2003
contributed to cutting the government's estimated net gain from $570
million in fiscal year 2002 to $543 million for loans made in fiscal
year 2003. Administration costs are not specifically tracked for either
consolidation loan program, but available evidence indicates that these
costs have risen, primarily reflecting increased overall loan volumes.
What GAO Recommends:
In GAO's prior report, it recommended that Education assess the
advantages of consolidation loans for borrowers and the government in
light of program costs and identify options to reduce federal costs.
GAO suggested that options could include targeting the program to
borrowers at risk of default and changing from a fixed to a variable
rate the interest charged to borrowers. Furthermore, GAO recommended
Education consider how best to distribute program costs among
borrowers, lenders, and the taxpayers and, if statutory changes were
necessary to implement more cost-effective repayment options, to seek
such changes from Congress. Education agreed with our recommendation.
For more information, contact Cornelia Ashby at (202) 512-8403 or
ashbyc@gao.gov.
[End of section]
Mr. Chairman and Members of the Committee:
Thank you for inviting me here today to discuss issues related to
consolidation loans and their cost implications for taxpayers and
borrowers. Consolidation loans, available under the Department of
Education's (Education) two major student loan programs--the Federal
Family Education Loan Program (FFELP) and the William D. Ford Direct
Loan Program (FDLP)--help borrowers manage their student loan debt. By
combining multiple loans into one loan and extending the repayment
period, a consolidation loan reduces monthly repayments, which may
lower default risk and, thereby, reduce federal costs of loan defaults.
Consolidation loans also allow borrowers to lock in a fixed interest
rate, an option not available for other student loans. Consolidation
loans under FFELP and FDLP accounted for about 48 percent of the $87.4
billion in total new student loan dollars that originated during fiscal
year 2003. FFELP consolidation loans comprised about 84 percent of the
fiscal year 2003 consolidation loan volume, while FDLP consolidation
loans accounted for the remaining 16 percent.
Two main types of federal cost pertain to consolidation loans. One is
"subsidy"--the net present value of cash flows to and from the
government that result from providing these loans to borrowers. For
FFELP consolidation loans, cash flows include, for example, fees paid
by lenders to the government and a special allowance payment by the
government to lenders to provide them a guaranteed rate of return on
the student loans they make. For FDLP consolidation loans, cash flows
include borrowers' repayment of loan principal and payments of interest
to Education, and loan disbursements by the government to borrowers.
The subsidy costs of FDLP consolidation loans are also affected by the
interest Education must pay to the Department of Treasury (Treasury) to
finance its lending activities. The second type of cost is
administration, which includes such items as expenses related to
originating and servicing direct loans.
My testimony today will focus on two key issues: (1) recent changes in
interest rates and consolidation loan volume and (2) how these changes
have affected federal costs for FFELP and FDLP consolidation loans. My
comments are based on the findings from our October 2003 report for
this Committee, Student Loan Programs: As Federal Costs of Loan
Consolidation Rise, Other Options Should Be Examined (GAO-04-101,
October 31, 2003). Those findings were based on review and analysis of
data from a variety of sources, including officials from Education's
Office of Federal Student Aid and Budget Service, and representatives
of FFELP lenders; a sample of student loan data extracted from
Education's National Student Loan Data System (NSLDS)--a comprehensive
national database of student loans, borrowers, and other information;
relevant cost analyses prepared by Education; and statutory, regulatory
and other published information. For this testimony, we updated our
numbers to reflect recent estimates made by the Department of
Education. Our work was conducted in accordance with generally accepted
government auditing standards.
In summary:
* Recent years have seen a drop in interest rates for student loan
borrowers along with dramatic overall growth in consolidation loan
volume. From July 2000 to June 2003, the interest rate for
consolidation loans dropped by more than half, with consolidation loan
borrowers obtaining rates as low as 3.50 percent as of July 1, 2003.
From fiscal year 1998 through fiscal year 2003, the volume of
consolidation loans made (or "originated") rose from $5.8 billion to
over $41 billion. The dramatic growth in consolidation loan volume in
recent years is due in part to declining interest rates that have made
it attractive for many borrowers to consolidate their variable rate
student loans at a low, fixed rate.
* Recent trends in interest rates and consolidation loan volume have
affected the cost of the FFELP and FDLP consolidation loan programs in
different ways, but in the aggregate, estimated subsidy and
administration costs have increased. For FFELP consolidation loans,
subsidy costs grew from $0.651 billion for loans made in fiscal year
2002 to $2.135 billion for loans made in fiscal year 2003. Both higher
loan volumes and lower interest rates available to borrowers in fiscal
year 2003 increased these costs. Lower interest rates increase these
costs because FFELP consolidation loans carry a government-guaranteed
rate of return to lenders that is projected to be higher than the fixed
interest rate paid by consolidation loan borrowers. When the interest
rate paid by borrowers does not provide the full guaranteed rate to
lenders, the federal government must pay lenders the difference. FDLP
consolidation loans are made by the government and thus carry no
interest rate guarantee to lenders, but changing interest rates and
loan volumes affected costs in this program as well. In both fiscal
years 2002 and 2003, there was no net subsidy cost to the government
because the interest rate paid by borrowers who consolidated their
loans was greater than the interest rate Education must pay to the
Treasury to finance its lending. However, the drop in loan volume and
interest rates that occurred in fiscal year 2003, contributed to
cutting the government's estimated net gain from $570 million in fiscal
year 2002 to $543 million for loans made in fiscal year 2003.
Administration costs are not specifically tracked for either
consolidation loan program, but available evidence indicates that these
costs have risen, primarily reflecting increased overall loan volumes.
In our prior report, we recommended that the Secretary of Education
assess the advantages of consolidation loans for borrowers and the
government in light of program costs and identify options for reducing
federal costs. Education agreed with our recommendation.
Background:
Consolidation loans differ from other loans in the FFELP and FDLP
programs in that they enable borrowers who have multiple loans--
possibly from different lenders, different guarantors,[Footnote 1] and
even from different loan programs--to combine their loans into a single
loan and make one monthly payment. By obtaining a consolidation loan,
borrowers can lower their monthly payments by extending the repayment
period longer than the maximum 10 years generally available on the
underlying loans. Maximum repayment periods allowed vary by the amount
of the consolidation loan (see table 1). Consolidation loans also
provide borrowers with the opportunity to lock in a fixed interest rate
on their student loans, based on the weighted average of the interest
rates in effect on the loans being consolidated rounded up to the
nearest one-eighth of 1 percent, capped at 8.25 percent. Borrowers can
qualify for consolidation loans regardless of financial need. Loans
eligible for inclusion in a consolidation loan must be comprised of at
least one eligible FFELP or FDLP loan, including subsidized and
unsubsidized Stafford loans, PLUS loans,[Footnote 2] and, in some
instances, consolidation loans. Both subsidized and unsubsidized
Stafford loans, and PLUS loans are variable rate loans. Other types of
federal student loans made outside of FFELP and FDLP, which may carry a
variable or fixed borrower interest rate, are also eligible for
inclusion in a consolidation loan, including Perkins loans, Health
Professions Student loans, Nursing Student Loans, and Health Education
Assistance loans (HEAL).[Footnote 3]
Table 1: Consolidation Loan Repayment Periods, by Loan Amount:
Amount: Less than $7,500 (FFELP);
Maximum term (years): 10.
Amount: Less than $10,000 (FDLP);
Maximum term (years): 12.
Amount: $7,500 to $9,999 (FFELP);
Maximum term (years): 12.
Amount: $10,000 to $19,999;
Maximum term (years): 15.
Amount: $20,000 to $39,999;
Maximum term (years): 20.
Amount: $40,000 to $59,999;
Maximum term (years): 25.
Amount: $60,000 or more;
Maximum term (years): 30.
Source: Higher Education Act, Congressional Research Service, and
Education.
[End of table]
The Federal Credit Reform Act (FCRA) of 1990 helps define federal costs
associated with consolidation loans and was enacted to require
agencies, including Education, to more accurately measure federal loan
program costs. Under FCRA, Education is required to estimate the long-
term cost to the government of a direct loan or a loan guarantee--
generally referred to as the subsidy cost. Subsidy cost estimates are
calculated based on the present value of estimated net cash flows to
and from the government that result from providing loans to
borrowers.[Footnote 4] For FFELP consolidation loans, cash flows
include, for example, fees paid by lenders to the government[Footnote
5] and a special allowance payment by the government to lenders to
provide them a guaranteed rate of return on the student loans they
make. For FDLP consolidation loans, cash flows include borrowers'
repayment of loan principal and payments of interest to Education, and
loan disbursements by the government to borrowers. Unlike FFELP, FDLP
involves no guaranteed yields or special allowance payments to lenders
because the program is a direct loan program. The subsidy costs of FDLP
consolidation loans are also affected by the interest Education must
pay to Treasury to finance its lending activities. Another type of cost
pertaining to consolidation loans is administration, which includes
such items as expenses related to originating and servicing direct
loans.[Footnote 6]
In estimating loan subsidy costs, Education first estimates the future
economic performance (net cash flows to and from the government) of
direct and guaranteed loans when preparing its annual budgets. These
first estimates establish the subsidy estimates for the current-year
originated loans. The data used for the first estimates are reestimated
in later years to reflect any changes in actual loan performance and
expected changes in future performance. Reestimates are necessary
because projections about interest and default rates and other
variables that affect loan program costs change over time. Any increase
or decrease in the estimated subsidy cost results in a corresponding
increase or decrease in the estimated cost of the loan program for both
budgetary and financial statement purposes.
Borrowers' Rates Have Dropped, and Loan Volume Has Risen:
Recent years have seen a drop in interest rates for student loan
borrowers along with dramatic overall growth in consolidation loan
volume. From July 2000 to June 2003, the interest rate for
consolidation loans dropped by more than half, with consolidation loan
borrowers obtaining rates as low as 3.50 percent as of July 1, 2003.
From fiscal year 1998 through fiscal year 2003, the volume of
consolidation loans made (or originated) rose from $5.8 billion to over
$41 billion. Over four-fifths of the fiscal year 2003 loan volume is in
FFELP. While overall volume rose in 2003, the trends differed by
program. FDLP consolidation loan volume for fiscal year 2003 decreased,
but loan volume in the larger FFELP increased, resulting in total
consolidation loan volume of well over $41 billion.
The dramatic growth in consolidation loan volume in recent years is due
in part to declining interest rates that have made it attractive for
many borrowers to consolidate their variable rate student loans at a
low, fixed rate. Figure 1 shows the relationship between these two
factors. When interest rates are low, some borrowers may find it in
their economic self-interest to consolidate their loans so that they
can lock in a low fixed interest rate for the life of the loan, as
opposed to paying variable rates on their existing loans, regardless of
whether they need a consolidation loan to avoid difficulty in making
loan repayments and avert default.
Figure 1: Consolidation Loan Volume Increased Dramatically as Borrower
Interest Rates Fell from Fiscal Year 2001 to Fiscal Year 2003:
[See PDF for image]
[End of figure]
Underscoring the potential attractiveness of these loans to potential
borrowers, many lenders, including newer loan companies that are
specializing in consolidation loans, have aggressively marketed
consolidation loans to compete for consolidation loan business as well
as to retain the loans of their current customers. Their marketing
techniques have included mass mailings, telemarketing, and Internet
pop-ups to encourage borrowers to consolidate their loans. This
increased marketing effort has likely contributed to the record level
of consolidation loan volume.
Changes in Interest Rates and Loan Volume Affect FFELP and FDLP Costs
in Different Ways, but in the Aggregate, Estimated Costs Increased:
While the estimated future costs for consolidation loans can vary
greatly from year to year, low interest rates and recent loan volume
changes have resulted in substantial increases in overall costs to the
federal government. However, in light of the differences between how
FFELP and FDLP operate, the subsidy costs within these two programs
were affected in very different ways. For FFELP, the result was a
substantial increase. For FDLP, the result was a narrowing of the net
difference between the estimated interest payments paid by consolidated
loan borrowers to Education and the costs paid by Education to Treasury
to finance direct loans.
FFELP Subsidy Costs Affected by Increased Special Allowance Payments to
Lenders and Increased Loan Volume:
Estimated subsidy costs for FFELP consolidation loans rose from $0.651
billion for loans made in fiscal year 2002 to $2.135 billion for loans
made in fiscal year 2003. The increase is largely due to the higher
interest subsidies the government is expected to pay to lenders to
ensure they receive a guaranteed rate of return on student loans and
the result of greater loan volume. The interest subsidy, which is
called a special allowance payment (SAP), is based on a formula
specified in law and paid by Education to lenders on a quarterly basis
when the "guaranteed lender yield" exceeds the borrower rate. This
guaranteed lender yield is currently based on the average 3-month
commercial paper[Footnote 7] interest rate plus an additional 2.64
percent. When this guaranteed yield is higher than the amount of
interest being paid by borrowers, Education makes up the difference. If
the borrower's interest rate exceeds the guaranteed lender yield,
Education does not pay a SAP, and the lender receives the borrower
rate.
Education's estimate of $2.135 billion in subsidy costs for FFELP
consolidation loans made in fiscal year 2003 is based on the assumption
that the guaranteed lender yield will rise over the next several years,
reflecting Education's assumption that market interest rates are likely
to rise from the historically low levels experienced in fiscal year
2003. The effect of this rise is shown in figure 2, where the bottom
line shows the fixed borrower rate for a FFELP consolidation loan made
in the first 9 months of fiscal year 2003, and the top line shows
Education's estimated values for the guaranteed lender yield over time.
In fiscal year 2003, market interest rates were such that the
guaranteed lender yield established under the SAP formula was actually
below the borrower rate. Lenders, therefore, received only the rate
paid by borrowers; no SAP was paid. However, in future years, when the
guaranteed lender yield is expected to increase and be above the
borrower rate, Education would have to make up the difference in the
form of a SAP. As figure 2 shows, Education's assumptions would call
for lenders to receive a SAP over most of the life of the consolidation
loans made in fiscal year 2003.
Figure 2: Illustration of Estimated SAP Paid to Holders of FFELP
Consolidation Loans Originated in Fiscal Year 2003:
[See PDF for image]
[A] The estimated lender yield, which is based on the average 3-month
commercial paper rates, as provided by the Office and Management and
Budget, does not vary much after fiscal year 2007 since the projected
commercial paper rates do not vary much after fiscal year 2007. The
actual lender yield could vary from these projections depending on
future interest rates.
[B] This borrower rate is for a consolidation loan originated from
October to June of fiscal year 2003 and whose underlying loans are
Stafford loans disbursed after July 1, 1998, and in repayment at time
of consolidation.
[End of figure]
An increase in loan volume also played a role in the subsidy cost
increase from fiscal years 2002 to 2003. However, the effect of the
increased loan volume was not as large as that of the higher interest
subsidies the government is expected to pay to lenders in the future.
FDLP Loans also Affected by Changing Interest Rates:
Subsidy costs can occur within FDLP as well, but in a different way.
FDLP's consolidation program is a direct loan program and, therefore,
involves no guaranteed yields to private lenders. Still, the program
has potential subsidy costs if the government's cost of borrowing is
higher than the interest rate borrowers are paying. The government's
cost of borrowing is determined by the interest rate Education pays
Treasury to finance direct student loans, which is equivalent to the
discount rate.[Footnote 8] The difference between borrowers' rates and
the discount rate--called the interest rate spread--is a key driver of
subsidy estimates for FDLP loans. When the borrower rate is greater
than the discount rate, Education will receive more interest from
borrowers than it will pay in interest to Treasury to finance its
loans, resulting in a positive interest rate spread--or a gain
(excluding administrative costs) to the government. Conversely, when
the borrower rate is less than the discount rate, Education will pay
more in interest to Treasury than it will receive from borrowers, which
will result in a negative interest rate spread--or a cost to the
government.
For FDLP consolidation loans made in fiscal years 2002 and 2003, no
such negative interest rate spreads were incurred in either year, based
on the methodology Education uses to determine these costs. In both
years, borrower interest rates for FDLP consolidation loans were
somewhat higher than the discount rate, resulting in a net gain to the
government. However, while Education continued to benefit from lending
at interest rates higher than its cost of borrowing for FDLP
consolidation loans made in fiscal year 2003, the size of this benefit
declines from $571 million in fiscal year 2002 to $543 million in
fiscal year 2003.
The smaller net gain that occurred in fiscal year 2003 reflects both a
decrease in the loan volume and a narrowed difference between the
discount rate and the borrower rate. Loan volume in fiscal year 2003
was $6.7 billion, a decrease from $8.8 billion in fiscal year 2002. In
fiscal year 2003, this difference narrowed in part because borrower
rates dropped more than the discount rate. The borrower rates for FDLP
consolidation loans dropped 1.2 percentage points, from 6.3 percent in
fiscal year 2002 to 5.1 percent in fiscal year 2003. The discount rate,
on the other hand, dropped by only 0.88 percentage points, from 4.72
percent in fiscal year 2002 to 3.84 percent in fiscal year 2003. The
resulting interest rate spread decreased from 1.59 percent to 1.22
percent (see table 2). In other words, each $100 of consolidated FDLP
loans made in fiscal year 2002, will result in $1.59 more in interest
received by Education than it will pay out in interest to the Treasury.
A similar loan originated in fiscal year 2003, however, will generate
only $1.22 more in interest for the government.
Table 2: Interest Rate Spread for FDLP Consolidation Loans Originated
in Fiscal Years 2002 and 2003:
Fiscal year: 2002;
Borrower rate: 6.31%;
Discount rate: 4.72%;
Interest rate spread: 1.59%;
Estimated interest payments for each $100 of loans: 1.59% x $100 =
$1.59.
Fiscal year: 2003;
Borrower rate: 5.06%;
Discount rate: 3.84%;
Interest rate spread: 1.22%;
Estimated interest payments for each $100 of loans: 1.22% x $100 =
$1.22.
Source: GAO analysis of data provided by Education's Budget Service.
[End of table]
Administration Costs also Increase, Mainly because of Loan Volume:
Loan volume affects administrative costs, in that cost is in part a
function of the number of loans originated and serviced during the
year. As a result, when loan volume increases, administration costs
also increase. Education's current cost accounting system does not
specifically track administration costs incurred by each of the student
loan programs. Consequently, we were unable to determine the total
administration costs incurred by consolidation loan programs or any
off-setting administrative cost reductions associated with the
prepayment of loans underlying consolidation loans. However, based on
available Education data, we were able to determine some of the direct
costs associated with the origination, servicing, and collection of
FDLP consolidation loans. For fiscal year 2002, these costs totaled
roughly $52.3 million. This does not include overhead costs, which
include costs incurred for personnel, rent, travel, training, and other
activities related to maintaining program operations. For fiscal year
2003, the estimated costs for the origination, servicing, and
collection of FDLP consolidation loans is projected to increase to
$59.5 million. While we similarly were unable to determine Education's
administration costs directly related to FFELP consolidation loans,
they are likely to be smaller than for FDLP consolidation loans. This
is because a large portion of FFELP administration cost is borne
directly by lenders, who make and service the loans. The special
allowance payments to lenders, which rise and fall as interest rates
change, are designed to ensure that lenders are compensated for
administration and other costs and provided with a reasonable return on
their investment so that they will continue to participate in the
program.
Concluding Observations:
As the discussion of both FFELP and FDLP loans shows, interest rates
have a strong effect on whether subsidy costs occur and how large they
are. The movement of subsidy costs for consolidation loans made in
future years will depend heavily on what happens to interest rates. As
we have shown, subsidy cost estimates for FFELP consolidation loans can
increase substantially, depending on how much the guaranteed lender
yield rises above the fixed rate paid by borrowers, which, in turn,
requires the federal government to pay subsidies to lenders.
Conversely, if borrowers obtained consolidation loans with a fixed
interest rate at a time when rates were expected to decrease in the
future, federal subsidy costs could be lower, than is currently the
case, because the borrower rate could exceed the rate guaranteed to
lenders, and the federal government might not be required to pay lender
subsidies. For FDLP consolidation loans, allowing borrowers to lock in
a low fixed rate might result in decreased federal revenues if the
variable interest rates on those loans borrowers converted to a
consolidation loan would have otherwise increased in the future. The
exact effects of FDLP consolidation loans, however, depend on a number
of factors, including the length of loan repayment periods, borrower
interest rates, and discount rates.
We noted in our prior report[Footnote 9] that borrowers' choices
between obtaining a fixed rate consolidation loan or retaining their
variable rate loans can significantly affect federal costs. While
consolidation loans may be an important tool to help borrowers manage
their educational debt and thus reduce the cost of student loan
defaults, the surge in the number of borrowers consolidating their
loans suggests that many borrowers who face little risk of default are
choosing consolidation as a way of obtaining low fixed interest rates-
-an economically rational choice on the part of borrowers. If borrowers
continue to consolidate their loans in the current low interest rate
environment, and interest rates rise, the government assumes the cost
of larger interest subsidies. Providing for these larger interest
subsidies on behalf of a broad spectrum of borrowers may outweigh any
government savings associated with the reduced costs of loan defaults
for the smaller number of borrowers who might default in the absence of
the repayment flexibility offered by consolidation loans.
In our October 2003 report, we also discussed the extent to which
repayment options other than consolidation loans allow borrowers to
simplify loan repayment and reduce repayment amounts. We found that
other repayment options that allow borrowers to make a single payment
to cover multiple loans and smaller monthly payments are now available
for some borrowers under both FFELP and FDLP, but these alternatives
are not available to all borrowers. In that report, we concluded that
restructuring the consolidation loan program to specifically target
borrowers who are experiencing difficulty in managing their student
loan debt and at risk of default, and/or who are unable to simplify and
reduce repayment amounts by using existing alternatives, might reduce
overall federal costs by reducing the volume of consolidation loans
made. In addition, making the other nonconsolidation options more
readily available to borrowers might be a more cost-effective way for
the federal government to provide borrowers with repayment flexibility
while reducing federal costs. An assessment of the advantages of
consolidation loans for borrowers and the government, taking into
account program costs and the availability of, and potential change to,
existing alternatives to consolidation, and how consolidation loan
costs could be distributed among borrowers, lenders, and the taxpayers,
would be useful in making decisions about how best to manage the
consolidation loan program and whether any changes are warranted.
In our October 2003 report, we recommended that the Secretary of
Education assess the advantages of consolidation loans for borrowers
and the government in light of program costs and identify options for
reducing federal costs. We suggested options that could include
targeting the program to borrowers at risk of default, extending
existing consolidation alternatives to more borrowers, and changing
from a fixed to a variable rate the interest charged to borrowers on
consolidation loans. We also noted that, in conducting such an
assessment, Education should also consider how best to distribute
program costs among borrowers, lenders, and the taxpayers and any
tradeoffs involved in the distribution of these costs. Furthermore, if
Education determines that statutory changes are needed to implement
more cost-effective repayment options, we believe it should seek such
changes from Congress. Education agreed with our recommendation.
Mr. Chairman, this concludes my prepared statement. I would be pleased
to respond to any questions that you or other members of the Committee
may have.
GAO Contact and Acknowledgments:
For further contacts regarding this testimony, please call Cornelia M.
Ashby at (202) 512-8403. Individuals making key contributions to this
testimony include Jeff Appel, Susan Chin, Cindy Decker, and Julianne
Hartman-Cutts.
FOOTNOTES
[1] State and nonprofit guaranty agencies receive federal funds to play
the lead role in administering many aspects of the FFELP program,
including reimbursing lenders when loans are placed in default and
initiating collection work.
[2] Both subsidized and unsubsidized Stafford loans are available to
undergraduate and graduate students. The interest rates borrowers pay
on these loans adjust annually, based on a statutorily established
market-indexed rate setting formula, and may not exceed 8.25 percent.
To qualify for a subsidized Stafford loan, a student must establish
financial need. The federal government pays the interest on behalf of
subsidized loan borrowers while the student is in school. Students can
qualify for unsubsidized Stafford loans regardless of financial need.
Unsubsidized loan borrowers are responsible for all interest costs.
PLUS loans are variable rate loans that are available to parents of
dependent undergraduate students. The interest rates on these loans
adjust annually, based on a statutorily established market-indexed rate
setting formula, and may not exceed 9 percent. Parents can qualify for
PLUS loans regardless of financial need.
[3] Perkins Loans are fixed rate loans for both undergraduate and
graduate students with exceptional financial need. Perkins loans are
made directly by schools using funds contributed by the federal
government and schools; borrowers must repay these loans to their
school. The Health Professions Student Loans and Nursing Student Loans
are fixed rate loans for borrowers who pursue a course of study in
specified health professions. The HEAL program provided loans to
eligible graduate students in specified health professions. HEAL was
discontinued on September 30, 1998.
[4] Present value is the value today of the future stream of benefits
and costs, discounted using an appropriate interest rate (generally the
average annual interest rate for marketable zero-coupon U.S. Treasury
securities with the same maturity from the date of disbursement as the
cash flow being discounted).
[5] For consolidation loans, FFELP loan holders must pay, on a monthly
basis, a fee calculated on an annual basis equal to 1.05 percent of the
unpaid principal and accrued interest on the loans in their portfolio.
[6] Under FFELP, a large portion of the administration cost is borne by
the private lender. The federal government pays many of these costs in
its subsidy payment to lenders--specifically, in the 2.64 percent add
on paid over and above the 3-month rate on commercial paper.
[7] Commercial paper is short-term, unsecured debt with maturities up
to 270 days. It is issued in the form of promissory notes, primarily by
corporations. Many companies use commercial paper to raise cash for
current transactions and many find it to be a lower-cost alternative to
bank loans.
[8] While the discount rate is the interest rate used to calculate the
present value of the estimated future cash flows to determine subsidy
cost estimates, it is also generally the same rate at which interest is
paid by Education on the amounts borrowed from Treasury to finance the
direct loan program.
[9] GAO-04-101.
