oversight

Student Loan Programs: As Federal Costs of Loan Consolidation Rise, Other Options Should Be Examined

Published by the Government Accountability Office on 2003-10-31.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

               United States General Accounting Office

GAO            Report to Congressional Requesters




October 2003
               STUDENT LOAN
               PROGRAMS
               As Federal Costs of
               Loan Consolidation
               Rise, Other Options
               Should Be Examined




GAO-04-101
                                                October 2004


                                                STUDENT LOAN PROGRAMS

                                                As Federal Costs of Loan Consolidation
Highlights of GAO-04-101, a report to           Rise, Other Options Should Be Examined
congressional requesters




 The federal government makes
 consolidation loans available to
                                                On average, consolidation loan borrowers, over the 1987 to 2002 period, had
 help borrowers manage their                    higher levels of student loan debt, higher incomes, and larger loan
 student loan debt. By combining                repayments than did nonconsolidation borrowers. For example, the average
 loans into one and extending the               student loan debt among consolidation borrowers prior to consolidating
 repayment period, a consolidation              their loans was about $22,000 versus about $10,000 for nonconsolidation
 loan reduces monthly repayments,               borrowers. As a group, they defaulted less often on their consolidation loans
 which may lower default risk and,              than borrowers who did not consolidate their loans.
 thereby, reduce federal costs of
 loan defaults. Consolidation loans             Recent trends in interest rates and consolidation loan volumes have affected
 also allow borrowers to lock in a              consolidations in the Department of Education’s (Education) two major
 fixed interest rate—an option not              student loan programs—the Federal Family Education Loan Program
 available for other student loans—
 and are available to borrowers
                                                (FFELP) and the William D. Ford Federal Direct Loan Program (FDLP)—in
 regardless of financial need.                  different ways, but in the aggregate, estimated subsidy and administration
                                                costs have increased. Subsidy costs for FFELP consolidation loans grew
 GAO was asked to examine                       from $1.3 billion for loans made in fiscal year 2002 to nearly $3 billion for
 (1) how consolidation borrowers                loans made in fiscal year 2003. Lower interest rates available to borrowers in
 differ from nonconsolidation                   fiscal year 2003 increased these costs because FFELP consolidation loans
 borrowers; (2) how federal costs               carry a government-guaranteed rate of return to lenders that is projected to
 have been affected by recent                   be higher than the fixed interest rate consolidation loan borrowers pay.
 interest rate and loan volume                  Higher loan volumes also added to the estimated subsidy costs. Interest
 changes; and (3) the extent to                 rates and loan volume also affected costs for FDLP consolidation loans, but
 which repayment options—other                  in a different way. Because the interest rate the government charges
 than consolidation—are available
 to help simplify and reduce loan
                                                borrowers has been somewhat greater than the interest rate that Education
 repayments.                                    pays to finance its lending, consolidation loans have generated a net gain for
                                                the government in recent years. Lower rates paid by borrowers and reduced
                                                loan volume from recent record highs, however, reduced the net gain to
                                                $286 million for loans made in fiscal year 2003, down from $460 million the
 GAO recommends that the                        year before. While administration costs are not specifically tracked for either
 Secretary of Education assess the              loan program, available evidence indicates that these costs have also risen.
 advantages of consolidation loans
 for borrowers and the government
                                                Alternatives to consolidation, such as the ability to make a single repayment
 in light of program costs and
 identify options for reducing                  to cover multiple loans and obtain extended repayment terms, now give
 federal costs. Options could                   some borrowers opportunities to simplify and reduce loan repayments, but
 include targeting the program to               not all borrowers can use them. As a result, consolidation loans may be the
 borrowers at risk of default and               only option for some borrowers to simplify and reduce repayments.
 extending existing consolidation               Borrowers’ repayment choices—whether to obtain a consolidation loan or
 alternatives to more borrowers.                use other alternatives—have consequences for federal costs. While
 Education should also consider                 consolidation loans may remain an important tool to help borrowers, overall
 how best to distribute program                 federal costs in providing for consolidation loans may exceed federal savings
 costs among borrowers, lenders                 from reduced defaults. An assessment of the advantages of consolidation
 and the taxpayers. Education                   loans for borrowers and the government, taking into account program costs
 agreed with our recommendation.
                                                and how costs could be distributed among borrowers, lenders, and the
www.gao.gov/cgi-bin/getrpt?GAO-04-101.
                                                taxpayers, would be useful for decisionmakers.
To view the full product, including the scope
and methodology, click on the link above.
For more information, contact Cornelia Ashby
at (202) 512-8403 or ashbyc@gao.gov.
Contents


Letter                                                                                 1
              Results in Brief                                                         4
              Background                                                               6
              Consolidation Borrowers Had More Debt, Higher Incomes, and
                 Differed in Other Ways When Compared with Nonconsolidation
                 Borrowers                                                             9
              Interest Rates and Increased Loan Volumes Have Increased
                 Federal Costs                                                        16
              Repayment Options Other Than Consolidation Loans That Allow
                 Borrowers to Simplify Loan Repayments and Reduce Repayment
                 Amounts Exist, but Borrowers’ Use of These Options Is Limited
                 by Several Factors                                                   28
              Conclusion                                                              35
              Recommendation for Executive Action                                     36
              Agency Comments                                                         36

Appendix I    Comments from the Department of Education                               38



Appendix II   GAO Contacts and Staff Acknowledgments                                  39
              GAO Contacts                                                            39
              Staff Acknowledgments                                                   39


Tables
              Table 1: Annual Income and Annual Student Loan Repayment of
                       Consolidation Borrowers Compared with
                       Nonconsolidation Borrowers Entering Repayment in 1999          11
              Table 2: Number of Lenders of Consolidation Borrowers Compared
                       to Nonconsolidation Borrowers Originating Loans, January
                       1987 to November 2002                                          15
              Table 3: Interest Rate Spread for FDLP Consolidation Loans
                       Originated in Fiscal Years 2002 and 2003                       23
              Table 4: Description of Borrower Repayment Plans                        29
              Table 5: Comparison of Repayment Periods for FFELP
                       Consolidation and Nonconsolidation Loans, by Repayment
                       Plan                                                           30
              Table 6: Repayment Periods for FDLP Consolidation and
                       Nonconsolidation Loans, by Repayment Plan                      31




              Page i                                    GAO-04-101 Student Loan Programs
          Table 7: Comparison of Borrowers’ Options under Consolidation
                   and Nonconsolidation Loans                                      32


Figures
          Figure 1: Average Student Loan Debt of Consolidation Loan
                   Borrowers Prior to Consolidation Compared with
                   Nonconsolidation Borrowers Originating Loans January
                   1987 to November 2002                                           10
          Figure 2: Repayment Periods of Consolidation Loans Compared
                   with Nonconsolidation Loans Originating from January
                   1987 to November 2002                                           12
          Figure 3: Type of School Attended by Consolidation Loan
                   Borrowers Compared with Nonconsolidation Borrowers
                   Originating Loans, January 1987 to November 2002                13
          Figure 4: Percentage of Consolidation Loan Borrowers Who
                   Borrowed for Graduate/Professional School Compared
                   with Nonconsolidation Borrowers Originating Loans,
                   January 1987 to November 2002                                   14
          Figure 5: Average Number of Loans of Consolidation Loan
                   Borrowers Compared with Nonconsolidation Borrowers
                   Originating Loans, January 1987 to November 2002                15
          Figure 6: Percentage of Consolidation Borrowers Who Defaulted
                   on Consolidation Loans Compared with Nonconsolidation
                   Borrowers Who Defaulted on Loans, January 1987 to
                   November 2002                                                   16
          Figure 7: Consolidation loan volume increased as borrower interest
                   rates fell                                                      18
          Figure 8: Illustration of Estimated SAP Paid to Holders of FFELP
                   Consolidation Loans Originated in Fiscal Year 2003              20
          Figure 9: Illustration of Net Subsidy Costs to the Federal
                   Government for Consolidation Loans Made in Fiscal Year
                   2002 Using Three Different Sets of Interest Rate
                   Assumptions                                                     26




          Page ii                                    GAO-04-101 Student Loan Programs
Abbreviations

FCRA              Federal Credit Reform Act
FDLP              William D. Ford Direct Loan Program
FFELP             Federal Family Education Loan Program
HEA               Higher Education Act
HEAL              Health Educational Assistance Loans
IRS               Internal Revenue Service
NSLDS             National Student Loan Data System
SAP               special allowance payment




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Page iii                                             GAO-04-101 Student Loan Programs
United States General Accounting Office
Washington, DC 20548




                                   October 31, 2003

                                   The Honorable John A. Boehner
                                   Chairman
                                   Committee on Education and the Workforce
                                   House of Representatives

                                   The Honorable Howard P. “Buck” McKeon
                                   Chairman
                                   Subcommittee on 21st Century Competitiveness
                                   Committee on Education and the Workforce
                                   House of Representatives

                                   For over 2 decades, the federal government has made consolidation loans
                                   available to help borrowers cope with large amounts of federal student
                                   loan debt. Consolidation loans are designed to help borrowers stay current
                                   on loan payments, thereby reducing the government’s costs of paying for
                                   defaults. Instead of making concurrent repayments on several loans over a
                                   period usually limited to 10 years, consolidation loan borrowers can
                                   combine their loans and extend their repayment periods beyond 10 years,
                                   thereby reducing monthly repayments. Consolidation loans also allow
                                   borrowers to lock in a fixed interest rate, unlike most other federal
                                   student loans, which carry an interest rate that varies from year to year.
                                   Between fiscal year 2000 and 2002, the number of borrowers consolidating
                                   their federal student loans nearly doubled to almost 1 million, and the total
                                   amount—or volume—of loans being consolidated rose even more sharply,
                                   from $12 billion to over $31 billion. Consolidation loans are available
                                   under both of the Department of Education’s (Education) two major
                                   student loan program—the Federal Family Education Loan Program
                                   (FFELP) and the William D. Ford Direct Loan Program (FDLP)1—and, in
                                   fiscal year 2002, accounted for about 44 percent of these programs’ total
                                   loan volume.




                                   1
                                     Under FFELP, private lenders make consolidation loans to borrowers, with Education
                                   guaranteeing lenders loan repayment and a rate of return that is equal to the average
                                   3-month commercial paper rate plus 2.64 percent. As of June 30, 2003, that rate of return
                                   was 3.81 percent for consolidation loans made on or after January 1, 2000. Under FDLP,
                                   Education uses federal funds to make direct student loans.



                                   Page 1                                                GAO-04-101 Student Loan Programs
The increase in consolidation borrowers and loans has raised
congressional interest in the cost of the program for the federal
government. Two main types of federal costs are involved. One is
“subsidy”—the net present value of cash flows to and from the
government that result from providing these loans to borrowers.2 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.3

For years, consolidation loans were basically the only alternative available
to borrowers seeking to reduce the size of their loan repayments. In recent
years, however, some repayment options, such as graduated, extended,
and income-based repayment plans, have been added to FFELP and FDLP.
This change has raised congressional interest in the degree to which these
options extend payment relief to borrowers without requiring them to
consolidate their loans, and in the potential advantages and disadvantages
of the various approaches, both for borrowers and the federal government.
In light of the upcoming reauthorization of the Higher Education Act
(HEA) (which authorizes the consolidation programs), you asked us to
examine several issues concerning consolidation loans. As agreed with
your office, we focused our work on answering the following key
questions:




2
 The Federal Credit Reform Act of 1990 requires Education to estimate these subsidy costs,
using the net present value of cash flows to do so. 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). The
background section of the report will describe credit reform in more detail.
3
 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—more
specifically, in the 2.64 percent add on paid over and above the 3-month rate on
commercial paper.




Page 2                                                 GAO-04-101 Student Loan Programs
•   How do consolidation loan borrowers differ from nonconsolidation loan
    borrowers?

•   How are federal subsidy and administration costs for consolidation loan
    programs affected by recent interest rate and loan volume changes?

•   To what extent do repayment options other than consolidation loans allow
    borrowers to simplify loan repayment and reduce repayment amounts?

    Our work to answer these questions involved a variety of information
    sources, including officials from Education’s Office of Federal Student Aid
    and Budget Service, as well as representatives of FFELP lenders. To
    develop information about student borrowers, we analyzed a sample of
    student loan data from Education’s National Student Loan Data System
    (NSLDS)—a comprehensive national database of student loans,
    borrowers, and other information. The sample was a randomly drawn,
    representative sample that contained records on approximately 4.4 million
    loans held by 1.4 million students or their parents. The sample constituted
    4 percent of the overall NSLDS population of approximately 32 million
    students.4 To assess the reliability of the NSLDS data, we reviewed existing
    information about the sample and interviewed Education officials in
    Washington, D.C., responsible for performing data accuracy, validity, and
    integrity tests of NSLDS data. In addition, we performed electronic testing
    of key variables in our sample for obvious problems in accuracy and
    completeness. We determined that the NSLDS data were sufficiently
    reliable for this report. Our analysis on borrower characteristics focused
    on borrowers in the sample who originated loans from 1987 (the year
    consolidation loans were made available under the program as it is
    currently structured5) to November 2002. To develop information about
    the family income of borrowers and their repayment amounts, we
    analyzed data provided by the Internal Revenue Service (IRS) on family
    income and Education on loan repayments for a sample of borrowers who



    4
      Because we used a sample, there is a sampling error associated with estimates obtained
    from them. For a 95 percent confidence interval, all percentage estimates reported have
    sampling errors of plus or minus 1 percentage point or less. All reported estimates other
    than percentages have sampling errors not exceeding plus or minus 5 percent of the value
    of those estimates.
    5
    The current loan consolidation provisions were enacted by the Consolidated Omnibus
    Budget Reconciliation Act of 1985 (Pub. L . No. 99-272) and later revised by the Higher
    Education Amendments of 1986 (Pub. L. No. 99-498). The Student Loan Marketing
    Association (Sallie Mae) had previously been authorized to make consolidation loans.




    Page 3                                                GAO-04-101 Student Loan Programs
                   entered repayment in 1999. Our analysis of federal costs of consolidation
                   loans is also based in part on interviews with Education officials in
                   Washington, D.C., and a review of relevant analyses prepared by
                   Education. We reviewed the HEA and related Education regulations and
                   other published information to identify the repayment options available to
                   student loan borrowers. We conducted our work from July 2002 through
                   August 2003 in accordance with generally accepted government auditing
                   standards.


                   On average, consolidation loan borrowers, during the 1987 to 2002 time
Results in Brief   period, had higher levels of student loan debt, higher incomes, and larger
                   loan repayments than did nonconsolidation loan borrowers. The average
                   level of student loan debt among consolidation loan borrowers, prior to
                   consolidating their loans, was about $22,000 versus about $10,000 for
                   borrowers who did not consolidate their loans. Consolidation loan
                   borrowers were less likely than nonconsolidation loan borrowers to have
                   attended a proprietary (for profit) school and were more likely to have
                   borrowed while attending graduate/professional school. Most
                   consolidation loans had repayment periods that were longer than 10 years.
                   In addition, consolidation loan borrowers, on average, had twice as many
                   student loans as did nonconsolidation borrowers, and two-thirds of
                   consolidation loan borrowers had loans from more than one lender,
                   compared with about one-third of nonconsolidation loan borrowers.
                   Overall, once they had consolidated their loans, borrowers with
                   consolidation loans defaulted less often than borrowers who did not
                   consolidate their loans.

                   Recent trends in interest rates and consolidation loan volumes have
                   affected 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
                   $1.3 billion for loans made in fiscal year 2002 to nearly $3 billion for loans
                   made in fiscal year 2003. Lower interest rates available to borrowers in
                   fiscal year 2003 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. Higher loan volumes in the FFELP program also added to
                   the estimated subsidy costs. 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


                   Page 4                                        GAO-04-101 Student Loan Programs
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 Treasury to finance its lending. However, the drop in interest rates
that occurred in fiscal year 2003, among other things, reduced the
government’s estimated net gain to $286 million for loans made in fiscal
year 2003, down from $460 million for loans made the year before. A
decrease in loan volume from recent record highs also contributed to the
reduced gain. Administration costs are not specifically tracked for either
consolidation loan program, but available evidence indicates that these
costs have risen, primarily reflecting increased loan volumes.

Repayment options, other than consolidation loans, that allow borrowers
to simplify loan repayment and reduce repayment amounts—such as the
ability to make a single repayment to cover multiple loans and obtain
extended repayment terms—are now available to some borrowers under
both FFELP and FDLP, but these alternatives are not available to all
borrowers. If borrowers have multiple loans from a single lender, they can
make one monthly payment to cover all their loans. Many borrowers can
also adjust the amount of their monthly payments so that they make
smaller monthly payments at the start of repayment and larger monthly
payments during later repayment periods for each of their individual loans.
Moreover, borrowers with relatively large loan balances can extend their
repayment periods beyond a 10-year term, which results in smaller
monthly payments. While these alternatives to consolidation have been
added, borrowers must meet certain criteria to be able to use them. For
example, the ability to make a single payment is limited to borrowers
whose loans are currently with a single lender, and the ability to extend
repayment periods is, in some cases, limited to borrowers whose total loan
balances are above certain limits. For borrowers who cannot use these
options, consolidation loans remain the only vehicle under FFELP and
FDLP by which they may combine multiple repayments into one and
reduce the amount of their monthly repayments. Consolidation loans also
allow borrowers to lock in a fixed interest rate for the life of the loan—an
option not available to nonconsolidation loan borrowers in either
program. The ability to lock in a low interest rate for the life of the loan is
one factor that could motivate some borrowers to choose consolidation
over other options. Borrowers’ repayment choices, including whether to
obtain a consolidation loan or use other repayment alternatives, have
consequences for federal costs. While consolidation loans may remain an
important tool to help borrowers, overall federal costs in providing for
consolidation loans may exceed federal savings from reduced defaults.



Page 5                                        GAO-04-101 Student Loan Programs
                         In this report, we recommend 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 provided Education with a copy of our draft report for review and
                         comment. In written comments on our draft report, Education agreed with
                         our reported findings and recommendations. Education’s written
                         comments appear in appendix I. Education also provided technical
                         comments, which we incorporated where appropriate.


                         Congress created consolidation loans under Title IV of the HEA to help
Background               borrowers combine and reduce monthly repayments so as to help
                         decrease federal loan default costs. Consolidation loans are available
                         under Education’s two major student loan programs—the FFELP and
                         FDLP. Under FFELP, private lenders make loans to students with
                         Education guaranteeing the lenders loan repayment and a rate of return on
                         the loans they make. Under FDLP, the federal government makes loans to
                         students using federal funds.


FFELP and FDLP Offer     In addition to consolidation loans, a number of other types of loans are
Several Types of Loans   available under FFELP and FDLP, including subsidized Stafford,
                         unsubsidized Stafford, and PLUS loans. Both subsidized and unsubsidized
                         Stafford loans are variable rate loans that 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. Students
                         can qualify for unsubsidized Stafford loans regardless of financial need.
                         The federal government pays the interest on behalf of subsidized loan
                         borrowers while the student is in school. 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.

                         Consolidation loans differ from Stafford and PLUS loans in that they
                         enable borrowers who have multiple loans—possibly from different




                         Page 6                                      GAO-04-101 Student Loan Programs
lenders, different guarantors,6 and even from different loan programs—to
combine their loans into a single loan and make one monthly payment.
Consolidation loans are new originations that, in general, do not
contribute to increases in outstanding loan balances because they
refinance already existing loans.7 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 Stafford
and PLUS loans. 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 (subsidized and unsubsidized
Stafford loans, PLUS loans, and, in some instances, consolidation 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 loans8 (HEAL).

Consolidation loans under FFELP and FDLP accounted for about
44 percent of the $71.8 billion in total new student loan dollars that
originated during fiscal year 2002. FFELP consolidation loans comprised
about 72 percent of the fiscal year 2002 consolidation loan volume, while
FDLP consolidation loans accounted for the remaining 28 percent.



6
  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.
7
 In some cases, according to Education, borrowers’ outstanding loan balances may
increase if collections costs assessed borrowers are included in the amounts being
consolidated.
8
 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.




Page 7                                               GAO-04-101 Student Loan Programs
Federal Credit Reform Act       The Federal Credit Reform Act (FCRA) of 1990 was enacted to require
of 1990 Helps Define            agencies to more accurately measure the government’s cost of federal loan
Federal Costs Associated        programs and to permit better cost comparisons among and between
                                credit programs, such as FDLP and FFELP. Prior to implementing FCRA,
with Consolidation Loans        the budgetary cost of a new direct loan or loan guarantee was reported on
                                a cash basis. Thus, loan guarantees appeared to be free in the budget year,
                                while direct loans appeared to be as expensive as grants. As a result, costs
                                were distorted and credit programs could not be compared meaningfully
                                with other programs and with each other. FCRA and the related
                                accounting standards and budgetary guidance, together known as credit
                                reform, were established to more accurately measure the government’s
                                costs of federal credit programs.

Subsidy Costs                   As part of implementing credit reform, agencies are 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, based on the present value of
                                estimated net cash flows, excluding administration costs.

                                For FFELP loans, the subsidy cost of a loan guarantee is the net present
                                value, when a guaranteed loan is disbursed, of estimated cash flows such
                                as:

                            •   Payments by the government to lenders to cover loan defaults and interest
                                subsidies. (Interest subsidies include payments to lenders that provide
                                them a guaranteed rate of return on the loans they make as well as
                                payments of interest on behalf of subsidized Stafford loan borrowers who
                                are in periods of deferment).9

                            •   Payments by lenders to the government, including origination and other
                                fees, penalties assessed borrowers, and recoveries on defaulted loans.
                                (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 of the loans in their portfolio.)

                                For FDLP loans, the subsidy cost of a direct loan is the net present value,
                                at the time when the direct loan is disbursed, of estimated cash flows such
                                as

                            •   loan disbursements by the government to borrowers and


                                9
                                 Deferment equals a period of time during repayment in which the borrower, upon meeting
                                certain conditions, is not required to make payments of loan principal.




                                Page 8                                             GAO-04-101 Student Loan Programs
                       •   principal repayments and payments of interest by borrowers to the
                           government.

                           The subsidy costs of FDLP loans are also affected by the interest
                           Education must pay to Treasury to finance its lending activities.

Administration Costs       Administration costs include all costs directly related to FDLP program
                           operations, including loan servicing, loan system development and
                           maintenance, including computer costs, and the costs of collecting on
                           delinquent loans. For FFELP loans, lenders incur a substantial portion of
                           administration costs. The federal government initially pays many of these
                           costs by paying an allowance to the lenders. These allowances are part of
                           the subsidy cost under credit reform. For FDLP loans, the federal
                           government pays for administration costs directly.


                           Consolidation loan borrowers differed from nonconsolidation loan
Consolidation              borrowers in a variety of ways. On average, consolidation loan borrowers
Borrowers Had More         had higher student loan debt, higher incomes, larger annual loan
                           repayments, and longer repayment periods. They were also less likely to
Debt, Higher Incomes,      have attended a proprietary (or, for-profit) school and were more likely to
and Differed in Other      have borrowed while attending graduate/professional school. In addition,
                           they averaged more student loans from more lenders. Overall,
Ways When                  consolidation loan borrowers defaulted less often than borrowers who had
Compared with              not consolidated their loans.
Nonconsolidation
Borrowers
Consolidation Borrowers    Borrowers with consolidation loans had a higher average amount of
Had Higher Student Loan    student loan debt than nonconsolidation loan borrowers. Prior to
Debt and Incomes, Larger   consolidation, the average student loan debt for our sample of
                           consolidation loan borrowers from January 1987 through November 2002
Loan Repayments, and       was $21,735, more than twice the average of $9,587 for nonconsolidation
Longer Repayment Periods   borrowers (see fig. 1). While average student loan debt was higher for
                           consolidation loan borrowers, the average student loan debt for both types
                           of borrowers increased over time. Between 1992 and 2002, the average
                           student loan debt increased from $17,420 to $35,339 for consolidation loan
                           borrowers, and from $7,267 to $15,720 for nonconsolidation borrowers.




                           Page 9                                      GAO-04-101 Student Loan Programs
Figure 1: Average Student Loan Debt of Consolidation Loan Borrowers Prior to
Consolidation Compared with Nonconsolidation Borrowers Originating Loans
January 1987 to November 2002

Average student loan debt
$25,000
            21,735

$20,000



$15,000


                                  9,587
$10,000



 $5,000



     $0
       Consolidation        Nonconsolidation
      loan borrowers         loan borrowers
Source: GAO analysis of NSLDS data.

Note: Amounts analyzed and reported are in nominal dollars.



Borrowers with consolidation loans had higher average incomes and
higher average annual repayments on their student loans than
nonconsolidation loan borrowers. In addition, loan repayments comprised
a slightly higher percentage of the incomes of consolidation borrowers,
with an annual student loan repayment-to-income ratio of 9.4 percent for
consolidation loan borrowers and 8.4 percent for nonconsolidation
borrowers (see table 1). Not only did consolidation loan borrowers have
higher average incomes than nonconsolidation loan borrowers, 39 percent
of them had family incomes greater than $50,000, compared with 23
percent of nonconsolidation borrowers with family incomes greater than
$50,000.




Page 10                                                   GAO-04-101 Student Loan Programs
Table 1: Annual Income and Annual Student Loan Repayment of Consolidation
Borrowers Compared with Nonconsolidation Borrowers Entering Repayment in
1999

                                        Consolidation borrowers   Nonconsolidation borrowers
 Average income                                        $47,150                           $32,591
 Average annual
 repayment                                               $3,355                           $2,126
 Average student loan
 repayment-to-income ratio                                9.4%                              8.4%
Source: GAO analysis of IRS and Education data.

Note: The annual student loan repayment-to-income ratio was calculated as the average debt burden
across five income categories weighted by the number of borrowers in each category.


For the FDLP loans in our sample,10 consolidation loans tended to have
longer repayment periods than nonconsolidation loans. Over 62 percent of
consolidation loans had repayment terms of 12 years or more, compared
with 26 percent for nonconsolidation loans. The smaller loan balances
often carried by nonconsolidation loan borrowers could help explain why
a smaller portion of nonconsolidation loans had repayment periods of
more than 10 years. For example, under FDLP, many of the repayment
plans that allow the extension of repayment periods require a minimum
loan balance of $10,000. The repayment periods for loan balances over
$10,000 usually vary depending on the amount of the loan, with 30 years
being the maximum repayment period for loan balances of $60,000 or
more. Since our analysis indicates that nonconsolidation loan borrowers
had an average loan debt of $9,587, these borrowers would not qualify for
extended repayment periods. However, even when consolidation loan
borrowers had the option to extend their repayment term, nearly 4-in-
10 (37 percent) of the consolidation loans in our sample had a standard
10-year repayment period (see fig. 2).




10
     NSLDS does not contain information about repayment terms for FFELP loans.




Page 11                                                      GAO-04-101 Student Loan Programs
                             Figure 2: Repayment Periods of Consolidation Loans Compared with
                             Nonconsolidation Loans Originating from January 1987 to November 2002


                             Percent of borrowers
                             80
                                                               74


                                             62
                             60




                             40     37


                                                                     26

                             20




                              0
                                  Consolidation            Nonconsolidation
                                     loans                      loans

                                            10 years

                                            12+ years

                             Source: GAO analysis of NSLDS data.




Consolidation Borrowers      Consolidation loan borrowers were less likely than nonconsolidation loan
Were Less Likely to Attend   borrowers to have attended a proprietary (or, for-profit) school.
Proprietary Schools and      Additionally, borrowers with consolidation loans were somewhat more
                             likely to have attended public or private/nonprofit schools than were
More Likely to Have          nonconsolidation borrowers. Overall, 80 percent of consolidation
Borrowed While Attending     borrowers attended public or private/nonprofit schools and 74 percent of
Graduate/Professional        nonconsolidation borrowers attended a public or private/nonprofit school
School                       (see fig. 3).




                             Page 12                                          GAO-04-101 Student Loan Programs
Figure 3: Type of School Attended by Consolidation Loan Borrowers Compared
with Nonconsolidation Borrowers Originating Loans, January 1987 to November
2002

Percent of borrowers
60


      49                        48



40

           31

                                      26   26

                  20
20




 0
      Consolidation        Nonconsolidation
     loan borrowers         loan borrowers


                Public school

                Private/nonprofit school

                Proprietary school

Source: GAO analysis of NSLDS data.




Although both consolidation and nonconsolidation loan borrowers tended
to borrow prior to graduate/professional school, our analysis indicates
that consolidation loan borrowers were more likely than nonconsolidation
borrowers to have taken out a student loan while attending
graduate/professional school. About 28 percent of consolidation loan
borrowers borrowed while they were in graduate/professional school
compared with 12 percent of nonconsolidation loan borrowers (see fig. 4).




Page 13                                         GAO-04-101 Student Loan Programs
                          Figure 4: Percentage of Consolidation Loan Borrowers Who Borrowed for
                          Graduate/Professional School Compared with Nonconsolidation Borrowers
                          Originating Loans, January 1987 to November 2002

                          Percent of borrowers
                          30      28




                          20



                                                        12

                          10




                           0
                            Consolidation      Nonconsolidation
                           loan borrowers       loan borrowers
                          Source: GAO analysis of NSLDS data.




Consolidation Borrowers   Prior to consolidating their loans, consolidation loan borrowers averaged
Had More Loans and        more loans from more lenders than nonconsolidation loan borrowers.
Borrowed from More        Consolidation loan borrowers had taken out an average of about six loans
                          each, nearly twice the average number for nonconsolidation borrowers
Lenders                   (see fig. 5). Furthermore, consolidation loan borrowers were more likely
                          to have borrowed from more than one lender. Prior to consolidation,
                          28 percent of consolidation loan borrowers had loans from three or more
                          lenders compared with 9 percent for nonconsolidation borrowers (see
                          table 2).




                          Page 14                                      GAO-04-101 Student Loan Programs
                          Figure 5: Average Number of Loans of Consolidation Loan Borrowers Compared
                          with Nonconsolidation Borrowers Originating Loans, January 1987 to November
                          2002

                           Average number of loans
                           8



                                 6.25
                           6




                           4
                                                       3.18



                           2




                           0
                            Consolidation      Nonconsolidation
                           loan borrowers       loan borrowers
                          Source: GAO analysis of NSLDS data.




                          Table 2: Number of Lenders of Consolidation Borrowers Compared to
                          Nonconsolidation Borrowers Originating Loans, January 1987 to November 2002

                           Number of lenders                    Consolidation borrowers        Nonconsolidation borrowers
                           1                                                       37%                                69%
                           2                                                       35%                                22%
                           3 or more                                               28%                                 9%
                           Total                                                  100%                               100%
                          Source: GAO analysis of NSLDS data.




Consolidation Borrowers   Fewer consolidation loan borrowers in our sample had defaulted on their
Defaulted Less Often      consolidation loans than nonconsolidation borrowers had defaulted on
                          their loans. The overall default rate for consolidation loan borrowers who
                          had defaulted on their consolidation loans was about 8 percent compared
                          with the overall default rate of 23 percent for nonconsolidation borrowers
                          (see fig. 6).




                          Page 15                                                         GAO-04-101 Student Loan Programs
                     Figure 6: Percentage of Consolidation Borrowers Who Defaulted on Consolidation
                     Loans Compared with Nonconsolidation Borrowers Who Defaulted on Loans,
                     January 1987 to November 2002

                     Percent of borrowers
                     30


                                                   23

                     20




                     10       8




                      0
                       Consolidation       Nonconsolidation
                      loan borrowers        loan borrowers
                     Source: GAO analysis of NSLDS data.




                     Some consolidation loan borrowers had defaulted on a student loan prior
                     to obtaining their consolidation loan and then subsequently defaulted on
                     their consolidation loan as well. About one-fifth (19 percent) of
                     consolidation loan borrowers had, in fact, defaulted on a loan before they
                     obtained a consolidation loan; of these borrowers, about 23 percent
                     subsequently defaulted on their consolidation loans. Of the approximately
                     four-fifths (81 percent) of consolidation loan borrowers that had never
                     defaulted on a student loan prior to obtaining a consolidation loan, about
                     5 percent defaulted on their consolidation loan.


                     Although recent trends in interest rates and consolidation loan volumes
Interest Rates and   have affected the FFELP and FDLP consolidation programs in somewhat
Increased Loan       different ways, the net effect has been an increase in estimated subsidy
                     and administration costs for loans made in fiscal year 2003 as compared
Volumes Have         with loans made in fiscal year 2002. In FFELP, estimated subsidy costs
Increased Federal    rose from $1.3 billion for loans made in fiscal year 2002 to nearly $3 billion
                     for loans made in fiscal year 2003. These estimated subsidy costs are
Costs                affected by the amount the federal government must pay to lenders to
                     guarantee them a statutorily established rate of return, which fluctuates
                     over time as interest rates rise and fall. Increased FFELP consolidation
                     loan volume in 2003 also raised costs. For FDLP consolidation loans, the
                     margin of difference narrowed between the interest rate that Education


                     Page 16                                        GAO-04-101 Student Loan Programs
                        earned from borrowers and the rate that Education paid to the Treasury to
                        finance direct loans. As a result of this smaller difference, as well as an
                        expected decrease in demand for FDLP consolidation loans compared to
                        prior years, the estimated net interest gain to the government dropped
                        from $460 million in fiscal year 2002 to $286 million in fiscal year 2003. The
                        movement of subsidy costs for loans made in future years will depend
                        heavily on what happens to interest rates and loan volumes.
                        Administration costs are not specifically tracked for either loan program,
                        but available evidence indicates that these costs have also risen.


Borrowers’ Rates Have   Recent years have seen dramatic growth in loan volume for both
Dropped and Loan        consolidation loan programs, along with an overall drop in interest rates
Volumes Have Risen      for borrowers that correspond to the overall decline in interest rates.
                        From fiscal year 1998 through fiscal year 2002, the volume of consolidation
                        loans made (or “originated”) rose from $5.8 billion to over $31 billion. Of
                        the over $31 billion in consolidation loan volume for fiscal year 2002,
                        $22.7 billion was in the FFELP and $8.8 billion was in the FDLP. While
                        FDLP consolidation loan volume for fiscal year 2003 is expected to
                        decrease, FFELP loan volume is expected to increase, resulting in a total
                        consolidation loan volume of over $36 billion for the year. 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. From July
                        2000 to June 2003, the minimum fixed interest rate for consolidation loans
                        dropped 4 percentage points, with consolidation loan borrowers currently
                        obtaining rates as low as 3.50 percent in the year beginning July 1, 2003.
                        Figure 7 shows the relationship between these two factors. Under these
                        conditions, 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.




                        Page 17                                       GAO-04-101 Student Loan Programs
                          Figure 7: Consolidation loan volume increased as borrower interest rates fell

                          Loan volume in billions                    Borrower interest rate (percent)
                          40                                                                       10




                                                                                                   8
                          30


                                                                                                   6

                          20

                                                                                                   4


                          10
                                                                                                   2




                           0                                                                       0
                                 1998        1999        2000        2001            2002   2003
                               Fiscal year

                                         Loan volume

                                         Borrower rate
                          Source: GAO analysis of Education's Budget Service data.




                          Underscoring the potential attractiveness of these loans to potential
                          borrowers, many lenders, including newer loan companies that are
                          specializing in consolidation loans, are aggressively marketing
                          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.


Effect on Subsidy Costs   Overall estimated subsidy costs for consolidation loans made in fiscal year
Varies between Programs   2003 were greater than for consolidation loans made in fiscal year 2002. In
                          light of the differences between how the FFELP and FDLP operate,
                          however, the costs of these two programs were affected in very different
                          ways. For FFELP, the result was a substantial increase in estimated
                          subsidy costs. For FDLP, the result was a narrowing of the net difference
                          between the estimated interest payments paid by consolidated loan



                          Page 18                                                                  GAO-04-101 Student Loan Programs
                               borrowers to Education and the costs paid by Education to Treasury to
                               finance direct loans.

Increased Special Allowance    Estimated subsidy costs for FFELP consolidation loans are expected to
Payments to Lenders and        increase from $1.3 billion for loans made in fiscal year 2002 to almost
Increased Loan Volume Caused   $3 billion for loans made in fiscal year 2003. While part of the increase is
FFELP Subsidy Costs to Rise    the result of greater loan volume, the increase is primarily 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.

                               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 paper11 interest rate plus an additional 2.64 percent.
                               The amount of the quarterly SAP paid to loan holders equals the difference
                               between the guaranteed lender yield and the borrower rate divided by four
                               and multiplied by the average unpaid principal balance of all loans the
                               lender holds. 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 nearly $3 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. In
                               figure 8, the bottom line shows the fixed borrower rate for a FFELP
                               consolidation loan made in the first 9 months of fiscal year 2003, while 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 would therefore receive only
                               the rate paid by borrowers; no SAP would be 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 the figure shows, Education’s assumptions would


                               11
                                 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.




                               Page 19                                               GAO-04-101 Student Loan Programs
                                                           call for lenders to receive a SAP over most of the life of the consolidation
                                                           loans made in fiscal year 2003.

Figure 8: Illustration of Estimated SAP Paid to Holders of FFELP Consolidation Loans Originated in Fiscal Year 2003

Interest rate (percent)
8

                                                                                                                    a
7                                                                                            Estimated lender yield


6
                                                                           SAP is the difference between the lender yield and the
                                                                           borrower rate (if positive) times the principal balance.
5


4
                                                                                                  Borrower rateb


3


2


1


0
 2003          2004            2005             2006       2007         2008          2009                2010           2011         2012      2013      2014
    Fiscal year
Source: GAO analysis of Education's Budget Service data.
                                                           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 (OMB), 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 July1,1998, and in repayment at time of
                                                           consolidation.



                                                           In point of fact, Education is required to revise these estimates
                                                           periodically to adjust for changing assumptions about interest rates and
                                                           loan performance. Subsidy costs estimates for FFELP consolidation loans
                                                           can vary substantially, depending on how much the guaranteed lender
                                                           yield rises above the fixed rate paid by borrowers. Education is required to
                                                           account for such changes in subsidy cost estimates by annually updating,
                                                           or “reestimating,” loan program costs, in accordance with OMB budget




                                                           Page 20                                                              GAO-04-101 Student Loan Programs
guidance.12 Any increase or decrease in the subsidy cost estimates
resulting from reestimates is reflected in future program budget estimates
as appropriate and Education’s end of the fiscal year financial statements
whenever the reestimated amount is significant. Thus, Education’s
estimates for both fiscal year 2002 loans and fiscal year 2003 loans are
subject to change in the future.

An increase in loan volume also played a role in the subsidy cost increase
from fiscal years 2002 to 2003, but to a lesser degree than the higher
interest subsidies the government is expected to pay to lenders. On their
own, loan volumes can increase subsidy amounts. To illustrate, estimated
subsidy costs can be converted into subsidy rates, reflecting the estimated
unit cost per loan dollar to the federal government. For example, a $1,000
loan with a federal subsidy cost of $100 would have a subsidy rate of
10 percent. The subsidy rate for FFELP consolidation loans made in fiscal
year 2002 was approximately 5.9 percent. Given a fiscal year 2002 FFELP
consolidation loan volume of about $22.7 billion, and a subsidy rate of
5.9 percent, federal subsidy costs can be determined by multiplying the
loan volume by the subsidy rate ($22.7 billion X 0.059 = $1.3 billion).
Viewed in this way, it is clear that even if the subsidy rate remained the
same from fiscal year 2002 to 2003, the larger expected FFELP
consolidation loan volume of $30.5 billion in fiscal year 2003 would have
increased total subsidy costs to $1.8 billion (i.e., $30.5 billion X 0.059 =
$1.8 billion), an increase of $0.5 billion from fiscal year 2002. However, the
higher interest subsidies the government is expected to pay to lenders, as
previously discussed, also increased the subsidy rate for FFELP
consolidation loans made in fiscal year 2003. This rate—9.8 percent—
coupled with the estimated loan volume of $30.5 billion, resulted in the
total FFELP consolidation loan subsidy costs of about $3 billion
($30.5 billion X 0.098).




12
   To estimate the cost of loan programs, Education first estimates the future performance
of direct and guaranteed loans when preparing their annual budgets. These first estimates
establish the subsidy estimates for the current-year originated loans. The data used for the
first estimates are reestimated later to reflect any changes in loan performance and
expected changes in future economic 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.




Page 21                                                GAO-04-101 Student Loan Programs
Changing Interest Rates Also   Subsidy costs can occur within FDLP as well, but in a different way. The
Affected FDLP Consolidation    FDLP consolidation program is a direct loan program and therefore
Loans                          involves no guaranteed yields to private lenders. Still, the program has
                               potential subsidy costs determined in part by the relationship between
                               interest rates Education earns from borrowers—the borrower rate and the
                               rate Education pays Treasury to finance its lending. The government’s cost
                               of capital is determined by the interest rate Education pays Treasury to
                               finance direct student loans, which is equivalent to the discount rate.13 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 is expected to decline from
                               $460 million in fiscal year 2002 to $286 million in fiscal year 2003.14




                               13
                                 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.
                               14
                                The subsidy estimates for consolidation loans made in fiscal year 2003 were developed by
                               Education in August 2003. To account for recent changes in interest rates, we asked
                               Education to update its estimates as of August 18, 2003, using a discount rate that we
                               calculated based on the average of daily Treasury rates for various short- and long-term
                               maturities during fiscal year 2003. Because our calculation was as of August 18, 2003, we
                               approximated the Treasury rates through the remainder of the fiscal year based on the
                               August 18, 2003, rates. At the end of fiscal year 2003, when OMB determines the actual
                               discount rates for fiscal year 2003, estimated subsidy costs of the fiscal year 2003 FFELP
                               and FDLP consolidation loans will likely change.




                               Page 22                                              GAO-04-101 Student Loan Programs
The smaller net gain that is expected to occur in fiscal year 2003 reflects a
narrowed difference between the discount rate and the borrower rate. 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 2 percentage points, from 6 percent in fiscal
year 2002 to 4 percent in fiscal year 2003. The discount rate, on the other
hand, dropped by only 0.95 percentage points. The resulting interest rate
spread decreased from 1.1 percent to 0.05 percent (see table 3). In other
words, each $100 of consolidated FDLP loans made in fiscal year 2002, will
result in $1.10 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 $0.05 more in interest for the government.

Table 3: Interest Rate Spread for FDLP Consolidation Loans Originated in Fiscal
Years 2002 and 2003

 Fiscal             Borrower               Discount        Interest rate   Estimated interest payments
 year                    rate                   rate             spread          for each $100 of loans
 2002                      6.0%                 4.90%             1.1%              1.1% x $100 = $1.10
 2003                      4.0%                 3.95%            0.05%            0.05% x $100 = $0.05
Source: GAO analysis of Education’s Budget Service data.

Note: The discount rate of 3.95 percent is an estimated discount rate on August 18, 2003. The actual
discount rate for fiscal year 2003 may be higher or lower, which would reduce or increase the interest
rate spread for fiscal year 2003.


While Education revises estimates periodically to adjust for changing
assumptions about future interest rates for FFELP consolidation loans, the
borrower rate and the discount rate used to derive the subsidy cost for
FDLP consolidation loans made in fiscal year 2003 are generally fixed for
the life of the loans. As a result, the subsidy cost of FDLP consolidation
loans made in any given fiscal year do not vary in the way that subsidy
costs for FFELP consolidation loans do.15




15
  Subsidy cost estimates for consolidation loans made in fiscal year 2003 will be updated
when the actual discount rate for the loans made in fiscal year 2003 is known at the close
of fiscal year 2003. Reestimates for interest rates for FDLP consolidation loans would
generally not occur due to the fixed discount and borrower rates used for calculating
subsidy cost estimates. However, technical reestimates which are made after the close of
each fiscal year to adjust for changes in assumptions other than interest rates (e.g.,
defaults, recoveries, prepayments, and fees), may still occur and could result in changes to
the subsidy cost estimates.




Page 23                                                              GAO-04-101 Student Loan Programs
                             Loan volume also played a role in the smaller net gain that occurred in
                             fiscal year 2003. While FDLP consolidation loan volume increased from
                             about $5.4 billion in fiscal year 2000 to about $8.8 billion in fiscal year
                             2002, Education estimated a decrease in demand for FDLP consolidation
                             loans for 2003, expecting volume to be about $6 billion.16 The unit cost per
                             loan dollar, or subsidy rate, for FDLP consolidation loans made in fiscal
                             year 2002 was a negative 5.2 percent, which resulted in a negative
                             subsidy17—that is, a “gain”—to the government of $0.052 for each dollar
                             lent (excluding administrative costs). As previously discussed, the
                             difference between the discount rate and the borrower rate narrowed
                             from fiscal year 2002 to fiscal year 2003, which contributed to the
                             increased subsidy rate from a negative 5.2 percent to a negative
                             4.8 percent, resulting in a smaller gain, per loan dollar, to the government.
                             Had the subsidy rate remained the same from fiscal year 2002 to fiscal year
                             2003, the decrease in FDLP consolidation loan volume would have
                             resulted in a reduced gain to the government of about $147 million. The
                             subsidy rate increase from fiscal year 2002 to fiscal year 2003, however,
                             coupled with reduced loan volume, resulted in a reduced gain of
                             $174 million.


Subsidy Costs Are            As the discussion of both FFELP and FDLP loans shows, interest rates
Sensitive to Interest Rate   have a strong effect on whether subsidy costs occur and how large they
Changes                      are. As a measure of how great an effect different interest rate
                             assumptions can have, we asked Education to conduct two additional sets
                             of calculations for fiscal year 2002 FFELP and FDLP consolidation loans.
                             Using the same loan volume and other assumptions of the fiscal year 2002
                             estimates, Education applied the interest rate assumptions that were used
                             to develop the estimates for the fiscal year 2001 and 2003 consolidation
                             loans. These assumptions differed from those in place in fiscal year 2002,
                             as well as from each other. In general, the interest rate assumptions for
                             fiscal year 2001 were higher than the assumptions used in fiscal year 2002,
                             and future interest rates were expected to decrease. The interest rate
                             assumptions for fiscal year 2003, on the other hand, were generally lower


                             16
                              Education’s $6 billion estimate was calculated as part of the 2003 Mid-Session Review and
                             based on actual consolidation loan volume for the first two quarters of fiscal year 2003.
                             Actual volume may differ. Further, in July 2003, borrower interest rates decreased from the
                             prior year, which may increase demand for FDLP consolidation loans during the remainder
                             of fiscal year 2003.
                             17
                              Negative subsidies mean subsidy costs that are less than zero. They occur if the present
                             value of cash inflows to the government exceeds the present value of cash outflows.




                             Page 24                                               GAO-04-101 Student Loan Programs
than the assumptions used in fiscal year 2002, and future interest rates
were expected to increase.

Calculating subsidy estimates under these three different sets of interest
rate assumptions produced substantially different results. As figure
9 shows, the results of this analysis indicated that for FFELP consolidation
loans, the fiscal year 2001 interest rate assumptions would result in
estimated subsidy costs totaling $129 million, or about $1 billion less than
the estimated subsidy costs under the actual fiscal year 2002 estimates. In
contrast, the fiscal year 2003 interest rate assumptions resulted in
estimated subsidy costs totaling $2.4 billion, an increase of more than
$1.2 billion in subsidy costs, even though the estimate was calculated
across the same volume of loans. For FDLP consolidation loans, the
analysis indicated that a greater interest rate spread between the discount
rate and the borrower rate for the fiscal year 2001 interest rate
assumptions, resulted in a net gain to the government totaling about
$645 million or about $264 million more than the gain under the actual
fiscal year 2002 estimates. In contrast, the fiscal year 2003 interest rate
assumptions resulted in an estimated subsidy cost to the government
totaling about $370 million, a change of about $751 million. This increase
is primarily due to the negative interest rate spread in which the borrower
rate used in fiscal year 2003 was less than the discount rate used in the
fiscal year 2003 interest rate assumptions.




Page 25                                      GAO-04-101 Student Loan Programs
                            Figure 9: Illustration of Net Subsidy Costs to the Federal Government for
                            Consolidation Loans Made in Fiscal Year 2002 Using Three Different Sets of Interest
                            Rate Assumptions


                                Results using                                Results using                           Results using
                            FY 2001 assumptions                          FY 2002 assumptions                     FY 2003 assumptions
                            Billions
                             $2.5                                                                                         2.41


                            $2.0


                            $1.5
                                                                                       1.169

                            $1.0


                            $0.5                                                                                                   0.37
                                    0.129
                            $0.0


                            -$0.5                                                              -0.381

                                              -0.649
                            -$1.0

                                 FY 2001 assumptions                           FY 2002 assumptions                   FY 2003 assumptions
                            Discount rate (FDLP)          5.31%          Discount rate (FDLP)           4.90%    Discount rate (FDLP)     5.47%
                            Lender yield (FFELP)                         Lender yield (FFELP)                    Lender yield (FFELP)
                            -- In FY 2001                 7.53%          -- In FY 2002                  4.52%    -- In FY 2003            4.02%
                            -- In 10 years                7.36%          -- In 10 years                 7.36%    -- In 10 years           7.36%
                            Borrower rate                 7.75%           Borrower rate                 5.63%    Borrower rate            4.13%


                                       Subsidy costs for FFELP loans

                                       Subsidy costs for FDLP loans

                            Source: GAO analysis of Education's Budget Service data.

                            Note: Results were obtained by applying Education’s interest rate assumptions for fiscal years 2001,
                            2002, and 2003 to the 2002 consolidation loans. Negative subsidy costs for FDLP using fiscal years
                            2001 and 2002 rates represent a net gain for the federal government.



Administration Costs Also   Loan volume affects administrative costs, in that cost is in part a function
Increase, but Mainly        of the number of loans originated and serviced during the year. As a result,
Because of Loan Volume      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



                            Page 26                                                                     GAO-04-101 Student Loan Programs
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 total includes approximately
$31 million for loan origination, $19 million for loan servicing, and
$3 million for loan collection. The $52.3 million does not include overhead
costs, which include such expenses as 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 by about $7 million 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 under FFELP,
a large portion of 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.




Page 27                                      GAO-04-101 Student Loan Programs
                       Repayment options, other than consolidation loans, that allow borrowers
Repayment Options      to simplify loan repayment and reduce repayment amounts are now
Other Than             available to some borrowers under both FFELP and FDLP, but these
                       alternatives are not available to all borrowers. Since consolidation loans
Consolidation Loans    were first offered to borrowers, Congress has changed student loan
That Allow Borrowers   programs in ways that provide borrowers with these loan repayment
                       options. These options include provisions for combining multiple loan
to Simplify Loan       payments into one and for restructuring the repayment terms or
Repayments and         lengthening the repayment period in order to lower monthly repayment
Reduce Repayment       amounts. However, these options are limited, in some cases, to borrowers
                       who have loans with one lender, or whose loan balances meet certain
Amounts Exist, but     criteria. These options also differ from the consolidation loan program in
Borrowers’ Use of      that they carry a variable borrower interest rate, while consolidation loans
                       allow borrowers to lock in a fixed interest rate. In today’s environment,
These Options Is       with current low interest rates that are expected to rise over time, the
Limited by Several     ability to lock in a low fixed rate may affect many borrowers’ decisions
                       about which approach to take. Borrowers’ choices of whether to use
Factors                consolidation loans or these other options have a budgetary effect for the
                       federal government. Proposed legislation has been introduced in the
                       108th Congress that, among other things, would replace the fixed
                       borrower interest rate for consolidation loans with a variable interest rate.


Flexible Repayment     Other options, outside of consolidation, now exist for some borrowers to
Options Similar to     make single payments on multiple loans and reduce their payment
Consolidation Are      amounts—options that were unavailable when Congress first introduced
                       consolidation loans under the FFELP. For example, when Congress
Available to Some      created the FDLP in 1993, Education provided FDLP borrowers with the
Borrowers              ability to combine payments on multiple FDLP loans into a single
                       payment. Similarly, in 1999, Education promulgated regulations requiring
                       FFELP lenders to combine all of a borrower’s FFELP loans into a single
                       account to be repaid under a single repayment schedule. Furthermore,
                       Congress has provided borrowers with a number of repayment plans that
                       give certain FFELP and FDLP borrowers who do not consolidate their
                       loans flexibility to reduce monthly payment amounts in a variety of ways.
                       For example, “graduated” and “income-sensitive” repayment plans
                       introduced in 1992, allow borrowers to make smaller payments early in a
                       repayment period, followed by larger payments in future years. (These
                       plans assume that a borrower’s income will increase over the repayment
                       period.) While borrowers who use the FFELP graduated and income-
                       sensitive repayment plans must generally repay their loans over a
                       10-year period, another repayment plan—“extended”—allows certain
                       FFELP borrowers to lengthen their repayment terms up to 25 years, thus


                       Page 28                                      GAO-04-101 Student Loan Programs
                                                               reducing monthly repayment amounts. Under FDLP, borrowers have
                                                               similar repayment options, plus additional flexibility to repay loans over
                                                               longer periods, outside of consolidation. Table 4 summarizes the
                                                               repayment plans available to borrowers under FFELP and FDLP.

Table 4: Description of Borrower Repayment Plans

                              FFELP repayment plans                                                     FDLP repayment plans
 Standard          Borrowers make fixed monthly payments of at least                 Standard     Borrowers make fixed monthly payments of at
                                          a
                   $50 for up to 10 years.                                                        least $50 for up to 10 years.a
 Graduated         Borrowers make smaller payments early in a                        Graduated Borrowers make fixed monthly repayments at two
                   repayment period, and larger payments later, within                         or more levels (usually a lower amount for the
                   certain limits (no repayment can be more than three                         early years of repayment and a larger amount in
                   times greater than any other). Repayment must occur                         the later years) over a period of time that varies
                   within 10 years.                                                            with the size of the loan and is the same as for the
                                                                                               FDLP extended repayment plan (see below).
                                                                                               Borrowers’ payments may not be less than the
                                                                                               interest due or less than 50 percent, or more than
                                                                                               150 percent, of the monthly repayment required
                                                                                               under the standard plan.
 Extended          Borrowers make fixed or graduated monthly                         Extended     Borrowers make fixed      Maximum term:
                   repayments of at least $50 for a period of time that                           monthly repayments of at
                   varies depending on the amount of the loan.                                    least $50 for a period of
                   Repayment must occur within 25 years. Extended                                 time that varies
                   repayment is limited to new borrowers on or after                              depending on the amount
                   October 7, 1998, who accumulate (after such date)                              of the loan:
                   outstanding loans totaling more than $30,000.                                  Amount:
                                                                                                  Less than
                                                                                                  $10,000…………………             12 years

                                                                                                  $10,000 to
                                                                                                  $19,999………                 15 years
                                                                                                  $20,000 to
                                                                                                  $39,999...…….              20 years
                                                                                                  $40,000 to
                                                                                                  $59,999……….
                                                                                                                             25 years
                                                                                                  $60,000 or
                                                                                                  more...………..               30 years
 Income-           Borrowers’ payment amounts may be adjusted                        Income-      Borrowers’ payment amounts are based on the
 sensitive         annually to reflect changes in a borrower’s income.               contingent   total amount of the borrower’s loan, income, and
                   Repayment plan is limited in the amount of                                     family size for a period up to 25 years. Under this
                   adjustment that can be made by statutory                                       repayment plan, borrowers repay based on annual
                   requirements that the loan be repaid within the 10-                            income for up to 25 years with any remaining
                   year maximum and that monthly repayments are, at a                             amount owed on the loan discharged at that time.
                   minimum, sufficient to cover interest.b
Sources: HEA, Congressional Research Service, and Education.




                                                               Page 29                                          GAO-04-101 Student Loan Programs
                                                               a
                                                                Because of the variable interest rate for nonconsolidation loans, the loan holder may adjust either the
                                                               size of the monthly repayment or the length of the repayment period annually. If the change in interest
                                                               rates would result in a borrower being unable to complete repayment within the 10-year maximum,
                                                               the loan holder may provide administrative forbearance for a maximum of 3 years (effectively
                                                               extending the repayment period).
                                                               b
                                                                FFELP regulations allow lenders some flexibility to extend repayment up to 15 years through
                                                               “administrative forbearance” to accommodate the variable interest rates and sensitivity to very low
                                                               incomes under this repayment plan.


                                                               Consolidation loan borrowers, like other FFELP and FDLP borrowers,
                                                               may choose among the four repayment plans offered under the programs.
                                                               Borrowers who consolidate under FFELP may—in addition to flexibility
                                                               offered by the repayment plans—extend their repayment periods up to
                                                               30 years by choosing a standard, graduated, or income-sensitive
                                                               repayment plan. Extending repayment periods, in general, will lower
                                                               borrowers’ monthly repayment amount. Table 5 compares the repayment
                                                               periods allowed by FFELP under consolidation with those allowed under
                                                               nonconsolidation.

Table 5: Comparison of Repayment Periods for FFELP Consolidation and Nonconsolidation Loans, by Repayment Plan

                      Maximum repayment period for nonconsolidation loans                           Maximum repayment period for consolidation loans
 Standard             Up to 10 years                                                                10-30 years
                                                                                                    depending on
                                                                                                    outstanding balance
                                                                                                    of loans:
                                                                                                    Amount
                                                                                                    Maximum period             10 years
                                                                                                    Less than $7,500...        12 years
                                                                                                    $7,500 to $9,999…… 15 years
                                                                                                    $10,000 to         20 years
                                                                                                    $$19,999…          25 years
                                                                                                    $20,000 to                 30 years
                                                                                                    $39,999…..
                                                                                                    $40,000 to
                                                                                                    $59,999…..
                                                                                                    $60,000 or
                                                                                                    more……..
 Graduated            Up to 10 years                                                                10-30 years depending on outstanding balance of loans
                                                                                                    (see above)
 Income-              Up to 10 years                                                                10-30 years depending on outstanding balance of loans
 sensitive                                                                                          (see above)
 Extendeda            Up to 25 years                                                                Up to 25 years
Sources: HEA, Congressional Research Service, and Education.




                                                               Page 30                                                      GAO-04-101 Student Loan Programs
                                                               a
                                                                Limited to borrowers who accumulate after October 7, 1998, outstanding loans totaling more than
                                                               $30,000.


                                                               Compared with FFELP borrowers, FDLP borrowers have more flexibility
                                                               to extend the repayment periods for FDLP loans without obtaining a
                                                               consolidation loan. Under the graduated and extended repayment plans,
                                                               for example, FDLP borrowers may obtain a repayment period of up to
                                                               30 years, regardless of whether they choose a consolidation loan or
                                                               nonconsolidation option. Table 6 shows the repayment periods available
                                                               for FDLP borrowers.

Table 6: Repayment Periods for FDLP Consolidation and Nonconsolidation Loans, by Repayment Plan

                                                                                     Maximum repayment period
 Standard                                                                            Up to 10 years
 Graduated                                                                           12–30 years depending on loan
                                                                                     amount:
                                                                                     Amount
                                                                                     Maximum period
                                                                                     Less than $10,000…..                       12 years
                                                                                     $10,000 to $19,999……                       15 years
                                                                                     $20,000 to $39,999……                       20 years
                                                                                     $40,000 to $59,999……                       25 years
                                                                                     $60,000 or more…....…                      30 years
 Extended                                                                            12–30 years depending on loan amount (see above)
 Income-contingent                                                                   Up to 25 years
Sources: HEA, Congressional Research Service, and Education.


                                                               While the options, outside of consolidation, allow some borrowers to
                                                               make single repayments on multiple loans and reduce their monthly
                                                               repayment amounts—thus achieving ends similar to consolidation loans—
                                                               not all borrowers can take advantage of these flexibilities. First, borrowers
                                                               who obtained FFELP loans from multiple lenders are still faced with
                                                               making multiple loan payments because lenders are only required to
                                                               combine borrowers’ repayments on the loans they make. Second,
                                                               borrowers may be required to meet certain eligibility criteria—such as
                                                               accumulating loans exceeding specified thresholds—to qualify for
                                                               extended repayment periods. Finally, borrowers who obtained loans under
                                                               multiple programs—FFELP, FDLP, or other programs—are also faced
                                                               with multiple payments and may or may not be able to obtain lower
                                                               monthly repayment amounts. Table 7 compares the extent to which
                                                               borrowers can combine multiple loan payments into one, lower monthly



                                                               Page 31                                                    GAO-04-101 Student Loan Programs
                                            repayment amounts, and extend repayment periods under consolidation
                                            and nonconsolidation options.

Table 7: Comparison of Borrowers’ Options under Consolidation and Nonconsolidation Loans

                                                                           Able to adjust monthly
                                                                           payments through
                                      Able to reduce to single             graduated or income-based             Able to extend the
 Composition of borrower’s loans      payment?                             approaches?                           repayment period?
 Consolidation loans
  FFELP                               Yes                                  Yes                                   Yes for all borrowers, with
                                                                                                                 length of period dependent on
                                                                                                                 loan balance.
  FDLP                                Yes                                  Yes                                   Yes for all borrowers, with
                                                                                                                 length of period dependent on
                                                                                                                 loan balance.
  Combination of FFELP and FDLP       Yes                                  Yes                                   Yes for all borrowers, with
 and/or other loansa                                                                                             length of period dependent on
                                                                                                                 loan balance.
 Nonconsolidation loans
  FFELP loans from a single lender    Yes                                   Yes                                  Yes, but only for borrowers
                                                                                                                 with loans totaling more than
                                                                                                                 $30,000.
  FFELP loans from multiple lenders   No                                    Yes                                  Yes, but only for borrowers
                                                                                                                 with loans totaling more than
                                                                                                                 $30,000.
  FDLP loans                          Yes                                   Yes                                  Yes for all borrowers, with
                                                                                                                 length of period dependent on
                                                                                                                 loan balance.
 Combination of FFELP and FDLP        No                                   Varies by type of loan                Varies by type of loan.
                   a
 and/or other loans
Source: GAO analysis.
                                            a
                                            Other federal student loans eligible for inclusion in a consolidation loan include Perkins loans, Health
                                            Professions Student loans, HEA loans, and Public Health Service Act Nursing Student Loans.



Available Options Involve                   Another key difference between consolidation loans and other repayment
Variable Interest Rates,                    options for nonconsolidation loans is that these other options carry a
While Consolidation Offers                  variable interest rate, while consolidation loans carry a fixed interest rate
                                            for the life of the loan. Depending on prevailing interest rates and
Currently Attractive Fixed                  borrowers’ expectations about future interest rates, this difference may
Rate                                        affect the decisions that borrowers make regarding whether to obtain a
                                            consolidation loan or use other options to combine payments, lower
                                            payments, and extend repayment periods. When interest rates are low, as
                                            they are now, and are expected to increase in the future, a consolidation



                                            Page 32                                                       GAO-04-101 Student Loan Programs
                            loan that carries a low fixed interest rate may be more attractive to
                            borrowers because a variable rate may exceed the fixed rate during most
                            or all of the remaining repayment period, which could be up to 30 years.
                            However, if rates are expected to decrease in the future, repayment
                            options that carry a variable rate may be more attractive, and borrowers
                            may choose other options over consolidation, hoping to take advantage of
                            lower rates in the future. Since it is difficult to predict interest rates over a
                            lengthy period, borrowers need to be aware of all the risks involved before
                            they make their final decision. Once student loans are consolidated, the
                            interest rate is fixed for the life of the loan and, under current law,
                            borrowers generally cannot reconsolidate their existing consolidation
                            loans to take advantage of lower interest rates. Consequently, borrowers
                            who chose to consolidate their student loans several years ago—and
                            locked in what are now high rates relative to what borrowers can now
                            obtain—are unable to take advantage of the current rate. For example,
                            borrowers who consolidated between February and June 1999, have a
                            locked rate of 8.25 percent.18 Borrowers who elected to consolidate
                            between July 2002 and June 2003 received a rate of 4 percent, and for
                            2004, the rate is expected to be about 3.5 percent.


Borrowers’ Choices          The choices that borrowers ultimately make will have consequences for
between Fixed or Variable   federal costs. As previously discussed, federal costs for FFELP
Rate Alternatives Affect    consolidation loans have recently increased because of the greater
                            difference between borrowers’ fixed low interest rate and the variable rate
Federal Costs               guaranteed to lenders, which is expected to increase in the future. In this
                            situation, were borrowers to choose an alternative option, costs to the
                            federal government would likely be less because a variable borrower rate
                            would increase along with the variable rate guaranteed to lenders and the
                            difference between the two rates would be less. This decreased difference
                            would result in decreased FFELP federal subsidy costs. If circumstances
                            were different, however, federal subsidy costs could increase. For
                            example, if borrowers obtained a consolidation loan with a fixed interest
                            rate at a time when rates were expected to decrease in the future, federal
                            subsidy costs would be lower, than is currently the case, because the
                            borrower rate would likely exceed the rate guaranteed to lenders, and the
                            federal government would not be required to pay a SAP. In such situations,
                            if borrowers were to choose an alternative option with variable borrower



                            18
                             This assumes that the underlying loans being consolidated were Stafford loans disbursed
                            between July 1995 and July 1998 and were in repayment at the time of consolidation.




                            Page 33                                             GAO-04-101 Student Loan Programs
                           rates, federal subsidy costs could increase because the borrower rate
                           would decline along with the variable rate guaranteed to lenders. In this
                           case, the decreased difference could result in increased FFELP federal
                           subsidy costs, if SAP payments became necessary.

                           Borrowers’ choices between fixed and variable rate loans and among
                           repayment periods also affect costs to the federal government associated
                           with FDLP loans. A significant driver of FDLP costs, as previously
                           discussed, is the difference between the discount rate and the borrower
                           rate. In general, higher borrower rates will result in Education receiving
                           larger interest payments from borrowers, thus decreasing federal costs.
                           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. For both programs, federal costs are also affected by the
                           repayment period chosen by borrowers. For example, longer FFELP
                           repayment periods can result in the federal government making special
                           allowance payments to lenders over a longer period of time. For FDLP,
                           longer repayment periods can increase the amount of interest borrowers
                           pay to Education on their loans and increase the amount of interest paid
                           by Education on the amounts borrowed from Treasury.


Proposed Legislation       Proposed legislation has been introduced in the 108th Congress that,
Concerning Consolidation   among other things, would replace the fixed borrower interest rate for
Loans Could Affect         consolidation loans with a variable interest rate, which will affect federal
                           costs associated with consolidation loans. In particular, the Student Loan
Federal Costs              Fairness Consolidation Act of 2003 (H.R. 2504) would eliminate provisions
                           that prevent borrowers who previously obtained a consolidation loan from
                           obtaining a new consolidation loan and replace the current fixed borrower
                           rate with a variable borrower rate for borrowers who refinance their
                           existing consolidation loans as well as for new consolidation loan
                           borrowers. 19 For example, borrowers who obtained a consolidation loan
                           in the past and are paying higher rates of interest would be provided the



                           19
                             Other proposed legislation includes the Consolidation Student Loan Flexibility Act of
                           2003 (H. R. 942) and the College Loan Assistance Act of 2003 (H.R. 2505). H.R. 942 would,
                           among other things, eliminate a requirement that borrowers certify to having sought and
                           been unable to obtain a consolidation loan from any holders of the outstanding loans the
                           borrower has selected for consolidation. Like H.R. 2504, H.R. 2505 would, among other
                           things, eliminate provisions that prevent borrowers who previously obtained a
                           consolidation loan from obtaining a new consolidation loan.




                           Page 34                                               GAO-04-101 Student Loan Programs
             opportunity to obtain a new consolidation loan at current (lower)
             borrower interest rates. In addition, in “re-consolidating” their loans, the
             proposed legislation would replace the current fixed borrower rate with a
             variable borrower rate. If enacted, the proposed legislation would affect
             federal costs due to the refinancing of previous consolidation loans and
             the change from fixed to variable borrower interest rates.


             Although additional options to consolidation are now available that give
Conclusion   some FFELP and FDLP borrowers opportunities to simplify loan
             repayment and reduce repayments to more manageable levels, not all
             borrowers qualify. As a result, many borrowers may find that
             consolidation loans remain the only option for combining loans and
             lowering their monthly repayments. While consolidation loans may thus
             remain 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 for FFELP consolidation
             loans. Providing for these larger interest subsidies on behalf of a broad
             spectrum of borrowers, however, 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. 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. 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 changes to,


             Page 35                                      GAO-04-101 Student Loan Programs
                     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.


                     We recommend that the Secretary of Education assess the advantages of
Recommendation for   consolidation loans for borrowers and the government in light of program
Executive Action     costs and identify options for reducing federal costs. Options 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. 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. If Education determines that statutory changes are needed to
                     implement more cost-effective repayment options, it should seek such
                     changes from Congress.


                     We provided a draft of this report to Education for review and comment.
Agency Comments      In commenting on the draft, Education agreed with our reported findings
                     and recommendation, noting that our work will contribute to the policy
                     discussions related to the reauthorization of the HEA. In addition,
                     Education noted that it was pleased with our conclusion that
                     consolidation loans have advantages for borrowers and may help them
                     avoid default and that improving flexible repayment options for borrowers
                     would provide several benefits. Education also provided technical
                     comments, which we incorporated where appropriate. Education’s written
                     comments appear in appendix I.


                     As agreed with your offices, unless you publicly announce its contents
                     earlier, we plan no further distribution of this report until 30 days from its
                     issue date. At that time we will send copies to the Secretary of Education
                     and other interested parties. We will also make copies available to others
                     upon request. In addition, the report will be available at no charge on
                     GAO’s Web site at http://www.gao.gov




                     Page 36                                       GAO-04-101 Student Loan Programs
If you or your staff have any questions or wish to discuss this material
further, please call me at (202) 512-8403, or Jeff Appel at (202) 512-9915.
Other contacts and staff acknowledgments are listed in appendix II.




Cornelia M. Ashby
Director, Education, Workforce,
 and Income Security Issues




Page 37                                       GAO-04-101 Student Loan Programs
                   Appendix I: Comments from the Department
Appendix I: Comments from the Department
                   of Education



of Education




         Page 38                                       GAO-04-101 Student Loan Programs
                  Appendix II: GAO Contacts and Staff
Appendix II: GAO Contacts and Staff
                  Acknowledgments



Acknowledgments

                  Jeff Appel (202) 512-9915
GAO Contacts      Susan Chin (206) 287-4827




                  In addition to those named above, Cindy Decker, Ben Jordan, Heather
Staff             Macleod, Corinna Nicolaou, Stan Stenersen, Vanessa Taylor, and Marcia
Acknowledgments   Carlsen made important contributions to this report.




(130269)
                  Page 39                                   GAO-04-101 Student Loan Programs
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