oversight

Consolidated Student Loans: Borrowers Benefit but Costs to Them and the Government Grow

Published by the Government Accountability Office on 1990-06-15.

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

                        CONSOLIDATED
                        STUDENT LOANS
                        Borrowers Benefit but
                        Costs to Them and the
                        Government Grow

                                                  d


                                       IIlllIII
                                            IIllll
                                         141607




_l___.__-_ ---_---.--         -----
(;/lo   /‘111l1b90-H
Human Resources Division

I%204708

June 15,199O

The Honorable Edward M. Kennedy
Chairman, Committee on Labor and
   Human Resources
IJnited States Senate

The Honorable Augustus F. Hawkins
Chairman, Committee on Education
  and Labor
House of Representatives

In response to the requirements of the Higher Education Amendments of 1986, this report
addresses the impact of the student loan consolidation program.

We found that the program has benefited borrowers by reducing their monthly payments,
thereby easing their repayment burden. However, because consolidated borrowers have
longer repayment periods, their total interest costs are higher. In addition, the government’s
interest subsidy payments to lenders increase primarily because of the longer repayment
periods, This report contains several options for the Congress to consider for changing the
program to reduce the government’s costs.

We are sending copies of this report to the Secretary of Education, appropriate congressional
committees, and other interested parties.

This report was prepared under my direction, and I can be reached on (202) 275-1793 if you
have any questions, Other major contributors are listed in appendix X.




Franklin Frazier
Director, Education and
   Employment Issues
                                                                                     I
Executive Summary


             During the 1980s student-loan debt burden grew steadily as the cost of
Purpose      a postsecondary education increased. Annual student loan default costs
             also increased from $235 million in fiscal year 1981 to nearly $1.4 bil-
             lion in 1986. The Congress established the student loan consolidation
             program in 1986 to respond to this rise in debt burden and default costs.
             Under this program, borrowers can refinance loans received from a vari-
             ety of lenders and loan programs. Typically, the monthly payments are
             lower after consolidation than they would be in aggregate for borrowers
             with multiple loans. The Congress’s intent was to reduce borrowers’
             monthly payments so as to help decrease federal loan default costs.

             The program will end in fiscal year 1992 unless reauthorized by the
             Congress. GAO is required to evaluate this program by the Higher Educa-
             tion Amendments of 1986. To do so, GAO examined the possible cost
             effects the consolidation program is having on borrowers, defaults, and
             government interest subsidies.


             Student borrowers must have a minimum of $5,000 in eligible student
Background   loan debt in order to consolidate their loans. Depending on the total
             amount owed, students are allowed from 10 to 26 years to repay a con-
             solidated loan. The interest rate charged on consolidated loans is set by
             law at the higher of 9 percent or a weighted average of the interest rates
             on loans being consolidated (rounded to the nearest whole percentage
             rate). In addition, unlike the bulk of the original underlying loans, bor-
             rowers pay no loan origination fee for consolidated loans. For example,
             the Stafford Student Loan Program carries a 5-percent up-front fee,
             payable to the federal government, to help offset government program
             costs. Such a one-time fee is not uncommon when a borrower refinances
             a consumer loan.

             About 63,000 borrowers consolidated approximately $905 million in stu-
             dent loans between October 1986-when the program began-and Sep-
             tember 30, 1988. These consolidations are insured against losses by state
             and private nonprofit guaranty agencies; these agencies, in turn, are
             reinsured by the Department of Education.

             GAO gathered information   on participating lenders and their loan portfo-
             lios from the guaranty agencies and the Department of Education. GAO
             also analyzed the consolidated loan portfolios of 36 lenders who held
             about $790 million, or about 87 percent, of all consolidated loans made
             by September 30, 1988. GAO discounted the stream of future payments
             (costs) into present value terms. This allows comparisons of costs


             Page 2                                  GAO/HRD-90-S Consolidated Student Loarm
                           Executive Summary




                           incurred in different time periods. Cited cost projections are given in
                           both present value and as the simple sum of payments (undiscounted).


                           The loan consolidation program has been successful in reducing borrow-
Results in Brief           ers’ monthly payments, thereby easing their payment burden. However,
                           borrowers’ lower payments and longer repayment terms are offset by
                           higher interest costs because of the extended repayment lengths of their
                           loans. In addition, borrowers who consolidated their loans have rarely
                           defaulted-only     107 of 63,000 such borrowers defaulted through Sep-
                           tember 1988. However, it is too early to assess the overall impact on
                           default reduction because the program had been in existence less than 2
                           years and some of those borrowers that consolidated may yet default.

                           Loan consolidation has resulted in, and will probably continue to result
                           in, larger government interest subsidies than would have resulted had
                           the underlying loans remained unconsolidated. GAO estimates that for
                           those loans consolidated for the 36 lenders, as of September 30, 1988,
                           the government’s subsidy costs could be $7.5 million higher ($48 million
                           undiscounted) than had the same loans gone unconsolidated. However,
                           any default avoidance resulting from this program could help offset
                           these increased costs, GAO also projects that the additional costs for
                           loans consolidated through 1994-assuming that the program is
                           reauthorized-may     be $365 million ($860 million undiscounted). The
                           Congress, therefore, in the future, may want to consider changes to the
                           program to help defray or avoid part or all of these additional costs as
                           the program continues to grow.



Principal Findings

Consolidated Borrower 'S   The longer repayment terms of consolidated loans make it easier for bor-
Have Lower Monthly         rowers to repay their student loans by reducing their monthly pay-
                           ments, but consolidation also increases their total interest costs. For
Payments but Higher        example, a borrower owing $10,000 could pay about $101 a month after
Interest Costs             consolidating his or her loan, compared with about $12 1 a month he or
                           she was paying for a number of individual loans with the same total
                           value. However, this borrower’s total interest payments will be higher
                           over the 15-year life of the consolidated loan, increasing from $3,419
                           ($4,559 undiscounted) if the loans were not consolidated to $5,371
                           ($8,257 undiscounted) if they were.


                           page3                                   GAO/HRD-SO-8 Consolidated Student Loans
                               ExecutiveSummary




Few Consolidated               As of September 1988, only 107 of the approximately 63,000 consoli-
Borrowers Had Defaulted        dated borrowers had defaulted, at a cost of about $1.4 million. It is diffi-
                               cult to estimate just how many of those consolidated borrowers who are
on Their Loans                 now repaying their loans might have defaulted if there was no consoli-
                               dation program. It is too early to assess the overall impact on default
                               reduction as a result of this program. The program had been in existence
                               less than 2 years and for the loans GAO analyzed, some of those borrow-
                               ers who consolidated might default in subsequent years.


Consolidation Results in       Students in federally guaranteed loan programs generally receive loans
Increased Subsidy Costs        from lenders at below-market rates of interest (statutorily-set). Lenders
                               receive a special allowance payment (or interest subsidy) from the gov-
                               ernment to bring their yields more in line with market rates charged on
                               other kinds of consumer loans. However, these interest subsidy pay-
                               ments are higher when consolidated for three reasons:

                           9 The maximum repayment period for unconsolidated loans is 10 years,
                             but the government pays subsidies for a longer period-up to 25
                             years-for consolidated loans. (See p. 23.)
                           . The government also subsidizes certain loans that were unsubsidized
                             before consolidation. (See p. 24.)
                           l Higher subsidy costs under consolidation are associated with graduated
                             loan repayments. (See p. 26.)

                               For the consolidated loans GAO analyzed, these factors could increase
                               program costs by as much as $7.6 million ($48 million undiscounted)
                               over the repayment life of these loans. More important, these costs are
                               for loans consolidated only through fiscal year 1988. Subsequent loans
                               will increase the program cost further. For example, the Department of
                               Education estimates that another $6.6 billion in loans may be consoli-
                               dated during fiscal years 1989-94. If this growth does occur and these
                               future loans have characteristics that are, on average, similar to those
                               GAO analyzed, the possible increase in interest subsidy costs may be
                               another $365 million ($860 million undiscounted). (See p. 27.)

                               These increased interest subsidy costs could be reduced if legislative
                               provisions similar to those enacted by the Consolidated Omnibus Budget
                               Reconciliation Act of 1986 for consolidated loans were still in effect. At
                               that time, the interest rate was the higher of 10 percent or the highest
                               rate of the loans being consolidated; the special allowance payment fac-
                               tor, at 3 percent, was one-quarter of 1 percent lower. If these provisions
                               were now in effect, the government’s subsidy costs would be negated. In


                               Page 4                                   GAO/HRD90-8 Consolidated Student Loans
                       Executive Summary




                       addition, charging consolidated borrowers an origination or refinancing
                       fee would also raise revenue to help offset program costs.


                       GAO has identified four options that the Congress may wish to consider
Matters for            in its deliberations. These options should be considered in relationship to
Consideration by the   how much this program may reduce loan defaults, The first option
Congress               would be to let the program expire in 1992, as currently authorized, or
                       rescind its authority before that time. The other three would better bal-
                       ance the benefits available to borrowers who wish to consolidate their
                       student loans, but these options would reduce the additional interest
                       subsidy costs to the government while it continues to operate the pro-
                       gram (see p. 35). Program participation by lenders and borrowers may
                       be affected with the enactment of these options because they either
                       increase the costs to borrowers or reduce lender profits. Although pro-
                       gram cost impacts have been estimated, no data existed, at the time of
                       GAO'S review, for estimates of possible changes in participation rates.


                       The Department of Education and four of the five lenders providing
AgerICYConments        data for GAO'S review provided written comments on a draft of this
                       report (see apps. VIII and IX). The Department stated that GAO had
                       presented the Congress with several good options to consider. The lend-
                       ers generally stated that more data were needed to determine the impact
                       of the program on loan defaults and on reducing default costs. While
                       GAO does not disagree with the lenders’ views, it made its analyses with
                       the data that were available, and it recognizes in the report the limita-
                       tions of its evaluations. In addition, GAO incorporated in the report tech-
                       nical comments offered by the lenders.




                       Page 5                                  GAO/HRD-SO-8 Consolidated Student Loans
Conntents


Executive Summary                                                                                 2

Chapter 1                                                                                        10
Introduction           Loan Consolidation Program
                       Objectives, Scope, and Methodology
                                                                                                 10
                                                                                                 13

Chapter 2                                                                                        16
Borrowers Have         Reduced Monthly Payments Possible
                       Longer Repayment Periods Mean Higher Interest Costs
                                                                                                 16
                                                                                                 17
Lower Monthly          Few Defaults Have Occurred                                                18
Payments and Higher    Conclusions                                                               19
Interest Costs-Few     Agency Comments and Our Evaluation                                        20
Default
Chapter 3                                                                                        22
Government’s Subsidy   Government’s Subsidy Costs Will Be Greater
                       Consolidating New Stafford Loans Could Greatly Increase
                                                                                                 22
                                                                                                 26
Costs Will Increase        Subsidy Costs
                       Consolidation Program Growth Could Cause Additional                       27
                           Cost Increases
                       Program Costs Also Sensitive to Fluctuations in Treasury                  29
                           Bill Rates
                       What Can Be Done to Reduce the Government’s Costs                         30
                           While Preserving the Program’s Benefits?
                       Conclusions                                                               34
                       Matters for Consideration by the Congress                                 36
                       Agency Comments and Our Evaluation                                        36

Appendixes             Appendix I: Cumulative Consolidated Student Loans and                     40
                           Defaults (as of Sept. 30, 1988)
                       Appendix II: Lenders Included in GAO Analysis                             41
                       Appendix III: Methodology Used to Estimate Consolidated                   42
                           Loan Program Costs
                       Appendix IV: Underlying Loans Consolidated at Lenders                     46
                           Reviewed (as of Sept. 30,1988)
                       Appendix V: Decrease in Future Subsidy Costs by                           46
                           Increasing Borrowers’ Minimum Interest Rates




                       Page 6                                GAO/HRD-90-S Consolidated Student Loans
                       Contents




                       Appendix VI: Amount of Revenue Raised by Charging                           47
                           Various Loan Origination Fees to Offset Additional
                           Future Interest Subsidy Costs
                       Appendix VII: Decrease in Future Subsidy Costs by                           48
                           Lowering Special Allowance Payments to Lenders
                       Appendix VIII: Comments From the Department of                              49
                           Education
                       Appendix IX: Comments From the Lenders                                      50
                       Appendix X: Major Contributors to This Report                               62

Related GAO Products                                                                               64

Tables                 Table 1.1: Repayment Terms for a g-Percent Consolidated                     11
                           Loan
                       Table 1.2: An Illustration of How the Special Allowance                     12
                           Payment Is Calculated
                       Table 1.3: Lenders’ Consolidated Loan Portfolios                            13
                           Guaranteed (as of Sept. 30, 1988)
                       Table 2.1: Monthly Payments for Consolidated Loans Are                      16
                           Generally Lower
                       Table 2.2: Graduated Repayment Plans Reduce Monthly                         17
                           Payments for a $15,000 Consolidated Loan
                       Table 2.3: Total Interest Costs Higher for Consolidated                     18
                           Loans
                       Table 2.4: Borrowers Who Consolidate Attend Different                       19
                           Schools for Longer Periods Than Most Defaulters
                       Table 3.1: Subsidy Costs Increase as Loan Volume Grows                      29
                       Table 3.2: Selected Legislative Factors That Influence the                  31
                           Cost of the Loan Consolidation Program
                       Table 3.3: A lo-Percent Loan Interest Rate Could Cover                      32
                           Future Program Costs (Present Value Costs)
                       Table 3.4: A 5-Percent Origination Fee Would Cover Most                     33
                           of the Estimated Future Incremental Program Costs
                           (Present Value Costs)
                       Table 3.5: Decreasing the Special Allowance Rate to                         33
                           3 Percent Covers Less Than Half of the Program’s
                           Estimated Future Present Value Costs




                       Page 7                                  GAO/HRD-90-8 Consolidated Student Loans
          Contents




Figures   Figure 3.1: Volume of Loans Consolidated by Repayment                    24
               Term
          Figure 3.2: Which Student Loans Are Eligible for Federal                  25
               Subsidy?
          Figure 3.3: Estimated Future Growth of the Consolidation                  28
               Program
          Figure 3.4: Subsidy Costs Increase With Higher Treasury                  30
               Bill Rates




          Abbreviations

          AUAS       Auxiliary Loans to Assist Students
          CBO        Congressional Budget Office
          COBRA      Consolidated Omnibus Budget Reconciliation Act
          GAO        General Accounting Office
          HEAF       Higher Education Assistance Foundation
          NELLIE
            MAE      New England Education Loan Marketing Corporation
          SALLIE
            MAE      Student Loan Marketing Association
          SIS        Supplemental Loans for Students
          IJSAF      United Student Aid Funds, Inc.


          Page 8                                 GAO/HRLWO-8 Consolidated Student Loans
Page 9   GAO/HRD-90-8 Chwolidated   Student Loans
Chapter 1

Introduction


                     Steadily escalating postsecondary education costs in the 1980s have, in
                     part, led to a growing number of students who accumulate large student
                     loan debt by obtaining more federally guaranteed and subsidized loans.
                     This growth has been accompanied by an increasing number of loan
                     defaults, especially on loans issued under the Guaranteed Student Loan
                     Program. 1As loan volume increased to over $12 billion in fiscal year
                     1989, defaults on these kinds of loans rose from about $235 million, in
                     fiscal year 1981; to about $1.4 billion, in fiscal year 1986; to almost $2
                     billion, in fiscal year 1989.

                     In 1986, to help students deal with the higher costs of loan repayments
                     and to help reduce defaults on federally guaranteed student loans, the
                     Congress established a loan consolidation program. Under this program,
                     instead of making concurrent payments on several loans over a period
                     usually limited to 10 years, students can consolidate these loans and
                     make smaller monthly payments over 10 to 25 years, depending on the
                     size of the consolidated loan. The program was authorized for 6 years,
                     through fiscal year 1992.

                     Section 1314 of the Higher Education Amendments of 1986 requires GAO
                     to evaluate the loan consolidation program. This report is in response to
                     that mandate.


                     Students who graduate, or otherwise leave school with a number of
Loan Consolidation   loans, can be faced with sizeable combined monthly payments. Each
Program              loan borrowed under a federal student loan program typically requires
                     minimum payments of $50 a month, with a maximum repayment term
                     of 10 years.

                     The consolidation program was established to provide a means to help
                     student borrowers reduce their monthly payments. The program was
                     authorized by the Consolidated Omnibus Budget Reconciliation Act
                     (,co~tl\) of 1985 (P.L. 99-272) as amended by the Higher Education
                     Amendments of 1986 (P.L. 99-498) and the Higher Education Technical
                     Amendments Act of 1987 (P.L. 100-50). The program allows a student to
                     combine multiple loans into a single loan, make one monthly payment,
                     and, in most cases, repay the loan over a longer period.

                     To be eligible for a consolidated loan, a borrower must owe at least
                     $5,000 in eligible student loans. These loans include
                     -
                     ’ F:ffective .July 1, 1938, this program was renamed the Stafford Student Loan Program.



                     Page 10                                               GAO/HRD-90-8 Consolidated Student Loans
                                       Chapter 1
                                       Introduction




                                   . “regular” guaranteed student loans, now called Stafford student loans;z
                                   l Perkins loans (formerly called National Direct Student Loans);
                                   . Federally Insured Student Loans;
                                   . Supplemental Loans for Students (SLS);
                                   l Auxiliary Loans to Assist Students (ALAS); and
                                   . health professions student loans.

                                       In addition, a borrower can neither be in default nor be over 90 days
                                       delinquent on any loan being consolidated.

                                       The interest rates charged student borrowers on these loans vary. For
                                       example, Perkins loan borrowers pay an interest rate of 5 percent; YLS
                                       borrowers pay a market rate of interest, 10.45 percent for calendar year
                                       1989. In comparison, interest rates on consolidated loans are set at
                                       9 percent or at the weighted average of the interest rates on the loans
                                       being consolidated (rounded to the nearest whole percent), whichever is
                                       higher.

                                       In many instances, the interest rate charged student borrowers is less
                                       than the rates lenders could charge for consumer credit activities, such
                                       as personal loans or credit cards. The federal government compensates
                                       lenders with an interest subsidy to bring lenders’ rates of return more in
                                       line with market rates.

                                       The size of the consolidation loan determines the repayment term. This
                                       is illustrated in table 1.1 for a g-percent loan.

Table 1.1: Repayment Terme for a
9-Percent Consolidated Loan                                                                  Maximum repayment                      Monthly
                                       Loan
                                       -...~----amount           -___                             terms (in years)           payment  range
                                                                                                                                  ---__.-
                                       55,000.7,499
                                       ---------                        .-___                                   IO                 $63-595
                                       7,500-9,999
                                       -..--.---...-           ____----._______                ..--..                   12   .___--   85-114
                                       10,000-19,999
                                       ---_------...                                                     -~~--.-..--...-15           101-203
                                                                                                                                     -.._ --
                                       20.000-44,999                                                                    20           180-405
                                       45,000 or more                                                                   25        378 or more


                                       The 1986 amendments also allow borrowers with consolidated loans to
                                       establish graduated or income sensitive repayment schedules with their
                                       lenders. Graduated repayment plans reduce borrowers’ monthly pay-
                                       ments during the early years of repayment by allowing them to make

                                       “For this report, we refer to loans issued on or after July 1, 1988, as “Stafford loans” and loans issued
                                       before that date as “regular” guaranteed student loans.



                                       Page 11                                                 GAO/HRB90-8 Consolidated Student Loans
                                                                                                                   .
                                        Chapter 1
                                        Introduction




          ---
                                        only interest payments and offset these with higher subsequent pay-
                                        ments. In level payment plans, on the other hand, borrowers make the
                                        same monthly payments for the duration of a loan.

                                                                                                  ~~~
Federal Guarantees and                  Borrowers may obtain consolidated loans from a variety of participating
Subsidies                               lenders, including commercial banks, savings and loan associations, and
                                        credit unions. Guaranty agencies, which administer the program at the
                                        state level for the Department of Education, insure these loans by agree-
                                        ing to repay lenders if borrowers fail to do so because of death, disabil-
                                        ity, bankruptcy, or default. The Department, in turn, reimburses
                                        guaranty agencies for these repayments.

                                        The amount of interest subsidy the Department pays-to assure that
                                        consolidated loans provide lenders with close to market rates of
                                        return-can     vary. This subsidy, which is paid quarterly, is called a
                                        “special allowance payment.” The amount of this subsidy is based on a
                                        formula specified in the law. The formula establishes the student’s inter-
                                        est rate as a floor, but allows lenders to receive higher returns on these
                                        loans if market interest rates go above a certain level. The formula does
                                        this by adding 3.25 percent to the average 91-day Treasury bill rate and
                                        then subtracting the loan’s interest rate. For example, if the average
                                        91-day Treasury bill rate was 6.75 percent and the loan interest rate
                                        was 9 percent, the formula would provide an annual subsidy rate of 1.00
                                        percent, as shown in table 1.2. Because lenders receive this payment
                                        quarterly, the subsidy for an annual rate of 1.00 percent would be 0.25
                                        percent (1.00 percent divided by 4).

Table 1.2: An Illustration of How the
Special Allowance Payment Is            Factor                                                                   Percent
                                                                            -.-
Calculated                              Average 91-day Treasury bill rate                                             6.75
                                                                                       -___
                                        Subsidv rate                                                               + 3.25
                                        Market rate of return...--...--                                             10.00
                                        i-ban interest rate                          ____-...__                     - 9.00
                                        Annual subsidv factor                                                         1.00


                                        When Treasury bill rates drop to 5.75 percent or lower, the government
                                        discontinues paying subsidies for g-percent consolidated loans. During
                                        the first 2 years of the loan consolidation program, October 1986 to Sep-
                                        tember 1988, the average 91-day Treasury bill rates ranged from 5.5
                                        percent to 7.2 percent.




                                        Page 12                                   GAO/HRD-90-8 Consolidated Student Loans
                                         chapter 1
                                         Introduction




                                         To help offset its costs for defaults and interest subsidies, the Depart-
                                         ment of Education receives a S-percent loan origination fee, paid by bor-
                                         rowers, for Stafford loans. However, the consolidation program
                                         specifically prohibits the borrower from paying such a fee.


Growth of the Program                    The total amount of loans consolidated under this program increased
                                         from $263 million, as of September 30, 1987, to $905 million, as of Sep
                                         tember 30, 1988, a 244-percent increase. As shown in table 1.3, only 249
                                         lenders, of over 13,000 lenders that participate in federal student loan
                                         programs, held consolidated loans as of the end of fiscal year 1988.
                                         (This figure may double-count lenders who have consolidated loans
                                         guaranteed by more than one guaranty agency.) However, the 10 lend-
                                         ers with the largest consolidated loan portfolios held about $793 million,
                                         or about 88 percent, of these loans.

Table 1.3: Lenders’ Consolidated Loan
$t$lios    Guaranteed (as of Sept. 30,                                                          Consolidated loans
                                                                                                  Amount
                                         Portfolio rize               Lenders      Loans      (in millions)     Percent
                                         $15,000,000 or more                4      49,639     .     $736.4          81.4
                                         $10,000,000t0 514,999,999          2       2,371             28.5           3.2
                                         $5000.000 to $9.999.999            4       2.324             28.3           3.1
                                         5 1,000,000 to 5 4,999,999        37       6,406             80.8           8.9
                                         Less than $l,OOO,OOO             202       2,486             30.5           3.4
                                         Total                            249     63.226           $904.5          100.0




                                         The 1986 amendments required that we evaluate the loan consolidation
Objectives, Scope,and                    program. In subsequent discussions with the Subcommittee on Educa-
Methodology                              tion, Arts, and the Humanities, Senate Committee on Labor and Human
                                         Resources, and the Subcommittee on Postsecondary Education, House
                                         Committee on Education and Labor, we agreed to examine the observed
                                         or potential effect of this program on (1) borrowers, (2) defaults costs,
                                         and (3) the interest subsidy costs to the government.

                                         We obtained statistics on the consolidation program, as of the end of
                                         fiscal year 1988, from the Department. We held discussions with Depart-
                                         ment officials responsible for program policy, administration, and moni-
                                         toring. We reviewed the legislation and regulations, as well as the
                                         Department’s policy and procedural guidelines for the loan consolidation
                                         program. We subsequently discussed the results of our work with
                                         Department officials.


                                         Page 18                                 GAO/HRD-90-S Consolidated Student Loans
    Chapter 1
    Introduction




    To develop nationwide information on the current program, we sent a
    data collection instrument to representatives of the 47 state and private
    nonprofit guaranty agencies, which either guarantee or service consoli-
    dated loans for the 50 states, the District of Columbia, Puerto Rico, the
    Virgin Islands, and the Pacific Islands. Agencies were to provide data, as
    of September 30, 1988, on the number and value of (1) consolidated
    loans they guaranteed and (2) defaulted consolidated loans. We asked
    the agencies to provide these data for each lender. All guaranty agencies
    responded, although not all agencies had guaranteed such loans. Appen-
    dix I summarizes these results.

    We evaluated the program’s effect on borrowers and the government by
    obtaining data from five lenders we judgmentally selected, based on the
    size of their consolidated loan portfolios and on the availability of loan
    data in their computerized data systems. The five were

l   Student Loan Marketing Association, Washington, D.C.;
l   Citibank Corporation, Rochester, New York;
l   New England Education Loan Marketing Corporation, Braintree,
    Massachusetts;
l   Virginia Education Loan Authority, Richmond, Virginia; and
l   Pennsylvania Higher Education Assistance Agency, Harrisburg,
    Pennsylvania.

    In addition to information on its own loan portfolio, the Pennsylvania
    agency provided us with data on 31 other lenders whose consolidated
    loans it services (bills and collects from the borrowers). These additional
    lenders brought the total number of lenders we reviewed to 36. In all,
    these 36 lenders held approximately $790 million, or about 87 percent,
    of the $905 million in consolidated loans guaranteed as of the end of
    fiscal year 1988. Appendix II lists the 36 lenders.

    We measured the effect of the program on the government by (1) esti-
    mating the subsidies that the Department of Education would pay for
    students’ consolidated loans, held in the 36 lenders’ portfolios, and
    (2) comparing this with the estimate of the subsidies the Department
    would pay if these loans had remained unconsolidated. This permitted
    us to estimate the incremental costs of the program. When estimating
    future program costs, we discounted the stream of future payments
    (costs) into present value terms. This allows comparisons of costs
    incurred in different time periods. As a result, our cost projections are
    given in both present value and as the simple sum of payments-
    referred to in this report as undiscounted. Because the special allowance


    Page 14                                  GAO/HRD-90-8 Consolidated Student Loans
Chapter 1
Introduction




payment is tied directly to the Treasury bill rate and influences the fed-
eral cost of the program, we also analyzed the sensitivity of this pay-
ment to changes in Treasury bill rates; this enabled us to determine how
fluctuations in these rates could affect expected government subsidy
costs. Appendix III contains a detailed description of the methodology
we used to estimate these future interest subsidy costs.

There was no practical way by which we could estimate how many of
the consolidated borrowers who are repaying their loans might have
defaulted had there been no program. In addition, because the lenders
had insufficient information on certain characteristics (such as students’
courses of study or the length of school enrollments) of borrowers, we
were unable to develop a profile of borrowers participating in the pro-
gram. However, we obtained information from a guaranty agency on
what it found on the attributes of consolidated borrowers; we then com-
pared this information with information found during our previous
review of student loan defaults.” We also obtained the views of lender
and guaranty agency officials on what they believed was the impact of
this program on default reduction.

Our field work was carried out from June 1988 through May 1989. Our
review was conducted in accordance with generally accepted govern-
ment auditing standards.




“Defaulted Student Loans: Preliminary Analysis of Student Loan Borrowers and Defaulters (GAO/
ImD-8%llZBR, June 14,1988).



Page 16                                             GAO/HRD-90-8 Consolidated Student Loans
Chapter 2

Borrowers Have Lower Monthly Payments and
Higher Interest Costs-Few Default

                                         The loan consolidation program was established for two principal rea-
                                         sons. One was to help student loan borrowers cope with their large stu-
                                         dent loan debts. The other was to reduce the government’s costs by
                                         limiting loan defaults. It was believed that lower monthly payments
                                         available through the consolidated loan program would help borrowers
                                         avoid default, in turn benefiting the government through lower default
                                         costs on federally guaranteed loans.

                                         We found the program helps borrowers reduce their monthly payments,
                                         but it can also increase the interest borrowers may pay over the life of
                                         their loans. It is less clear, however, how significantly the program will
                                         reduce student loan default costs. Although borrowers with only 107 of
                                         63,000 consolidated loans have defaulted during the first 2 years of the
                                         program, we were unable to determine whether that number would have
                                         been different had there been no program. However, it is too early to
                                         assess the overall impact on default reduction.


                                         While consolidated loans have repayment terms of 10 to 25 years
Reduced Monthly                          (depending on the amount borrowed), unconsolidated loans (which are
Payments Possible                        referred to as the underlying loans) have maximum repayment terms of
                                         up to 10 years, regardless of the loan amount. In general, the larger the
                                         amount consolidated, the longer a borrower has to repay and the greater
                                         the benefit in terms of reduced monthly payments. The monthly pay-
                                         ments for consolidated (at 9 percent interest) and underlying (at 8 per-
                                         cent interest) loans, ranging from $5,000 to $45,000, are shown in table
                                         2.1. As shown, borrowers who consolidate $7,500 or more benefit in
                                         terms of reduced monthly payments, with those having the longest
                                         repayment terms receiving the greatest reduction in monthly payments.
                                         (The monthly payment amounts shown would repay the loan amounts
                                         over the full life-repayment    length-of the loans.)

Table 2.1: Monthly Payments for
Consolidated Loans Are Generally Lower                          Consolidated
                                                              payment length             Loan monthly payment             Increase/
                                         Amount                    (in- years)          Underlying   Consolidated         decrease
                                         $5,000                                  10          $60.66 --         $63.34               $2.68
                                         7,500                                   12
                                                              --..-. --..---.---_____         91.00
                                                                                          _--.-..-~-     ..-_-. 85.35          --. -5.65
                                         10,000                                  15          121.33            101.43    ~--     -19.90
                                         20,000
                                         ___--..   -.-                           20          242.66            179.95
                                                                                                                  _____--~       -62.71
                                         45,000                                  25          545.97            377.64          -168.33




                                         Page 16                                          GAO/HRD-90-S Consolidated Student Loans
                                        Chapter 2
                                        Borrowers Have Lower Monthly Payments
                                        and Higher Interest Costs-Few Default




                                        In the portfolios of the 36 lenders we reviewed, 83 percent of the consol-
                                        idated loans were for $10,000 or more.


Graduated Repayment                     Graduated repayment plans reduce a borrower’s monthly payments dur-
Further ReducesMonthly                  ing the early years of repayment by allowing the borrower to make only
                                        interest payments. For example, under a 4-year graduated repayment
Payments                                plan, a borrower pays only interest for the first 4 years and then pays
                                        principal and interest for the remaining term. During the first 4 years
                                        under a 4-year graduated repayment plan, as shown in table 2.2, a bor-
                                        rower with a $15,000 consolidated loan (at 9 percent) will have a
                                        smaller monthly payment ($113 versus $152) and will pay $39 less a
                                        month than under a level payment plan, in which the monthly payment
                                        is the same throughout the repayment period. On the other hand, the
                                        borrower’s payments for the 5th through 15th years will be higher than
                                        they would have been under a level payment plan.

Table 2.2: Graduated Repayment Plans
Reduce Monthly Payments for a $15,000                                                   Monthly payment amount for
Consolidated Loan                                                               Level               P-year            4-year
                                        Repayment
                                        .---.--..- years                         plan      graduated plan    graduated plan
                                        land2       ~-                          $152                  $113                $113
                                        3and4                                    152                   163                 113
                                        5to15                                    152                   163                 179


                                        All but 1 of the 36 lenders we reviewed offer graduated repayment
                                        plans to borrowers who consolidated their loans. Of the approximately
                                        53,000 consolidated loans held by these 35 lenders, about 40,000 (75
                                        percent) were being repaid under a graduated repayment plan. Only 1 of
                                        these 35 lenders said it offered graduated repayment plans for unconsol-
                                        idated loans.


                                        Borrowers who consolidate their student loans generally pay more in
Longer Repayment                        interest over the repayment life of the consolidated loan, and they must
Periods Mean Higher                     balance this additional cost with the benefits that they perceive accrue
Interest Costs                          to them. For example, borrowers are able to reduce their monthly pay-
                                        ments for their student loan debt; this allows them to use their current
                                        dollars for other purposes, including the payment of other consumer
                                        debts (such as credit cards), which have higher interest rates.

                                        Because consolidated loans generally have longer repayment periods,
                                        their principal balances outstanding remain higher for a longer period.


                                        Page 17                                         GAO/HRD9043 Consolidated Student Loans
                                             Chapter 2
                                             Borrowers Have Lower Monthly Payments
                                             and Higher Interest Costs-Few Default




                                             As a result, a borrower’s total interest costs will increase. The total
                                             undiscounted interest that a borrower would pay on a consolidated loan
                                             (at 9 percent) and an unconsolidated loan (at 8 percent), for debts rang-
                                             ing from $5,000 to $45,000, are shown in table 2.3. The interest costs are
                                             higher for consolidated loans for each loan amount, and the difference is
                                             more significant as the loan amount increases. For example, the total
                                             interest for a $45,000 loan is nearly $18,000 higher in present value
                                             terms ($47,775 undiscounted) primarily because the (1) interest rate is
                                             higher and (2) repayment period has been extended from 10 to 25 years.

Table 2.3: Total Interest Costs Higher for
Consolidated Loans                                                               Borrowers’s total loan interest
                                             Amount of student
                                                       -_____ debt              Unconsolidated         Consolidated     Increase
                                             $5.000                                      $2,280               52,601         $321
                                             7,500
                                             --_-.                                        3,419                4,791        1,372
                                             10,000
                                             ~--.                                         4,559                8,257        3,698
                                                                                                                            --
                                             20.000
                                             -l--.
                                                                                          9.119               23.187       14.068
                                             45,000                                      20,517               681292       47,775




Graduated Repayments                         Graduated repayment plans can further increase a borrower’s total
Increase Interest Costs                      interest costs. These plans cause a higher principal amount to remain
                                             outstanding for longer periods, resulting in additional costs for the bor-
                                             rower. For example, a borrower with a $10,000 consolidated loan repaid
                                             over 15 years will pay $653 ($1,131 undiscounted) more in interest
                                             under a 4-year graduated repayment plan than under a level payment
                                             plan ($6,024 versus $5,371 discounted). If that same borrower had a 2-
                                             year graduated plan, the increased interest cost would be $322 ($552
                                             undiscounted).


                                             We were unable to determine how many borrowers who had consoli-
Few Defaults Have                            dated their loans might have defaulted had there been no such program.
Occurred                                     We did, however, determine from information obtained from the guar-
                                             anty agencies that borrowers with only 107 of the approximately 63,000
                                             consolidated loans, representing about $1.4 million of the $905 million
                                             consolidated loans, had defaulted through September 1988.

                                             We also identified data indicating that borrowers who consolidated their
                                             loans have different characteristics than most loan defaulters. In June
                                              1988, we reported that, overall, 35 percent of vocational students
                                             defaulted on their loans in contrast to 12 percent of the students who



                                             Page 18                                      GAO/HRD-9044 Consolidated Student Loans
                                       chapter   2
                                       Rorrowere Have Lower Monthly Payments
                                       and Higher Intereet Coat+-F’ew Default




                                       attended a traditional e-year or 4-year school, Similarly, a study by the
                                       Higher Education Assistance Foundation (HEAF) (a guaranty agency) of
                                       the profile of borrowers who had consolidated their loans by December
                                       3 1, 1988, found that (I) most loan consolidators attended schools in
                                       which enrollment periods were 2 years or longer and (2) the majority
                                       were in school for more than 1 year. This study’s results appears to con-
                                       firm our findings that borrowers with large student loan debt who
                                       attended school for longer periods -the profile of a student who consoli-
                                       dated his or her student loan-are less likely to default. (See table 2.4.)

Table 2.4: Borrowers Who Consolidate
Attend Different Schools for Longer    Numbers in percent
Periods Than Most Defaulters                                                         Consolidated
                                       Comparative factors                              borrowere           Defaulters
                                       Kind of school attended
                                           Vocational                                           14                  42
                                       il-year
                                       -~~          or 4-year                                 - 83                  43
                                           Other                                                 3                  15
                                       Years attended
                                           1 or less                                            37                  63
                                           More
                                       ... _-     than   1
                                                    _____-.   _____.                            60                  37
                                           No information                                        3                   0
                                       Source: HEAF.


                                       On the basis of our earlier work and the HEAF study, it appears that the
                                       loan consolidation program may not significantly reduce defaults. Most
                                       lender and guaranty agency officials we interviewed generally shared
                                       this belief. Borrowers who take the time and make an effort to consoli-
                                       date, some of these officials said, were probably less prone to default on
                                       their loans. Defaulters, according to these officials, generally attend
                                       school for 1 year or less, and usually drop out of school.


                                       The loan consolidation program can provide assistance to borrowers
Conclusions                            needing help repaying their student loans. Its lower monthly payments
                                       help borrowers more easily fit loan repayment into their budgets. How-
                                       ever, the reduced monthly payments must be weighed against the
                                       increased interest costs these borrowers can pay. These increases can be
                                       considerable for borrowers with larger amounts of debt.

                                       Whether the program leads to a decrease in defaults is still unanswered.
                                       The likelihood of this occurring to a significant degree is uncertain. In
                                       addition, borrowers who have the highest propensity to default are


                                       Page 19                                  GAO/HRD-998 Consolidated Student Loans
                      Chapter 2
                      Bomwers Have Lower Monthly Payment8
                      and Higher Interest Costs-Few Default




                      unlikely to participate in the consolidation program. By contrast, those
                      borrowers most likely to consolidate their loans are generally among
                      those with the lowest default rates. However, because the loans we ana-
                      lyzed had been consolidated for less than 2 years, it is too early to assess
                      the program’s effect on default reduction.



Agency Comments and
Our Evaluation

Lenders’ Comments     The lenders have mixed opinions regarding our assessment of the likely
                      impact the program has on reducing defaults. The New England Educa-
                      tion Loan Marketing Corporation (NELLIE MAE) agreed that the program
                      is likely to have little impact on reducing default costs. On the other
                      hand, Citibank and the Pennsylvania Higher Education Assistance
                      Agency said that (1) we understate the program’s impact on default
                      reduction and (2) additional time and study are required to more ade-
                      quately address this matter.

                      The Student Loan Marketing Association (SALLIE MAE) also said that we
                      understate the program’s impact on default reduction and, after our
                      review, provided new data from its portfolio showing that loan consoli-
                      dation has a positive impact on repayment behavior. SALLIE MAE said its
                      experience shows these rates: a 2-percent default rate for borrowers
                      who consolidated their loans versus a 9.8 percent default rate for bor-
                      rowers attending 4-year colleges who did not consolidate their loans.

                      These comments illustrate the uncertainty about how loan consolidation
                      may reduce defaults. As the program matures, we agree that further
                      study would be useful to more adequately evaluate these issues.

                      Citibank also provided information showing that the average amount of
                      a consolidated loan in its portfolio decreased from approximately
                      $12,300 during the period October 1986 through September 30, 1988, to
                      $6,500 during the period October 1988 to December 1989. Citibank sug-
                      gested we expand our study to include an analysis of this newly pro-
                      vided data.

                      This information was provided for a period subsequent to the comple-
                      tion of our analysis, and we agree that more study could be done in the



                      Page 20                                 GAO/HRD-90-8 Consolidated Student Loans
chnpter 2
Borrewere Have Lower Monthly Paymente
and Higher Interest Costs-Few Default




future. However, if this issue is examined further, future analysis
should also determine whether Citibank’s experience is being encoun-
tered by the other major lenders with consolidated loans.




Page 21
Govemment’sSubsidy CostsWill Increase


                            For the loans we analyzed, the loan consolidation program could result
                            in a relatively small decrease in the government’s interest subsidy costs
                            for the first 10 years. However, almost half of the loans consolidated
                            have repayment periods of 20 years or more, which can significantly
                            increase the government’s costs. For the 36 lenders we examined, the
                            program may increase the government’s subsidy by an estimated $7.5
                            million ($48 million undiscounted). Any default avoidance resulting
                            from this program would help offset these increased costs.

                            As the program continues to grow, so can the interest subsidy costs to
                            the government. The Department of Education estimates that another
                            $6.6 billion in loans may be consolidated during fiscal years 1989-94. If
                            these future loans have the same characteristics as those we analyzed,
                            for these 6 years, the additional interest subsidy cost to the government
                            could be about $365 million ($860 million undiscounted). The program’s
                            costs would be greater if interest rates on Treasury bills increase, but
                            would decline if these rates decrease.

                            The Congress has several options that would minimize or offset these
                            potential cost increases. The first option would be to let the program
                            expire in 1992, as currently authorized. Other options, which would
                            affect borrowers, include (1) charging them a loan origination fee or
                            (2) increasing their loan interest rates. These two options would increase
                            the borrowers’ costs, which may limit their future participation in this
                            program. A fourth option would affect lenders by reducing their interest
                            subsidy payments-and       income- which could limit or reduce their will-
                            ingness to make consolidated loans in the future.


                            The Department of Education’s subsidy costs for the consolidated loan
Government’s Subsidy        portfolio will rise during the loans’ repayment periods. It is difficult to
Costs Will Be Greater       isolate each element of such cost increases, but there are three principal
                            factors that contribute to them:

                        l Longer repayment terms available to borrowers make consolidated loans
                          more expensive for the government to subsidize.
                        l The consolidation of certain kinds of loans, normally unsubsidized dur-
                          ing their repayment, increases the loan portfolio subject to subsidy.
                        . The graduated repayment plans, which reduce borrowers’ monthly pay-
                          ments, generally add to the government’s costs because interest subsi-
                          dies are paid on the loans’ principal balances, which remain higher for
                          longer periods,



                            Page 22                                  GAO/HRD-90-8 Consolidated Student Loans
                         Chapter 3
                         Government’s Subsidy Costs Will Increase




                         We conducted a comparative cost analysis to determine whether the
                         loan consolidation program could increase or decrease the government’s
                         subsidy costs. Using a 91-day Treasury bill rate of 7.99 percent (rate in
                         effect for the loan portfolio on Oct. 1, 1988), we determined the subsidy
                         costs for the loans that were consolidated and compared them with the
                         subsidy costs had these same loans remained unconsolidated. We made
                         this comparison using data from the 36 lenders whose consolidated loan
                         portfolios totaled about $790 million through September 30, 1988.
                         (App. III contains a detailed description of our methodology for estimat-
                         ing the program’s cost.)

                         The combination of the three factors could increase the government’s
                         cost by about $7.5 million ($48 million undiscounted) for the consoli-
                         dated loan portfolios held by the 36 lenders. For the loans we analyzed,
                         the projected subsidy costs for the first 10 years were $9.1 million less
                         ($4,5 million less undiscounted) for the underlying loans than loans con-
                         solidated. This reduction occurs, in part, because the underlying guaran-
                         teed student loans have an interest rate of 8 percent; the consolidated
                         loans, 9 percent. As a result, the borrower pays an additional 1 percent-
                         age point of interest, thereby reducing the government’s subsidy by the
                         same percentage. If default savings of 1 percent were achieved on the
                         principal amount ($790 million) of the loans we analyzed, the increased
                         subsidy costs would be offset. However, we were unable to estimate
                         what these default savings may be.


Longer Repayment Terms   A first reason for increased subsidy is that the longer the repayment
Increase Subsidy Costs   period, the more interest subsidy the government can pay. Consolidated
                         loans have repayment terms ranging from 10 to 25 years, depending on
                         the amount borrowed and consolidated; regardless of the loan amount.
                         As discussed above, during the first 10 years of repayment, the subsidy
                         costs on the borrowers’ loans could be less if the loans were consolidated
                         rather than if they had remained unconsolidated.

                         According to data provided by the lenders we reviewed, over 80 percent
                         of their loan volume has repayment terms of 15 years or more. (See
                         fig. 3.1.)




                         Page 23                                    GAO/HRD90-8 Consolidated Student Loans
                                 Chapter 3
                                 Government’s Subsidy Costs Will Increase




Figure 3.1: Volume of Loans
Consolidated by Repayment Term
                                                                                        26-year repayment term ($62.0 million)



                                                                                        1O-year repayment term ($52.7 million)




                                                                                        1Syear repayment term ($77.1 million)




                                                                                        l&year repayment term ($270.7 million)




                                                               -/-’
                                                \ir


                                                                                        20-year repayment term ($327 million)




Previously Unsubsidized          A second reason for increased subsidy costs is that consolidating loans
Loans Now Being                  previously unsubsidized can add to the portfolio subject to subsidy. As
                                 shown in figure 3.2, of the kinds of loans eligible for consolidation, only
Subsidized                       two-Stafford    loans and Federally Insured Student Loans-are eligible
                                 for interest subsidies before being included in a consolidated loan. In
                                 comparison, both Perkins and the health professions loans are unsub-
                                 sidized.’ The remaining two kinds of loans--&As and sLs-are generally
                                 unsubsidized, although they are subject to subsidy when Treasury bill
                                 rates exceed certain thresholds that are higher than those for Stafford
                                 loans.




                                 ‘Perkins and health professions loans are made by the schools and receive no government subsidies,
                                 although the government does provide the schools with capital funds to help establish their pro-
                                 grams. As such, the students borrow the moneys from the schools and repay their loans to the
                                 schools’ revolving fund. These funds are then used to make loans to other students or are returned to
                                 the government.



                                 Page 24                                               GAO/HRD-90-3 Consolidated Student Loans
                                      Chapter 3
                                      Government’s Subsidy Costa Will Increase




Figure 3.2: Which Student Loans Are
Eligible for Federal Subsidy?                                                                      Loan Consolidation        Program
                                         Separate Student Loan Programs


                                         Federally Insured Student Loans                          Federally Insured Student Loans
                                         Stafford Loans (previously called                        Stafford Loans (previously called
                                            Guaranteed Student Loans)                                Guaranteed Student Loans)

                                           These loans are eligible for an                          These loans are eligible for an
                                       interest subsidy from the government.                    interest subsidy from the government.




                                        Auxllary Loans to Assist Students
                                        Supplemental Loans for Students                         Auxiliary Loans to Assist Students
                                                                                                Supplemental Loans for Students
                                            These loans are eligible for an
                                        interest subsidy only if the borrower’s                     These loans are eligible for an
                                           variable interest rate exceeds 12                    interest subsidy from the government.
                                                        percent.




                                                  Perkins Loans                                           Perklns Loans
                                        Health Professions Student Loans                        Health ProfessIons Student Loans

                                          These loans are not eligible for an                       These loans are eligible for an
                                                  interest subsidy.                             interest subsidy from the government.



                                      Note: The variable interest rate is determined by adding 3.25 percent to the 52.week Treasury bill rate.
                                      As a result, the Treasury bill rate must exceed 8.75 percent before an interest subsidy is paid (3.25
                                      percent + 8.75 percent = 12 percent).


                                      If any Perkins and health professions loans are consolidated, the gov-
                                      ernment can incur additional subsidy costs. For the lenders we
                                      reviewed, borrowers consolidated about $55 million of such loans. A
                                      summary of these loans by their repayment terms is shown in appendix
                                      IV.




                                      Page 25                                                  GAO/IiRD-90-8 Consolidated Student Loans
                              Chapter 3
                              Government’s Subsidy Costs Will Increase




Graduated Repayments          A third reason why the government pays more in interest subsidies for
Increase SiJbsidies Paid to   consolidated loans than underlying loans is attributed to graduated
                              repayment plans. These plans increase the government’s costs because
Lenders                       subsidy payments are made on a larger principal balance for a longer
                              period. Under graduated repayment plans, borrowers make only interest
                              payments for a few years; their principal balances remain the same
                              rather than decline as with an amortizing loan, which means that the
                              government may pay more subsidies.

                              The 35 lenders that offer borrowers the option of using a graduated
                              repayment plan used them for about 75 percent of their consolidated
                              loan portfolios. We estimate that the government’s subsidy costs to lend-
                              ers using these plans could increase by about $7.4 million ($13 million
                              undiscounted) over the repayment period for such loans; by about
                              $114.3 million, if the borrowers used level payment plans; and by about
                              $12 1.7 million, if the borrowers used a mix of level and graduated plans,
                              as currently in these lenders’ portfolios.


                              The Higher Education Amendments of 1986 shifted more of the respon-
Consolidating New             sibility for paying interest on Stafford loans to the borrower by increas-
Stafford Loans Could          ing the borrower’s interest rate for these loans during the 5th and
Greatly Increase              remaining years of repayment. Effective July 1, 1988, Stafford loans
                              disbursed to new borrowers-those       who borrowed under the Stafford
Subsidy Costs                 Student Loan Program for the first time-carry       an S-percent interest
                              rate during their first 4 years of repayment and a lo-percent interest
                              rate thereafter (referred to as an 8/10 percent loan). Previously, guaran-
                              teed student loan borrowers paid interest at a single interest rate (typi-
                              cally 8 percent) throughout the repayment period. In addition, the 1986
                              amendments also reduced the government’s special allowance payment
                              factor from 3.6 percent to 3.25 percent on loans made to new borrowers
                              for periods of enrollment on or after November 16,1986. These changes
                              were made to reduce the government’s subsidy costs.

                              The savings from these revisions, however, will be partially offset for
                              such loans when consolidated. To provide an indication of what may
                              happen to the government’s costs when Stafford loans with the new
                              interest (8/10 percent) and subsidy (3.25 percent) rates are repaid, we
                              recomputed the subsidy costs for the underlying guaranteed student
                              loans in the consolidated loan portfolios of the 36 lenders. We substi-
                              tuted these new interest and subsidy rates for the previous rates of the
                              underlying loans. We assumed that all borrowers would repay their
                              loans using level payment plans. (This assumption was made because


                              Page ‘26                                   GAO/HRD-99-9 Consolidated Student Loans
                        Chapter 3
                        Goverument’s Subsidy Costs Will Increase




                        there was no practical way to predict how many borrowers would
                        choose graduated repayment plans if they had 8/10 percent underlying
                        Stafford loans.)

                        The new rates could reduce the government’s subsidy costs for these
                        loans from $94.4 million to $70.7 million ($126.4 million to $89 million,
                        respectively, undiscounted) if the underlying loans were not consoli-
                        dated. Therefore, when unconsolidated, the new rates could result in a
                        subsidy cost savings of $23.7 million ($3’7.4 million undiscounted). When
                        the new loans are consolidated, however, these cost savings are not real-
                        ized because under loan consolidation, the subsidy costs would be $114.4
                        million ($191.8 million undiscounted).

                        Conversion of Stafford loans to consolidated loans could also add to the
                        government’s costs in another way. Borrowers subject to the increase in
                        interest rates, from 8 to 10 percent, may decide to switch to a g-percent
                        consolidated loan before their 5th year of repayment, thereby avoiding
                        the lo-percent interest rate during the remaining years of the Stafford
                        loans. The government could then have to pay up to an additional 1 per-
                        centage point in interest subsidies, depending on Treasury bill rates. (It
                        is too early to estimate to what extent this may occur because borrowers
                        who have 8/10 percent loans have not yet entered their 5th year of
                        repayment.)


                        The loan consolidation program grew to almost $1 billion during its first
Consolidation Program   2 years. In fiscal year 1988, its 2nd year, the program grew by $642
Growth Could Cause      million, from $263 million to a total of $905 million. The Department of
Additional Cost         Education estimated, in June 1989, that consolidated loan volume will
                        continue to increase. As shown in figure 3.3, the Department projected
Increases               the volume will increase in each succeeding fiscal year through 1994
                        (this assumes that the program will be extended beyond its authorized
                        period ending in fiscal year 1992). The expected volume of new loans is
                        $765 million in fiscal year 1989, increasing to $1.35 billion in fiscal year
                        1994, for a projected cumulative growth to about $6.6 billion,




                        Page 27                                    GAO/HRD-90-8 Consolidated Student Loans
                                        chapter3
                                        Govemment’s Subsidy Costs Will Increase




Flguro 3.a Estlmatod Future Growth of
the Consolktrtlon Program
                                        2.0   Bllllom of dolkm




                                        1.4

                                        1.3                                        I
                                        1.0
                                                      I
                                                                 r




                                              1999      1990         1991   1992       1993   1994
                                              Flrorl yaw
                                        Source: Department of Education


                                        Future interest subsidy costs could also increase for these new consoli-
                                        dated loans. The potential incremental cost-as compared with the
                                        loans remaining unconsolidated-may       total $365 million for the loans
                                        projected to be consolidated in fiscal years 1989-94 ($860 million undis-
                                        counted), as shown in table 3.1. This estimate assumes that (1) the
                                        future consolidated loan volume projected by the Department will have
                                        the same proportional mix of underlying loans as those held by the 36
                                        lenders we reviewed, (2) lenders will receive a special allowance pay-
                                        ment based on a 3.25 percentage rate for underlying Stafford loans, and
                                        (3) for their underlying Stafford loans, borrowers would be subject to
                                        the interest rate increase from 8 to 10 percent starting in the 5th year of
                                        repayment.




                                        Page 28                                               GAO/HRD90-8 Consolidated Student bans
                                       Chapter3
                                       Govemment’s Subsidy Costa Will Increase




fable 3.1: Subsidy Costs Increase as
Loan Volume Grows                      Dollars in millions
                                                                       Projected
                                                              consolidated loan            Total incremental                  Present value of
                                       Fiscal year --__       -..--.-    volume                subsidy Costa                 incremental cost
                                       ii89             ------         --        $765                  $99.6                               $42.2
                                       1990
                                       ---__-           ----__-.                1,023 -.                133.2                                56.5
                                       1991            --.-.____--.----         1,067                   138.9                                58.9
                                       i992                                     1.153                   150.1                                63.7
                                       1993                             ~-.-    1,245                   162.1                                68.8
                                       1994                                     1,352                   176.0 -                              74.6
                                       Total                                 -$6,605                  $659.9                              $364.7
                                       “These figures include total subsidy costs incurred over the repayment life of the consolidated   loans
                                       originated each year.



                                       The special allowance payment formula for consolidated loans is tied to
Program Costs Also                     91-day Treasury bill rates. Increases and decreases in these rates can
Sensitive to                           significantly affect the level of subsidies the government pays. The sub-
Fluctuations in                        sidy formulas for loans eligible for loan consolidation, except Perkins
                                       and health professions loans, are also tied to this Treasury bill rate. As
Treasury Bill Rates                    such, changes in Treasury bill rates can affect the cost of these subsidy
                                       payments and comparisons between the underlying and consolidated
                                       loans.

                                       Our calculations use the 91-day Treasury bill rate in effect for the first
                                       quarter of fiscal year 1989. That rate, 7.99 percent, was used by the
                                       Department of Education to determine, for that quarter, the amount of
                                       interest subsidy payments due to lenders holding loans subject to inter-
                                       est subsidies, These payments are directly tied to the Treasury bill rate,
                                       that is, when the rate changes, so does the government’s costs.

                                       To analyze the sensitivity of program costs to changes in Treasury bill
                                       rates, we recomputed our estimates for the consolidated loan portfolios
                                       held by the 36 lenders we reviewed, using the same methodology and
                                       assumptions as before, except we substituted higher and lower Treasury
                                       bill rates in our baseline estimate. This analysis showed that declining
                                       Treasury bill rates would result in consolidated loans becoming less
                                       expensive to subsidize than either &percent guaranteed student loans,
                                       8/10-percent Stafford loans, or 12-percent ALAS and SLSloans. However,
                                       as shown in figure 3.4, higher average Treasury bill rates over the life of
                                       these loans would result in additional costs, and consolidated loans
                                       become proportionately more costly as the rates increase.



                                       Page 29                                                   GAO/HRD90-8 Consolidated Student Loaus
                                                                                                                                       .
                                          Chapter 3
                                          Government’s Subsidy Costa Will Increase




Figure 3.4: Subsidy Costs Increase Wlth
Higher Treasury Bill Rates
                                          500       Millions of dollan

                                          450
                                          490
                                          3sa

                                          300                                                                       A

                                          269                                                            A

                                          290

                                          150                                   A

                                          100

                                           50 *--




                                            s.75                     6.75             7.75                   9.7s       9.75           10.75
                                            Treasury bill rate (percmt)

                                                    -         9% consolidated loans
                                                    ---I      8% guaranteed and 12% ALAS and SLS loans
                                                    m         MO% Stafford and 12% ALAS and SLS loans




                                          The earlier actions of the Congress in considering, enacting, and modify-
What Can Be Done to                       ing the loan consolidation program provide context and insight into how
Reducethe                                 the costs of the program could be reduced.
Government’s Costs
While Preserving the
Program’s Benefits?

How Selected Legislative                  There are three principal factors, established by law, that affect the
Factors in the Program                    amount of government subsidy for the loan consolidation program: (1)
                                          the borrower’s interest rate, (2) special allowance payments to the
Determine Subsidy Costs                   lender, and (3) length of the repayment period. As shown in table 3.2,
                                          these factors-as established in COBRAof 1985, which authorized the
                                          loan consolidation program- were subsequently modified by the Higher
                                          Education Amendments of 1986. These modifications clearly increased
                     ”                    the government’s potential subsidy costs because (1) borrower interest




                                          Page 30                                                    GAO/HRD-90-S Consolidated Student Loans
                                      Chapter 3
                                      Government’s Subsidy Costs Wffl Increase




                                      rates decreased, (2) the lender special allowance payment factor
                                      increased, and (3) the maximum repayment period was lengthened.

That Influence the Cost of the Loan   Provision                      COBRA of 1985                   1986 amendments
Consolidation Program                 -_~.            --
                                      Interest rate                  10 bercent or hiahest rate of   Minimum of 9 oercent or
                                                                     loans being congolicfated       weighted average of loans
                                                                                                     being consolidated, rounded
                                                                                                     to nearest percent
                                      Special allowance payment     Average of 91 -day Treasury      Average of 91 -day Treasury
                                      rate                          bills plus 3.0 percent           bills plus 3.25 percent
                                      Repayment length              Maximum of 15 years,             Maximum of 25 years,
                                                                    debendina on amount owed         debendina on amount owed


                                      The Congressional Budget Office’s (CBO) cost estimate for the loan con-
                                      solidation provisions in COBRA concluded that there would be some
                                      budget savings from creating the program, but did not provide a specific
                                      net savings estimate. CBO also predicted that other savings would occur
                                      due to default reductions. It estimated that perhaps 1 percent of those
                                      borrowers who consolidated their loans would have defaulted if there
                                      was no consolidation program. Overall, CBO stated that

                                      “The special allowance costs would increase due to the extended repayment terms
                                      but would decrease due to the combined effect of setting the total yield at the 91-
                                      day treasury bill rate plus 3 percent and increasing the interest rate on the loan to
                                      10 percent.”



Policy Options for                    On the basis of these earlier considerations, we developed and analyzed
Reducing Government                   four options that could help defray part, or all, of the future estimated
                                      increase in the government’s interest subsidy costs. The first would be
Subsidy Costs                         to let the program expire in 1992, as currently authorized, or rescind its
                                      authority before that time. However, if the program is to preserve the
                                      principal benefit to students -the reduction of monthly payments for
                                      students with high debt-there are at least three other options.

Increasethe Borrower’s Interest       The option that could reduce future program cost growth the most
Rate                                  would be to increase the minimum loan interest rate charged borrowers
                                      for their consolidated loans. For example, an increase in the borrower’s
                                      minimum interest rate, from 9 percent to 10 percent, could decrease the
                                      government’s total subsidy costs by about $55 million for fiscal years
                                       1989-94 (after adjusting for present value). Increasing the interest rate
                                      by 1 percentage point would more than offset the costs associated with
                                      the Department’s projected program growth for fiscal years 1989-94, as



                                      Page 31                                          GAO/HRD-90-8 Consolidated Student Loam
                                         chapter 3
                                         Government’s Subsidy Costs Will Increase




                                         shown in table 3.3. In appendix V, we have also estimated the cost
                                         reduction associated with increasing loan interest rates from 9 to 10 per-
                                         cent in increments of 0.25 percent. Although any increase in student
                                         costs could be expected to reduce student participation, the monthly
                                         payment reductions and consolidation of several payments would still
                                         provide a benefit to students. And under current Stafford loan rules,
                                         students will actually be paying lo-percent interest on their unconsoli-
                                         dated loans, beginning in their 5th year of repayment.
Table 3.3: A lo-Percent Loan interest
  ate Could Cover Future Program Costs   Dollars in millions
PPresent Value Costs)
                                                                    Incremental subsidy             Decrease in subsidy
                                                                      costs for 9 percent          costs with 1O-percent
                                         Year
                                         -~                                           loan                   interest rate             Difference
                                                                                                                                               -
                                         1989                                        $42.2                              $48.6                  $6.4
                                         1990           ~_                             56.5                              64.9                    8.4
                                         1991
                                         -..--          --                             58.9                              67.7                    8.8
                                         1992                                          63.7                              73.2                    9.5
                                         1993                                          68.7                              79.0                   10.3
                                         1994
                                         ---~--                                        74.6                              85.8                   11.2
                                         Total                                      $364.7                            $419.2                  $54.5
                                         Note: Computations based on the Department’s     consolidated   loan projections for the repayment life of
                                         the loans consolidated in each of these years.


Charge Borrowers      a Loan             A second option that would increase borrower costs and offset higher
Origination Fee                          program costs would be to charge consolidated loan borrowers an origi-
                                         nation or refinancing fee. Such a one-time fee, similar to the fee charged
                                         borrowers of subsidized Stafford loans (currently 5 percent) and bor-
                                         rowers who consolidate or refinance their consumer debt, could be used
                                         by the Department of Education to help offset the program’s additional
                                         subsidy costs. The lender would forward this fee to the Department
                                         after the loan was made. The Department would receive these moneys
                                         up front rather than over the life of the loan.

                                         If consolidated loan borrowers were charged an origination fee, the
                                         money needed to pay this fee could be added to the principal balance of
                                         their loans, as is the current practice for Stafford loans. The resulting
                                         principal balances of the borrowers’ loans would increase, which could
                                         subsequently offset some of the additional revenues the government
                                         would receive from the imposition of the fee. As shown in table 3.4,
                                         charging a &percent fee on the Department’s projected consolidated
                                         loan growth for fiscal years 1989-94 would raise about $33 1 million of
                                         the $412 million needed to offset the estimated incremental costs of this



                                         Page 32                                                  GAO/HRD-90-8 Consolidated Student Loans
--
                                        Chapter 3
                                        Government’s Subsidy Costa Will Increase




                                        program.” (App. VI includes the amount of funds raised with a loan orig-
                                        ination fee of 1,2,3, or 4 percent.)

Table 3.4: A &Percent Origination Fee
Would Cover Most of the Estimated       Dollars in millions
Future Incremental Program Costs        --                                      Incremental           Amount raised with a
(Present Value Costs)                   Year                                   subsidy cost                 5-percent fee                 Difference
                                        1989                                               $47.7                          $38.3              -- -$9.4
                                        i.i@i--                                             63.9                            51.2                -12.7
                                        1991                                                66.6                            53.4                -13.2
                                        1992                                                72.0                            57.7                -14.3
                                        1993                  _____-                        77.7                            62.3                -15.4
                                        1994                                                84.5                           67.6                 -16.9
                                        Total                                          $412.4                            $330.5                -$61.9
                                        Note: Computations based on the Department’s consolidated loan projections for the repayment life of
                                        the loans consolidated   in each of these years.


Decreasethe Lenders’Special             A third option would be to decrease the special allowance payment to
Allowance Payment                       lenders, a provision COBRA included when the program was enacted. For
                                        example, lowering the current rate from the 91-day Treasury bill rate
                                        plus 3.25 percent to 3 percent would decrease the government’s cost by
                                        about 29 percent. As shown in table 3.5, this reduction would raise
                                        $107 million-about    $258 million short of what would be needed to off-
                                        set the estimated future incremental subsidy costs.

Table 3.5: Decreasing the Special
Allowance Rate to 3 Percent Covers      Dollars in millions
                                        _-.-
Lea8 Than Half of the Program’s                                                Incremental
Estlmated Future Present Value Costs                                          subsidy coat             Decrease in subsidy
                                                                              using a 3.25-          costs with a t-percent
                                        Fiscal year
                                        ---.                                 percent factor                 payment factor                Difference
                                        1989
                                        -^_I_-.                                            $42.2                          $12.3                 $29.9
                                        1990
                                        -.---.._____-                                       56.5                            16.6                  39.9
                                        1991                                                58.9                            17.2                  417
                                        .__I__---                 .____
                                        1992                                              63.7                              18.7                  45.0
                                        1993                                              68.8                              20.1                  48.7
                                        1994
                                        ____-__-                                          74.6                              21.8                  52.8
                                        Total                                          $364.7                            $106.7                $256.0
                                        Note: Computations based on the Department’s         consolidated   loan projections for the repayment life of
                                        the loans consolidated in each of these years.


                        Y
                                        “The estimated present value costs for each fiscal year’s portfolio are higher in table 3.4 than in table
                                        3.3 because we analyzed each option independently and, as such, included loan origination fees in the
                                        loans’ principal balances in table 3.4. Therefore, the total loan amounts eligible for interest subsidies
                                        would increase.



                                        Page 33                                                      GAO/HRD-90-9 Consolidated Student Loans
                                                                                           .
              Chapter 3
              Government’s Subsidy Costs Will Increase




              To offset the entire $364.7 million in future incremental costs, we esti-
              mate that the special allowance factor would have to be reduced to
              2.25 percent. This and similar computations are shown in appendix VII
              for special allowance payment factors in 0.25 percent increments, from
              2.25 percent to 3.25 percent.

              Although a reduction in the special allowance payment rate would
              reduce lenders’ profits, their continued participation in the program
              would be linked to the costs they incur in making and servicing loans in
              relationship to their income. Consolidated loans may be considerably
              more profitable to lenders than Stafford loans because their servicing
              costs are lower as a percentage of the loan amount. This is because
              (1) borrowers who consolidated their loans are less likely to become
              delinquent during repayment (less lender servicing necessary) and
              (2) consolidated loans are larger (over five times as large on average)
              and their default rate is much lower (less than 1 percent versus 10 per-
              cent) than those of Stafford loans.


              The loan consolidation program will continue to cost the government
Conclusions   more money through increased interest subsidies than had there been no
              such program. Although the government was expected to benefit, in
              part, through decreased loan defaults, no data existed to evaluate possi-
              ble reduced default savings. Furthermore, the increase in federal costs
              of interest subsidies costs could be (1) substantial as loan volume grows
              and (2) more substantial if Treasury bill rates increase above current
              levels.

              The program was designed primarily to assist student borrowers and, as
              such, they receive the benefit of reduced monthly payments. On the
              other hand, the larger loan amounts, as well as potentially lower loan-
              servicing costs associated with low-risk borrowers, could probably make
              the program more attractive and profitable to lenders than Stafford
              loans.

              Any reduction in program costs will either raise student costs or
              decrease lender profit or both; both could be expected to reduce pro-
              gram participation. Although the cost savings of the various options can
              be readily estimated, we know of no data that would allow us to esti-
              mate the effect on program participation. We believe the benefits of this
              program, compared with its cost, can-and most likely will-be ques-
              tioned during budget reconciliation discussions or reauthorization of the
              IIigher Education Act. This is also likely given the continued budget


              Page 34                                    GAO/HRD-90-8 Consolidated Student Loans
                           Chapter 3
                           Government’s Subsidy Costs Will Increase




                           stringency that student aid programs face and will continue to face
                           because of large federal deficits.

                           Therefore, the Congress, in its deliberations, may want to consider the
                           options we identified to either (1) eliminate or not reauthorize the pro-
                           gram or (2) better balance the benefits available to borrowers who wish
                           to consolidate their student loans against the additional costs to the gov-
                           ernment in operating the program. These expected future costs should
                           be evaluated by using their present value rather than not discounting
                           the costs to better reflect the government’s costs that can occur over a
                           lo-year to 25-year loan repayment period.


                           If the Congress wishes to retain and reauthorize the program and main-
Matters for                tain the benefits to students with loan consolidations, while reducing
Consideration by the       program costs, it may wish to consider enacting one or more of the fol-
Congress                   lowing cost reduction measures:

                       l charging consolidated loan borrowers a loan origination fee,
                       . increasing the minimum interest rate on consolidated loans, or
                       l reducing the lenders’ special allowance payment rate.




                           Page 35                                    GAO/HRD-90-S Consolidated Student Loans
                          Chapter 3
                          Government’s Subsidy Costs Will increase




Agency Comments and
Our Evaluation

Department of Education   The Department said that we had presented the Congress with several
                          good options related to the loan consolidation program and had no fur-
                          ther comment. The lenders’ comments varied and are summarized
                          below.


Lenders’ Comments
IA 1a.n
      Subsidies           In general, the lenders expressed concern about how we made our cost
                          comparisons, specifically, the methodology and discussion dealing with
                          the government’s interest subsidy (special allowance) payments for both
                          consolidated and nonconsolidated (underlying) loans. NELLIEMAE and
                          SALLIEMAE disagreed with our categorization of Perkins and health pro-
                          fessions loans as unsubsidized loans, which we said become subsidized
                          after they are consolidated. Both lenders said that these two kinds of
                          loans receive indirect interest subsidies because their interest rates are
                          lower than the rates at which the government borrows money. SALLIE
                          MAE also suggested that with these two kinds of loans, consolidation
                          saves the government money because the underlying Perkins and health
                          loans are repaid more quickly, thereby making more funds available for
                          loans to other students without additional government subsidies.

                          While we do not disagree that there are government costs associated
                          with all federal student loan programs, such as seed money to help
                          schools set up their Perkins loans, the discussion on pages 24-25 is
                          directed to the special allowance payments these loans receive upon con-
                          solidation. Before consolidation, lenders holding Perkins and health pro-
                          fessions loans (the schools) do not receive such federal payments.

Cost Assumptions          SALLIEMAE was also concerned that our cost comparisons overstate the
                          additional subsidy costs attributed to consolidated loans because we
                          excluded from our analysis the costs associated with defaults, delin-
                          quencies, deferments, and forebearances.

                          As we state in our methodology discussion in appendix III, we excluded
                          these factors from our cost comparisons because, at the time of our
                          review, lenders did not have data available to measure the extent to



                          Page 36                                    GAO/HRD-90-8 Consolidated Student Loans
                       Chapter 3
                       Gwemment’s   Subsidy Costs Will Increase




                       which loan consolidation may be affected by these factors, Therefore,
                       their exclusion was one of the premises for our assumptions about
                       repayment terms.

Graduated Repayments   SALLIEMAE also expressed concern that we are not acknowledging the
                       default reduction potential of proposed legislation (S. 29), which, if
                       enacted, would extend graduated repayment terms to all Stafford loans,
                       While we were aware of this pending legislation, we do not know
                       whether it will be enacted. Further, we are not evaluating whether grad-
                       uated repayment plans could reduce default costs. We, rather, state that
                       these plans contribute to increasing the government’s interest subsidy
                       costs.

Growth Projections     SALLIEMAE disagreed with the projections we used on the growth of the
                       consolidated loan portfolio through 1994. It stated that past program
                       growth was influenced by borrower awareness, and that it is unlikely
                       future growth would continue at such a high rate. SALLIEMAE said our
                       projections through 1994 may be overstated by as much as $1.5 billion.

                       We have no basis to either agree or disagree with the SALLIEMAE esti-
                       mate. We used the Department’s estimate because it is the responsible
                       federal agency for consolidated loans, and its growth projections are
                       used when submitting its budget to the Congress.

Lmn Profitability      All four lenders questioned our use of data on the costs to make and
                       service both consolidated and Stafford loans because (1) the data were
                       obtained from one lender and (2) we use the data to support an option
                       for reducing the interest subsidy rate factor. We have revised our report
                       and deleted the information showing the costs for this one lender to
                       more clearly recognize that these costs are dependent on the economic
                       situations of each lender.

                       Citibank also said that high-balance loans are generally more profitable
                       than low-balance loans. In addition, Citibank said, a reduction in the fed-
                       eral subsidy rate for consolidated loans may result in lenders’-that
                       now hold both consolidated and nonconsolidated loans-opting to con-
                       centrate on consolidated loans in the future. These lenders may be less
                       willing to make the smaller, less profitable, nonconsolidated loans,
                       thereby reducing student access to these loans.

                       We have no basis for agreeing or disagreeing with Citibank that this
                       change in lender behavior may occur. However, given the relatively
                       small number of originating lenders that had consolidated loans in their


                       Page 37                                    GAO/HRDSO-8 Consolidated Student Loans
                  Chapter 3
                  Government’s Subsidy Costs Will Increase




                  portfolios, we are unsure of the extent such a change in behavior would
                  occur.

Program Options   NELLIEMAE and SALLIEMAE were concerned that the options we offered-
                  to charge students who chose to consolidate their loans an origination
                  fee or increase their minimum interest rate or both-would   make the
                  program more costly for students.

                  Our analysis shows that in the long run, loan consolidation is more
                  costly for students and can be more costly to the federal government,
                  depending on the cost savings from reduced defaults. The extent to
                  which these additional costs should be borne by the primary benefi-
                  ciaries (the students) or the taxpayers is an issue that is subject to con-
                  gressional debate. As a result, we are not recommending one option over
                  another, but are providing information on the alternatives available
                  should the Congress consider revising the structure of the consolidated
                  loan program.

Other Issues      SALLIEMAE also expressed concern that our report does not acknowledge
                  that a reduction of federal support for students, other than through loan
                  programs, has contributed to increased loan volume and higher average
                  loan balances. This is an issue we did not address and which goes
                  beyond the scope of this study.




                  Page 38                                    GAO/HRD-90-9 Consolidated Student Loans
Page 39   GAO/HRD-90-8 Consolidated Student Loans
Amendix   I

Cumulative ConsolidatedStudent Loans and
Defaults (as of Sept. 30,1988)

                                                                             Loans                    Defaults
              Guaranty agency                             Lenders      No.           Amount          No.    Amount
              Alabama                                            3     164        $2,167,424            5      $66,456
              Arkansas                                           1     165         2,125,790            1        7,446
              California --- -_--_-
              ___-.---                 .--~___--                 4   5,810        83,590,954            0            0
              Colorado                                           8   1,566        19,621,766            4       80,226
              Connecticut
              --.---.                                            6      27            356,418           0            0
              HEAFa                                             48   7,082       105,113,605            0            0
              Idaho                             .-____-          4      92            980,397           0            0
              Illinois                                          21   1,484        23,628,223            0            0
              Kentucky                                           1     195         2640,093             0            0
              Louisiana                                          1     154         2,402,848            1       13,848
              Massachusetts                                      2   2,038        29,695,251            2       18,971
              Michigan                                          19     261         3,022,784            0            0
              Mississippi                                        1      93         I, 166,988           0            0
              Missouri                                           1     141         1,594,761            0            0
              New Hampshire                                      2     121         1.6333172            0            0
              New Jersey                                        10     510         5,352,015            0            0
              New York                                          24   2,530        44,471,442            0            0
              Ohio                               .__-            4      75            920,949           0            0
              Pennsylvania                                      32   3,764        48,445,649            1       12,074
              Tennessee                                           1     66           877,580            0            0
              Texas                                              9     272         3,334,159            1        6,939
              USAF"                                 __          50  7,211         86,800,858           34      309,373
              Utah                                -.__-.---.      1    237         3,447,217            0            0
              Vermont                                            2     218         2,768,717            0            0
              Virginia                ~~~. --                    1     189         2,591,677            0            0
              Washington                                         6     152         2,130,288            1       21,216
              Wisconsin                                          3 28,609        423,632,916           57      816,401
              Total                                            265 63,226      $904,513,941          107 $1,352,950
              “The Higher Education Assistance Foundation (HEAF) reported guaranteeing consolidated loans for
              lenders In Anzona, the District of Columbia, Iowa, Kansas, Minnesota, Nebraska, Virginia, West Virginia,
              and Wyoming.

              “Unrted Student Aid Funds, Inc., (USAF) reported guaranteeing consolidated loans for lenders in Ari-
              zona, Delaware, Hawaii, Indiana, Iowa, Kansas, Louisiana, Missouri, Montana, New York, Ohio, Penn-
              sylvanra, Rhode Island, and Virginra.




              Page 40                                                  GAO/HRD-90-S Consolidated Student Loans
Appendix   II

Lenders Included in GAO Analysis


                Lender
                ___----___.                                                                                Location
                 Carteret Savings Bank                                                                      Parsipoanv, NJ
                 Cheltenham
                 ~--.-_--            Bank                                    --                             Rockledge, ~-___...--
                                                                                                                              PA
                Citibank Corporation                                                            -           Rochester,       NY
                 Commonwealth National Bank
                -------.---                                                -               ~~               Pittsburgh,      PA ----.-
                                                                                                                        _..____                   -.--
                 Dauphin
                 __-__--_.     Deposit       Bank
                                   ...--.------       and.---Trust                                          Harrisburg,       PA
                 Dollar Bank
                ____----                                                                                    Pittsburgh, PA
                .Equibank
                 ....___.-----_.           ___
                                        .-..----.-                           _~____.__                      Wilmington, DE
                                                                                                       ____-.~                                 _-
                 Fidelity    Bank
                -_..---------.--_-.--.-                                --.--.--__                           Upper Darby, ____--PA
                 First Eastern Bank                                             --             I____-       Wilkes-Barre, PA     .-.
                 First Fidelity                                                                             Newark, NJ
                First Fidelity,..-_____-
                                      South                                                                 Burlington, NJ’-------. ---._-
                First Pennsvlvania Bank                                                                     Philadelphia, PA
                 Fulton     Bank
                 ..-__-._---...-                      ._-..-~-__                                            East Petersburg, PA
                Gallatin      National
                 --.---.--..------.----..---Bank                                                            Uniontown,-- PA ---.--
                Hershey Bank                                                     ---                        Pittsburgh, PA ____-___
                Horizon       Financial
                 _-..-..----~.---..          -...___                                                        Huntingdon,r
                                                                          _____..
                Howard Savings                                                                              Livingston,---__..NJ
                Lehigh Valley Bank _ .-. .~.                                                                Bethlehem,
                                                                                                           ______.            PA
                Marine Bank                                                                                 Pittsburgh,_________
                                                                                                         ____.-              PA
                Meritor Credit Corporation .____-.                                                          Plymouth
                                                                                                               --.--       Meeting,      PA
                                                                                                                                          _--~--__
                McDowell National Bank                                                                      Sharon, PA
                Mellon Bank, Central                                              ---                       Pittsburgh,      PA
                                                                                                                      ______-.             -~-__.
                Mellon Bank, East                                                       ______-             Pittsburgh,
                                                                                                           ___-__            PA
                                                                                                                              --~. .-__          -..-.
                Mellon Bank, North                                          ~___..                          Pittsburgh, PA
                Mellon Bank, West                         ...____.-__._________-.--..---__                  Pittsburgh, PA                      -__
                Meridian Bank                                                                               Reading, PA _~---                     _~-
                Montclair Savings Bank                          -..--.-..                                   Montclair,
                                                                                                                   .__-- NJ
                New England Education Loan                                                                  Braintree, -.~..MA
                                                              --- Marketing Corporation
                Northeastern Bank of Pennsylvania                                                           Pittsburgh,      PA
                                                                                                                -_-.-----..-~-..                    .-
                Pennsylvania Higher Education Assistance             .______         Agency
                                                                                          __--              Harrisburg,       PA
                                                                                                                  -__-__-----.----
                Pittsburgh National Bank                                             ---..~~~               Pittsburgh,      PA
                                                                                                                        __----.-            .-___
                Provident National Bank                           .___-._I__                       _____.   Pittsburgh,      PA
                                                                                                                    ____.--.-.____..--
                Southwest
                    _. -...       National       Bank
                                      ._.-~-.........--.~ ._                                                Greensburg,         PA
                                                                                                                   _--..----__.-----..--               -
                Starpointe Savings- __..        and    Loan
                                                   --- ..-.-..--..-                                         Somerset,       NJ
                Student Loan Marketing Association                                                _-.-      Washington,
                                                                                                            ..----.___          DC
                                                                                                                                -___-..         __..
                Virginia Education Loan Authority                                                          Richmond, VA




                Page 41                                                                  GAO/HRD-908 Consolidated Student Loans
Appendix III

MethodologyUsed to Estimak Consolidated *
ban Program Costs

               To determine how loan consolidation may affect the overall interest sub-
               sidy costs of the Stafford Student Loan Program, we estimated the gov-
               ernment’s cost with and without the loan consolidation program. As a
               basis for our cost comparisons, we used data obtained from 36 lenders
               that had made consolidated loans guaranteed by the government. We
               selected these lenders based on (1) the size of their consolidated loan
               portfolios and (2) availability of loan data in their computerized data
               systems. These lenders held about 87 percent of all consolidated loans as
               of September 30, 1988.

               Each lender provided us with data on the original balances of consoli-
               dated loans in its portfolio as of September 30, 1988, and most lenders
               stratified their loans by payment plan and repayment term.’ We aggre-
               gated the lenders’ data and did separate computations on each stratum.
               For example, we used a level payment amortization to compute subsidy
               costs for all lo-year consolidated loans reported as being repaid with
               level payment plans. We then computed the subsidy costs for the
               remainder of these lo-year loans and their graduated repayment plans.
               We computed each combination of loan term and payment plan sepa-
               rately and added the results to obtain the total subsidy costs.

               We did this series of calculations to determine the total subsidy costs
               that the government may incur over the repayment periods of the con-
               solidated loans. After this, we repeated the calculations on the underly-
               ing guaranteed student loans and the Federally Insured Student Loans
               to determine what the subsidy costs would have been without the con-
               solidated loan program. We assumed these two kinds of loans would be
               paid in full over the statutory lo-year repayment period. We did not
               include Supplemental Loans for Students (SIS) or Auxiliary Loans to
               Assist Students (ALAS) in our computations of the subsidy costs for
               underlying loans; this is because these two kinds of loans normally are
               not eligible for interest subsidies at the Treasury bill rate we used for
               this analysis-7.99 percent. We compared the results to determine the
               incremental costs of the program. Our methodology is discussed below.

               We also sent a copy of this appendix to the five organizations represent-
               ing the 36 lenders that provided us with data for our cost analysis and
               asked them to review our methodology and provide us with any com-
               ments. Two organizations stated that our analysis should reflect that
               Stafford loans have a 3.25 percent rather than 3.5 percent subsidy rate.

               ‘One lendrr provided random sample data, which wc used to estimate the loan volumes in each
               category.



               Page 42                                             GAO/HRD-90-8 Consolidated Student Loans
                      Appendix III
                      Methodology Used to Estimate Consolidated
                      Loan Program Costs




                      Our analysis in chapter 3 addresses this change in subsidy rates.
                      Another also stated that our analysis should take into account the fact
                      that ALAS and SLS will be subject to an interest subsidy, effective July 1,
                       1989. We factored this into our computations for our analysis of the sub-
                      sidy costs under varying Treasury bill rates (see ch. 3).



Methodology
Characteristics and
Assumptions

Loan Principal        To determine the subsidy costs with the loan consolidation program, we
                      used the original balances of all consolidated loans in the lenders’ port-
                      folios as of September 30, 1988.

                      To determine the subsidy costs without loan consolidation, we used the
                      consolidated amounts of guaranteed student loans and Federally
                      Insured Student Loans. This is because these amounts also were subject
                      to a subsidy with the 7.99-percent Treasury bill rate we used for our
                      analysis. We used the amounts consolidated because this gave us a prin-
                      cipal amount identical to that of our first analysis. We assumed (1) all
                      loans, both consolidated and unconsolidated, entered repayment at the
                      same time and (2) that the first payment on these loans was made after
                      September 30, 1988.


Repayment Terms       For our computations on the consolidated loans, we did repayment
                      amortizations for each repayment period category specified in the 1986
                      Higher Education Amendments- 10,12,15,20, and 25 years. For our
                      computations on unconsolidated loans, we used a lo-year repayment
                      term, which is the maximum repayment term specified by the Higher
                      Education Act. For these computations, we assumed that all loans ran
                      full term; all payments were made monthly and on time; there were no
                      prepayments; there were no deaths, disabilities, or bankruptcies; and
                      there were no defaults, deferrals, or forebearances.


Subsidy Factors       Treasury bill rate. For both analyses, we used the 91-day Treasury bill
                      rate for the first quarter of fiscal year 1989, which was 7.99 percent. We
                      assumed this rate remained constant.



                      Page 43                                     GAO/HRD-90-8 Consolidated Student Loans
                         Appendix III
                         Methodology Used to Estimate Consolidated
                         Loan Program Costs




                         Special allowance rate. We used rates of 3.25 percent for consolidated
                         loans and 3.5 percent for unconsolidated guaranteed student loans and
                         Federally Insured Student Loans. When we included ALAS and SLSwe
                         used a 3.5 percent subsidy rate for these loans. We assumed the uncon-
                         solidated loans were issued prior to the 1986 amendments, which
                         reduced the subsidy rate on all guaranteed student loans from 3.5 per-
                         cent to 3.25 percent. We also assumed the subsidy rates for both the
                         consolidated and unconsolidated loans remained constant during their
                         repayment periods,

                         Interest rate. For consolidated loans, we used a g-percent interest rate-
                         which was the predominant interest rate for the consolidated loans in
                         the portfolios of the lenders we reviewed. For computing the subsidy
                         costs without the consolidation program, we used an &percent interest
                         rate. Most guaranteed student loans and federally insured loans eligible
                         for consolidation before September 30, 1988, had interest rates of 7,8,
                         or 9 percent. We used an interest rate of 8 percent in our calculations,
                         which we believe would be conservative.


Payment Plans            The lenders we reviewed offered level payment plans and a variety of
                         graduated repayment plans. We factored both kinds of plans, to the
                         extent they were used by the lenders, into our loan amortization
                         computations.


Present Value Analysis   To estimate the future subsidy costs, we discounted the stream of future
                         payments (costs) into present value terms. This allowed us to compare
                         the costs incurred in different time periods. To determine the present
                         value of the subsidy costs, we used an 8.61-percent discount rate for
                         both consolidated and unconsolidated subsidy costs. We calculated this
                         rate by averaging the bond yields in effect on October 1, 1988, for Trea-
                         sury bonds with maturities ranging from 1 to 25 years, We used these
                         kinds of bonds because their maturity dates were similar to the repay-
                         ment periods of consolidated loans,


Sensitivity Analysis     To determine the sensitivity of subsidy costs to changes in Treasury bill
                         rates, we recomputed our cost calculations using several Treasury bill
                         rates both above and below the 7.99-percent rate we used for our pri-
              Y          mary analysis. We assumed the various Treasury bill rates would
                         remain constant throughout the repayment of the loans.



                         Page 44                                     GAO/HRD-90-8 Consolidated Student Loans
Appendix   IV

Uinderlying Loans Consolidatedat Lenders
Reviewed(as of Sept. 30,198S)

                Dollars in millions
                                                             Loan amounts consolidated
                Kind   of-._--.--___
                _....-.._   loan consolidated      lo-year    12-year 15-year 20-year ___..--~~~
                                                                                             25-year       Total
                                                                                                            ...~~~~
                Stafford loans”                       $45.3 _____--
                                                                $71.3  $235.5      $245.4        $42.6
                                                                           __._~~___.~~-..-~_-.-.-..~    $640.1
                Supplemental Loans for
                Students”         ---_~_~~-... -~-___ 4.0
                _-.- -__-.--.- ___..                               2.8        17.6      59.0      11.1      94.5
                Perkins loans                           3.4        2.9        16.8      17.3       4.0      44.4
                Health professions student
                loans                                   0.1        0.1         0.7       5.4       4.4     10.7
                Total                                $52.8      $77.1      $270.6    $327.1      $62.1   $789.7

                “Includes Federally Insured Student Loans.
                “Includes Auxiliary Loans to Assist Students




                Page 45                                                  GAO/HRD-90-8 Consolidated Student Loans
Annendix      V

Decreasein Future Subsidy Costsby Increasing
Borrowers’ Minimum Interest Rates

Dollars tn mullions
                 .    _._--.---
                                           Loan
                                  interest rate                                    Fiscal year
Loan                                  (percent)        1989          1990          1991        1992            1993          1994          Total
Consolidated                              9.00      $110.77       $148.13       $154.50       $166.96       $180.28       $195.77~__- $956.41
N&consolidated                            8110        68.55         91.67         9561         103.31        111.56        121.14      591.84
                                                                                                                                         --
  Addrlional subsidy needed                           42.22         56.46         58.89         63.65         68.72         74.63      384.57
Consolidated                              9.25        98.78        132.10        137.78        148.88        160.76        174.58        852.88
Nonconsolidated                           8110        68.55         91.67         95.61        103.31        111.56        121.14        591.84
  Additional subsidy needed                          $30.23         40.43         42.17         45.57         49.20         53.44        261.04
Consolidated                              9.50        86.69        115.93        120.92        130.67        141.09        153.22        748.52
                                                                                                                                          --
Nonconsolfdated                           8110        68.55         91.67         95.61        103.31        111.56        121.14        591.84
  Additional subsidy needed                           18.14         24.26         25.31         27.36         29.53         32.08        156.68
Consolidated                              9.75
                                          __I-        74.51         99.64        103.93        112.30        121.27        131.69        643.34
Nonconsolidated                           8110        68.55         91.67         95.61        103.31        11156         121.14        591.84
  Addrtronal subsidy needed                            5.96          7.97          8.32          8.99          9.71         10.55         51.50
Consolrdated                              10.00        62.23         83.23         86.81         93.86       101.29-       110.00      537.36
Nonconsolidated                            e/10        68.55         91.67         95.61        103.31       111.56        121.14      591.84
  Addrtional subsidy needed                          -$6.32        -$8.44        -$8.80        -$9.51      -$10.27       -$I 1.14--$5zG
                                        Note: Figures shown (1) are in present value (to adjust for the cost of money to the government, (2) were
                                        developed assuming that the loans were unconsolidated S/l0 percent Stafford loans with a 3.25 per-
                                        cent special allowance rate, (3) were based on Department of Education projected consolidated loan
                                        volumes, (4) assume the mix of loans are the same as in our lenders’ profi!e as of September 30, 1988,
                                        and remained constant for all outlying years, and (5) are computed for the repayment life of the loans
                                        consolidated in each of these years.




                                        Page 46                                                 GAO/HRD-90-8 Consolidated Student Loans
Appendix      VI

Ajmount of RevenueRaisedby Charging
Various Loan Origination Feesto Offset
Additional F’uture Interest Subsidy Costs
Dollars in mullions                                                ___--
                                                                            Fiscal year
Origination fee option                       1989          1990             1991        1992         1993
                                                                                                 _______-_-___-  1994            Total
Future subsidy cost                                      $57.94
                                           $43.33 ---...._____.         $59.44        $65.32       $70.52       $76.59         $373.14
Amount raisedwith 1% fee-                    7.65         10.23          10.67          11.53      TGi-          13.52           68.05
  Addrttonal amount needed                  35.68         47.71          48.77          53.79       58.07        63.07          307.09
Future subsidy cost                          44.44         59.42           61.98        66.98        72.32         78.54___- 383.88
Amount raised wtth 2% fee                    15.30         20.46           21.34        23.06        24.90         27.04     132.10
  Additional amount needed’                  29.14         38.96           40.64        43.92        47.42         51.50     251.58
Future subsidy cost                          45.55         60.90            63.53       68.66        74.13       .- 80.50-.-    393.27
Amount raised with 3% fee                    22.95         30.69            32.01       34.59        37.35      _-- 40.56       198.15
  Addrtronal amount needed                   22.60         30.21           31.52-       34,07        36.78         39.94        195.12
Future subsidy cost                         46.65         62.39          65.07           73.32       75.93         82.46        405.82
Amount raised with 4% fee                   30.60         40.92          42.68           46.12       49.80         54.08        264.20
  Additronal amount needed                 $16.05        $21.47         $22.39      ----$27.20      $26.13        $28.38       $141.62
                              Note: Frgures shown (1) are rn present value (to adjust for the cost of money to the government, (2)
                              assume that the origination fee is added to the loan principal subject to interest subsidy, (3) are based
                              on Department of Education projected consolidated loan volumes, (4) assume the mix of consolidated
                              loans are the same as in our lenders’ portfolios as of September 30, 1988, and remain constant, (5)
                              assume all consolidated loans have a g-percent interest rate and the nonconsolidated loans have an
                              8/10-percent Interest rate, and (6) are computed for the repayment life of the loans consolidated in each
                              of these years.




                              Page 47                                                  GAO/HRD-90-8 Consolidated Student Loans
Appendix       VII

Decreasein F’uture Subsidy Costsby Lowering
SpecialAllowance Paymentsto Lenders

Dollars in millions
                                       Speclal
                                    allotiance
                                    payments                                           Fiscal year
Loan
Cchsolidated-~-                      (percent)
                                   .----                 1989             1990         1991 -      1992         1993          1994        Total
                                           3.25       $110.77         $148.13        $154.50   $166.96       $180.28      $195.77       $958.41
konconsolidated                            3.25         68.55           91.67      .-~ 95.61    103.31        111.56       121.14        591.84
  Additionalsubsidy   needed                            42.22           56.46          58.89     63.65         68.72        74.63        384.57
Consolidated                                  3.00
                                             ___-.______ 98.41---       131.60        137.26     148.32       160.16        173.92       849.67
Nondonsolidakk                                3.25
                               .-..-. _..--.-----__-     68.55           91.67         95.61     103.31       111.56        121.14       591.84
  Additionalsubsidy   needed                             29.86           39.93         41.65      45.01        48.60         52.78       257.83
Consohdated                                2.75 ----.-. 86.04             115.07
                                                                     ..-- ___-        120.02     129.69       140.08        152.07       742.93
konconsolldated                            3.25
                                      ...-___----       68.55              91.67       95.61     103.31       111.56        121.14      591.84
  Additionai s&hdy    needed                            17.49       --~ 23.40          24.41      26.38        28.52         30.93      151.09
Consolidated                               2.50         73.68            98.53        102.77     111.06       119.92        130.22      636.18
%onc&solidated                             3.25         68.55            91.67         95.61     103.31       111.56        121.14      591.84
  AdditIonal subsidy needed                              5.13             6.86          7.16       7.75         8.36          9.08 44.34
Consolidated                               2.25         61.32            82.00        85.53       92.42        99.80        108.37       529.44
Nonconshdated                              3.25         68.55            91.67        95.61      103.31       111.56        121.14       591.84
  AddItional subsidy needed                           -$7.23           -$9.67       -$10.08    -$10.89      -$11.76       -$12.77      -$62.40
                                         Note: Ftgures shown (1) are in present value (to adjust for the cost of money to the government), (2)
                                         were based on Department of Education projections for consolidated loans, (3) assume a g-percent
                                         interest rate for consolidated loans and an 8/10-percent rate for nonconsolidated loans, (4) assume the
                                         mix of consolidated loans IS the same as in our lenders’ portfolios as of September 30, 1988, and
                                         remains constant, and (5) are computed for the repayment life of the loans consolidated in each of these
                                         years.




                                         Page 48                                                 GAO/HRD-90-8 Consolidated Student Luaus
Appendix   VIII

CommentsFrom the Department of Education



                                                         UNITED            STATES DEPARTMENT                        OF EDUCATION
                                               OFFICE     OF THE      ASSISTANT        SECRETARY         FOR     POSTSECONDARY           EDUCATION




                                                                             MAR 11990

                  Mr.     Franklin     Frazier
                  Director         of Education                       and Employment       Issues
                  United       States    General                      Accounting    Office
                  Washington,         DC     20548


                  Dear       Mr.        Frazier:

                  Thank       you        for       the         opportunity              to     review            and      comment            on   the     draft
                  GAO report,                  “Consolidated                   Student            Loans:             Borrowers               Benefit          But
                  Cost       to    Them         and       the       Government               Grow,       ” GAO/HRD              90-09.


                  We have          found           the         GAO report             to     be    thoroughly                  researched               and    well
                  written.               You       have         presented             the      Congress             with        several           good
                  ooticns          to      consider.                  We have           no     further             comments             to    offer.


                                                                                            Sincerely,




                                                                                            Leonard     L. Haynes                  II
                                                                                            Ass.1 stant    Secretary




                                                         400    MARYLAND     AVE..   SW. WASHINGTON.       DC.    2020%    -




                             Page 49                                                                              GAO/HRD-90-8 Consolidated Student Loans
Appendix   IX

CommentsFrom the Lenders


                r-
                                                                                                   CITIBAN(0
                                 Stephen C. Biklen
                                 WCS Presrdenl




                     Febxuary   5, 1990


                     Mr. Franklin    Frazier
                     Director    of Education     and
                      Employment Issues
                     JJnited States General Accounting         Office
                     Human Resources Division
                     Washington,    D.C.     20548

                     Dear Mr. Frazier:
                     Thank you very much for the opportunity      to comment on the GAO
                     draft report   regarding consolidated   student loans under the
                     Stafford  Student Loan Program.
                     Citibank does have several         comments regarding       the report.      These
                     comments are as follows:
                     1)    The paper notes that consolidation           borrowers have rarely
                           defaulted.      If at all possible,     it would be extremely
                           valuable     to determine whether the consolidation           program has
                           an impact on defaults.         In order to do this two groups of
                           comparable borrowers would have to be monitored.                 One group
                           would consist      of borrowers who elected       consolidation     and the
                           other group would consist        of borrowers     with similar
                           characteristics      who did not consolidate.         Using statistical
                           sampling techniques       it would be possible       to determine
                           whether or not the consolidation          program had an impact on
                           defaults.
                     2)    The GAO Study covered the period from October 1986 to
                           September 30, 1988.            Citibank's      records indicate      that the
                           average balance of consolidation                borrowers    during this
                           period was approximately             $12,30OM.       During the period from
                           October 1988 to December 1989, the average indebtedness                      of
                           Citibank's       consolidation       borrowers     is $6,500.     We suspect
                           that the reason for this decrease is simply that many
                           borrowers       attending     shorter     school programs who took out a
                           Stafford      loan and a SLS loan totaling             $6,650 became aware of
                           consolidation        and elected to apply for it.             It is probably
                           appropriate        to determine whether this is a nationwide              trend
                            (from everything         we have heard from industry           sources, we
                           believe     this is the case) and if so the GAO study should be
                           expanded to look at this recent phenomenon.




                           Page 60                                         GAO/HRD-9043 Consolidated Student Loans
         Appendix IX
         Comments From the Lenders




WK. Franklin Frazier
Page 2
February 5, 1990

3)   The draft paper points out that there are negative               aspects
     to the consolidation        program, namely, increased      costs to the
     government due to extended repayment terms, the conversion
     of previously     unsubsidized     loans to a subsidized     status,     and
     graduated repayment terms which delay principal             repayment.
     A crucial    question   with respect to the consolidation          program
     is whether these increased         costs are offset    by lower
     borrower defaults.        Therefore,    Citibank believes     it is
     extremely    important    to pursue the point raised in item 1
     above.

4)   The GAO has identified     four possible    options with respect                    to
     the consolidation    program.     One is to discontinue    the
     program.    In order to reach a decision      regarding  this
     option,  it is extremely     important   to answer the question
     raised in point 1 above.
     The fourth    alternative       notes that consolidation      loans are
     much less costly       for the lender to service        and therefore
     special   allowance      subsidies     could be reduced thereby saving
     the government money.           Citibank    has two comments:
     -    This conclusion      is based on statistics    furnished   by one
          lender under the consolidation        program.    Before
          quantifying      the impact of consolidations     on reduced
          servicing     costs, additional  lenders should be studied.
          Citibank     would not support conclusions     based on the
          results     of one lender only.
     -    The second point is that lenders,                  when establishing
          profitability         targets,      view their     portfolio      as a whole.
          Even before loan consolidation                 existed     a lender's
          portfolio        was comprised of many different               types of loans,
          some high balance,           some low balance.           There is no
          question       that the high balance loans are more profitable
          than low balance loans.                 However, in an effort           to serve
          as many borrowers           as possible,       a lender views their
          portfolio        in total.      The high balance loans would offset
          lower profits         on the low balance loans.              Similarly,     loan
          consolidation         must be viewed the same way. The higher
          balance consolidation             loans enable a lender to offset
          lower profits         on smaller       balance loans.        Were the
          profits       on the consolidation          loans to be cut back
          sharply,       the effect      would be to reduce a lender's              over-
          all profitability           and would result         in a lender's
          willingness        to take     the smaller      balance loans, thereby
          reducing       access.




         Page 51                                             GAO/HRD-90-8 Consolidated Student Loans
          Appendix IX
          CommentsFromthe Lendem




                              - --.-.-- -- _....
                                             --_-- ___.--_---       0
Mr. Franklin Frazier
Page 3
February 5, 1990


We hope these comments are useful to you, and once again, thank
you for the opportunity to cement on draft report.   If you have
any questions, please do not hesitate to contact me at (716) 248-
7189.
Sincerely,


Stephe;      C. Biklen




          Page52
Appendix IX
Comments From the Lenders




                                         February 9, 1990




  Mr.  Franklin Frazier
  Director of Education b Employment Issues
  General Accounting Office
  441 G. Street N.W.
  Room W6737
  Washington, D.C. 20548


  Dear    Mr.   Frazier:

          Thank you for the opportunity to respond concerning
  staff's    draft that speaks about Consolidated Student Loans
  authorized by the Stafford Student Loan Program.
        I have read this report and I must congratulate   your
  staff on its content.     The report is understandable and
  reasonably uncomplicated.     It does, however, speak of a loan
  program that is managed by myself at PHEAA and has helped
  provide valuable debt management knowledge and services to
  over 11,000 PHFAA guaranteed borrowers to date.
         I am compelled to comment on this report's   position    on
  curbing defaulters.     It is my professional opinion that the
  relative   benefits of this program as they relate to default
  are grossly understated and unrealized at this time.         Addi-
  tional time and studies, gathering of data, etc., will be
  required to adequately address this program's true ability         to
  impact the student loan defaulter.
        To date, the Guaranteed Consolidation   Loan portfolio
  serviced by PHEAA has enjoyed a default rate of .02 percent.
  PHEAAhas guaranteed consolidation    loans since September.
  1987.




                Femsyhda   Higher Education Assistance Agency (PHEAA)
                            Network Consolidation Program
                   P.0. Box 8134l Handsburg, PA 17105l 1-800-338-5000




Page 63                                                GAO/HRD90-8 Consolidated Student Loans
    Appendix Ix
    Comments From the Lenders




                                    -2-




           Further conments will be made by myself and the PHEAA
      Loan Guarantee Division following Congressional actiOn.


            In closing, thank you for the opportunity    to     respond,
      and as in the past, I remain actively  available        as a resource
      for this study.

                                      Sincerely,



                                      Randy C. Knapp
                                      Manager, Loan Consolidation




      RCK:plh
      cc: Lou Bianchi
          File




Y




    Page 54                                        GAO/IUUMO-8 Ckmsolidated Student Lane
                  Appendix IX
                  Comments From the Lenders




                                                                 February    23, 1990


               Ht. Franklin Frazier
               Director of Education and Employment Issues
               General Accounting Office
               Human Remourcem Division
               WashLngton, DC 20548

               Dear Nr. Frazier:
                     Thank you for the opportunity       to comment on the draft       of  GAO’0
               CONSOLIDATED STDDENT LOAN STDDY. Generally,         I believe   the draft   study
               accurately  reflects  the limited benefit    of the current loan consolidation
               program to student loan borrowers and the increasea     in coats to a borrowera,
               landera and the government in the current program structure.
Deleted.       Page 2 - Nellie          Hae ha8 been an active consolidator                 of loans for reasons
               relating      to costs of education           in New England, a large graduate              student
               population       and for reaeonn       of portfolio     stability.        We do not believe that
               loan     consolidation     ia "generally      attractive"         to borrowers     because of     the
               single,    lower monthly payment. Our program literature                  and application   clearly
               point     out to borrowere       that in exchange for this lower monthly payment, the
               borrower      will pay substantially       more in interest         charges over the life of the
               loan.      Borrowerm     realize     this   and many eligible            borrowers choose not to
               consolidate      for this reamon.
               I would recommend       remtating      the q econd sentence   of the second paragraph on
Now on p, 2.   page 2 am followmt        “Nearly   all theso consolidations    ware handled by about 250
               of over      13,000 eligible        lenders,    each of which entered        into a specific
               consolidation      guarantee      agreement with guarantor8        electing      to guarantee
               consolidation      loans at no additional           fee.    Guarantorn      have reinsurance
               agreements with the Department of Education*.
               This restatement would correctly       state the insurance-reinmurance    relationships
               which exist and correct any misimpression that the Department of Education ham
               58 regional offices.         It would aho eliminate       the need for the misleading
               footnote    which characterizes      guaranty    agencies as V&.ldlemenn when in fact
               they ammume primary        insurance    responsibility    with contingent    roinaurance
               provided by the Department.


                                  50 Bra~nrree
                                             Hill F’ark.Suire 300, Bta1ntree,M~ssachusetrs02184-176)
                                                  617-849-1325 WO-EDU-LOAN




                  Page 65                                                   GAO/HRD-90-8 Consolidated Student Loans
                      AppendixIx
                      Canmenta From the Lenders




              Mr. Iranklin        Brarior                                                 February   23, 1990
              Pa9m two


Nowon p, 3.   Pa90   3 -   I l   graa th8t
                                         hiph balance borroworm    dotault at a much lowor rata than
              low balanaa        borroworm. Thm numborm l imply rotloct   that hiph balance borrouoro
              borrowed    to cornplot more yaarm of education,          improving their own economic
              pomition    and thum their       ability to repay.      I don't think    that focum of a
              conmolidation      program should bo default l avin9m because       thorn will likely      be
              1itt1..    I think    the focum im bettor placed on the roamonablammm         of requiring
              rapaywnt of high balance loanm within a 10 year wriod.
              I agram that the conmolidation            program pormitm loanm provioumly unmubridirod
              to bocoam partially         l ubmidizod aftor   conmolidation     but do not bolimvo that the
              full      comtm of the l uboidy l hould be viewed alono.             The Perkins    loanm which
              arm l ligiblo      for   conmolidation    are originally    mado    with 90% fodaral money at
              low intoram+ raton.            Thum, thim direct grant      carriom an implicit     opportunity
              corn+-rovonuom       that the federal government im foregoing            am a ramult of making
              tha principal        available    at nd coat to collogem and univormitiom.            Yom, there
              urn     l ubmidy comtm but thomm comtm arm lomm than the opportunity                      comt of
              maintaining     the Perkinm loan.
              I do not undermtand the roforence to tha GAO projection             that   therm arm
              potential     "unanticipated  comtm" for loanm conmolidatod through 1994 of $365
              million.       Your projoctionm    mhow that     if  thm Conqramm detorminom        to
              roauthorirm     and expand thm conmolidation  program and if $6.6 Billion    in loanm
              are conmolidated      ova the mix year mriod 1989-1994 and if Troamury Bill ratem
              r-in      conmtant, the l ubmidy comtm will br $365 million  (dimcountod).
              If  all of thorn. oventm occur           it will comt 5365 million    and will be tha romult
              Of  a conmaioum Congrrmmional            docimion.   They are not    hidden or unanticipated
              cO#tm.
Nowon p,4.    Pago 5 - In the second line         of the firmt full paragraph I would mug9omt
              submtituting   "federally omtabliahed ratem" for "below market ratam".  Londorm
              do not have dimcrotion to oet these ratem at any level.
Nowon p.5.    Pago 6 - The lamt paragraph roferm to roductionm in fodoral co&m which could
              bm    attainad through moveral changem in law pamming additional          charporn onto
              l tudontm and further roducinp      lmndor yield.      It  mhould br pointad    out that
              l tudmntm     have already     paid origination     form   on the vamt     majority     of
              the underlying     loanm boinp conmolidatod       and that thay will,    am a rmmult of
              conmolidation,     pay much more in interamt over the life of the loan.          ?urthmr,
              making a conmolidation       loan im anozmoumly time conmuming and comtly for a
              lmdor and rmducing yield im unwarranted.
              The  origination          and 8arvicing    comt   data  promentod in Table 3.7 on page 48 im
              far   too low to          accurately    roflmct    actual dollar comtm  of origination or of
              annual rarvicing          chargem.




                     Page66                                                  GAO/HRD-90-8 Consolidated Student Loans
           Appendix IX
           Canmenta From the Lendera




Wr. Ttanklin        Irarior                                                  Tobruary   23, 1990
Paga thrw

A8    I maid at thm outmet, I think the study prommntm an aecurato                and fairly
balanood   dxmcription     of the curront      conmolidation  program.  It 18 burdmod by a
groat doal of adminimtrativa          complexity roquirod by law and rmqulation.        It im
a program     which offerm      limited bonofltm to certain l tudont borroworm         whome
debt im l o mubmtantial and a&or-colloga               ouninpo mo limitad    that a monthly
l avinga of $40 18 worth the futurm corn+ of thoumandm morx in intoromt.
Student    borrowore    l hould bo aa concornod am the fodoral povarnmmnt that what
ofform much limited bonofitm co&m mo much.
Again, I appreciate   the opportunity  to participate in the mtudy &nd to               cammnt
on the draft  report.    If wa can be of furthor ammistanco, ploamm contact               OIO.




                                                    dawrmme     W. O'Tooh
                                                    Promidont
LWO/dmm




            ?!d               The New England Education Loan Marketing Corporation




           Page57                                                GAO/HRD-90-8ConsolidatedStudentLoans
-

             Appendix IX
             Comments From the Lenders




    STUDENT LOAN MARKETING ASSOCIATION
    1050 Thomas Jetlerson Street. N W
    WashinQton, D.C. 2C007.3871
    202-333.8ooo
                                                        March 9, 1990



    Mr. Joseph J. Eglin
    Assistant   Director,   Human Resources          Division
    United States Government Accounting              Office
    Washington,    D.C.   20548

    Dear Jay,
             We appreciated     the opportunity      to meet with you and your
    staff   again last week to discuss your report to Congress regarding
    consolidated     student loans.      As we stated in this meeting, we feel
    the report would benefit       from a more balanced presentation       of
    facts.     To reiterate    our earlier    discussions,   we are concerned with
    the following      aspects of the report:
                .      The failure      of the report to incorporate         the negative
                       ramifications       of delayed or lost payments (e.g.
                       defaults,     delinquencies,     deferments     and forbearances)
                       in calculating       subsidy differentials.        In effect,    GAO's
                       analysis     reviews the Stafford       Student Loan Program as
                       though it were a flawless         and risk-free      program.    The
                       consolidation       program was established       precisely   in
                       response to the default        risks inherent      in the Stafford
                       Student Loan Program.
                       Subsidy differentials     are distorted         because cumulative
                       SAP payments for loans originated          in     a given year are
                       expressed as a lump sum rather than             in the year that
                       they occur.     This approach disguises           the fact that the
                       subsidy costs to the government are             lower for
                       consolidated    loans in the first     six      years than they are
                       for Stafford    loans.
                .      The examination    of program impact on borrowers           is
                       superficial.     No consideration      is given to current
                       economic realities     impacting    students'   abilities      to
                       manage growing education       debt burdens.     Additionally,
                       the report suggests that borrower interest             costs are
                       too high but then goes on to recommend the assessment
                       of additional    borrower fees.
                .      The report does not acknowledge that reduction     of
                       Federal support for non-loan aid programs has also
                       contributed    to increased loan volume and higher average
                       loan balances.




             Page 68                                            GAO/HRD-90-8 Consolidated Student Loans
        Appendix M
        CommentaFromtheLenders




Mr. Joseph J. Eglin
March 9, 1990
Page Two


         .       The report misleads the reader by overstating     term and
                 loan amount in examples which explain   the difference      in
                 cost between a consolidated  and non-consolidated     loan.
         .       The reference  to government subsidy on eligible     loan
                 programs is incorrect.    Four out of six are eligible
                 for SAP payments and all programs are, in effect
                 subsidized.
         .       The report data on the cost of originating        and
                 servicing    consolidation   loans is not representative.
                 The implication      that the information is from one of the
                 largest   lenders is misleading.
         .       The report     does not acknowledge current   efforts  in
                 Congress to apply      graduated terms to all Stafford    loans
                 (Senate   Bill   129).
         It    is our understanding       that you were in agreement with us
on a number of these points           and that you would revise the
presentation      of certain    information    within  the report.     We have
enclosed language that         we suggest you utilize     as footnotes    to the
analysis.
         Again, thank you for meeting with us on this matter.              Please
let   me know if you would like to have further discussions.




Enclosure




       Page59                                        GAO/HRD-9043Consolidated
                                                                          StudentLoans
                                    AppendixIX
                                    CommentsFromthe Lenders




                                 Footnotes   to be Added to Report       on Consolidated      Student    Loans

                            Page Number                                Suggested     Language
NOW On pp. 2, 22, and 26.                          1 The loan consolidation            program was created as a
                                                   default   reduction     initiative.         Had such factors as
                                                   defaults,    delinquencies         and forbearances    been
                                                   taken into consideration            the differential    in
                                                   interest   subsidies      between consolidated       and
                                                   nonconsolidated      loans would have been diminished.
Now on p. 4.                                       ' The government provides  an indirect  subsidy on
                                                   the programs administered  by the schools because
                                                   it borrows the money at a higher rate than the
                                                   student borrower is charged.
Now on p, 24                                       Revise   the footnote      as follows:
                                                   ' Perkins and health professions             loans are made by
                                                   the schools and receive           indirect    government
                                                   interest     subsidies.       The government provides         the
                                                   schools with capital          funds to help establish         their
                                                   programs.       Money for these funds is raised at the
                                                   T-bill    rate.     The student then borrows the monies
                                                   at well below the T-bill            rate and repays the loans
                                                   to the schools'        revolving      fund, normally      over a
                                                   period of 10 years.           Upon repayment,       these funds
                                                   are then used to make loans to other students,                   or
                                                   are returned      to the government.          Consolidation
                                                   allows the funds to be returned             quickly     to the
                                                   revolving     fund thereby reducing         the amount of
                                                   money that needs to be raised by the government,
                                                   which in turn results           in fewer government
                                                   subsidies.
Now on pp. 4 and 26.                               ' Graduated repayment is considered       an effective
                                                   tool for reducing     student loan defaults.
                                                   Currently,    Congress is reviewing   legislation      to
                                                   apply graduated terms to all Stafford         Loans.
                                                    (Senate Bill   #29).
Now on pp, 19-20.                                  1 Data shows that loan consolidation         does have a
                                                   positive  impact on repayment behavior.          One lender
                                                   reported  a 2% cohort default    rate for consolidated
                                                   loans and a 9.8% cohort default      rate for loans
                                                   taken out by borrowers   attending     four-year
                                                   colleges.




                                    Page60                                         GAO/HRD-90-8ConsolidatedStudentLoans
      c
                              Appendix IX
                              Cenunente From the Lendem




                                                                 Suggested     Language

Now on pp. 27-28.                             ' Loan consolidation       experienced   high growth
                                              rates in the beginning       years due to increasing
                                              borrower   awareness: however, it is unlikely        that
                                              the program will     continue    to grow at such a high
                                              rate.    The cumulative     growth through 1994 may be
                                              overstated   by as much as $1.5 billion.
Deleted                                       ' Only two lenders responded to our request for
                                              data.      We were not provided        with underlying     data
                                              so we couldn't        confirm its validity.         Due to
                                              unique origination          and servicing    requirements    and
                                              qualifications         imposed by individual       programs,
                                              servicing      costs may vary widely.         For consolidated
                                              loans, the annual servicing             cost data provided
                                              ahowed a range of $7.50 to $23.40 per account
                                              annually;      origination     cost data was in a range of
                                              $30 to $50 per account.
Now on pp. 46,47,   and 48.                   Add to footnote.
                                              (5) additional   subsidy figure may be overstated
                                              because the impact of defaults,   delinquencies,
                                              forbearances   and deferments was not measured.




                         Y




                              Page 61                                        GAO/HRD-SO-8 Consolidated Student Loans
Appendix X

Major Contributors to This Report


                          Joseph J. Eglin, Assistant Director, (202) 276-5365
Human Resources           Christopher C. Crissman, Assignment Manager
Division,
Washington, D.C.

                          Charles M, Novak, Senior Evaluator
Seattle Regional Office   Charles H. Shervey, Evaluator-in-Charge
                          Sharon K. Eubank, Evaluator
                          Andrew Scott, Programmer/Analyst, Technical Assistance Group
                          Evan Stoll, Programmer/Analyst, Technical Assistance Group
                          Julie Rachiele, Technical Information Specialist




                          Page 62                                GAO/HRD99-8 Consolidated Student Loans
*




    Page 63   GAO/HRD-908 Consolidated Student Loans
RelatedGAO Products


             Guaranteed Student Loans: Credit Bureau Reporting Practices by Guar-
                                                                              -
             anty Agencies and Lenders (GAOjHRD-go-71BR, Apr. 9, 1990).

             Supplemental Student Loans: Who Are the Largest Lenders? (GAO/
             IIRD-go-72FS, Feb. 21, 1990).

             GAO VieWS on the Stafford Student Loan Program (GAO/T-HRD-90-13,
             Feb. 20,199O).

             Supplemental Student Loans: Who Borrows and Who Defaults (GAO/
             HRD-90-33FS,Oct. 17, 1989).

             Guaranteed Student Loans: Analysis of Student Default Rates at 7,800
             Postsecondary Schools (GAO/HRD-89-63BR, July 5, 1989).

             Defaulted Student Loans: Preliminary Analysis of Student Loan Borrow-
             ers and Defaulters (GAOIHRD-8%112BR, June 14, 1988).

             GAO'S Views on the Default Task Force’s Recommendations for Reducing
             Default Costs in the Guaranteed Student Loan Program (GAO/T-HRD-88-7,
             Feb. 2, 1988).

             Guaranteed Student Loans: Potential Default and Cost Reduction
             Options (GAO/HRD-88-52BR, Jan. 7, 1988).

             Guaranteed Student Loans: Analysis of Insurance Premiums Charged by
             Guaranty Agencies (GAO/HRD8SlGBR, Oct. 7, 1987).

             Guaranteed Student Loans: Legislative and Regulatory Changes Needed
             to Reduce Default Costs (GAO/HRD-87-76, Sept. 30, 1987).

             Defaulted Student Loans: Private Lender Collection Efforts Often Inade-
             qUate(GAO/HRD-87-48, Aug. 20, 1987).

             Defaulted Student Loans: Guaranty Agencies’ Collection Practices and
             Procedures (GAO/HRD-~~-~~~BR,July 17, 1986).




(104612)     Page 64                                GAO/HRD-90-8 Consolidated Student Loans