The Stafford Student Loan Program

Published by the Government Accountability Office on 1990-02-20.

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

GAO                         Testimony

on Delivery
Expected at
9:00 a.m. EST
February 20, 1990

                            Statement  of Franklin   Frazier
                            Director,  Education   and Employment Issues
                            Human Resources Division
                            United States General Accounting     Office

                            Before the
                            Subcommittee  on Permanent   Investigations
                            Committee on Governmental    Affairs
                            United States Senate


 . ( . I.-
LT.+\) ,’ .-HRD-30-13                                                      GAO   Form   160 (IZ,‘87)
recommendations       that could improve the program and reduce the
default    rate.     Some   of our recommendations         have been adopted by the
Congress and the Department,            e.g.,   actions    have been taken to
standardize      schools'     policies   on refunding      tuition     and fees, and to
delay loan disbursements            to schools    and students      until    30 days
after   enrollment      and an indication       of satisfactory        completion.
However, our recommendations            regarding     risk   sharing      by lenders and
guaranty     agencies     have not been adopted.

Loan consolidation        and the denial     of loans to schools      with default
rates over 30 percent         are two recent    actions   taken by the Congress
that could reduce the default          rate.    The Department     has recently
published     regulations     that address the default       problem.     For
example,    requiring     schools with default       rate over 20 percent     to
establish     a default    management plan is a major initiative           of the
Mr.   Chairman   and Members of the        Subcommittee:

I am pleased      to be here today to discuss     the Stafford    Student           Loan
Program.      This program is of extreme importance        to students
seeking a postsecondary      education    and to the future    workforce            of
our nation.       However, in recent   years it has been the subject                of
greater    scrutiny   and much of that has focused on those
student-borrowers      who have defaulted    on their  loans.

I will   focus my comments today on (1) how the Stafford         program
works,    (2) the growth in loans guaranteed      and defaulted,    and (3)
past GAO recommendations,     and recent  legislative     and regulatory


The Department     of Education     offers     seven major student         financial
aid programs.      These programs were established              by title     IV of the
Higher Education      Act, as amended, and include            Pell grants,
supplemental     educational    opportunity       grants,    college     work study,
Perkins   loans,   Stafford   loans,     Parent Loans for Undergraduate
Students    (PLUS), and Supplemental         Loans for Students          (SLS).      For
fiscal   year 1989, the Department          estimates     that the seven programs
made almost $18 billion       of student       aid available       through     over 9.8
million   awards.     (See table    1.)

Table 1:         Aid Available      and Number of Awards    for   the      Seven Maior
Financial       Aid Programs     (Fiscal  Year 1989)

                                                           Number of
                                  Aid   available          awards
Aid   orouram                     Jin   millions)          (in thousands)

Pell grants                          $4,863.0                      3,302
Supplemental   grants                    442.4                        633
Work study                               780.3                        835
Perkins  loans                           884.0                        826
Stafford                              8,431.0                      3,324
PLUS                                     689.0                        218
SLS                                   1.817.0                         676
Totals                              $17,906.7                      9,814

The Stafford      Student   Loan Program,    formerly    called    the Guaranteed
Student     Loan Program, consists      of Stafford,     PLUS, and SLS loans.
These three kinds of loans represented             60 percent     of federal
student     aid made available     in fiscal    year 1989.      These loans are
guaranteed     by the federal     government    against   borrowers'      death,
disability,     bankruptcy,     and default.     Banks, credit       unions,   and       .
savings     and loan associations      are the primary      providers     of student

The three       types of loans differ    somewhat    in their       terms and
conditions        and I would like  to highlight     some of      these differences.

Stafford     Loans

These loans --formerly       called  guaranteed    student     loans--are  the
largest    of the three loan types        (77 percent   of aid available       in
1989) and have been available          since the program was created          as part
of the Higher Education         Act of 1965.     The loans are based on the
student-borrower's       financial   needs which means that all borrowers
must show financial        need regardless    of their     income to qualify.
Other key facts     are:

      --Interest      rates    for new borrowers  are 8 percent      for the first
          4 years   of repayment     then 10 percent     after that.
      --Maximum     loans limits     are $17,250 for undergraduates          and
          $54,750   for graduate     students.
      --Borrowers       generally   have a 6-month grace period        after
          leaving   school before      repayment begins.

PLUS Loans

These loans enable parents      to borrow funds for each dependent
student    (those who are not generally     responsible   for their  own
financial     support) enrolled   at a school.    These loans basically
started   in 1981 and are not needs-based.        Other key facts   are:

      --Interest      rates are variable      and are determined       once a year
         with a ceiling        of 12 percent,   which is the current       rate.
      --Maximum loan limits          for each dependent     are $4,000 per year
          to a total     of $20,000.
      --There      is normally    no grace period     and repayment     must
        -generally      begin within     60 days after   disbursement.

SLS Loans

These loans are available         to independent     undergraduates          (those
students    generally    responsible    for their    financial        support)    and
graduate    students.     These loans basically        started      in 1982l and like
PLUS loans are not needs-based.            Also like PLUS loans,           SLS loans
generally    have the same interest        rate,  borrowing       limits,      and no
grace period.        However, some of the provisions           for SLS loans were
recently    changed in legislation        and I will    discuss       those changes
later    in my statement.

lSLS loans were part of the Auxiliary           Loans to Assist      Students
program prior   to 1986 and had terms         and conditions     similar   to   SLS
loans,  and both are reported  by the         Department     as SLS loans.

The program involves      five parties     including     students,   schools,
lenders,   guaranty   agencies,    and the Department        of Education.                 I
would like   to provide     some information       on each
                                                      each party.

The Student

The student        initiates       the loan process.         The student     provides
eligibility        information         to the school,     applies    to a lender      for the
loan after       eligibility         is determined,      arranges    for repayment with
the lender,        and repays the loan.            Stafford     loan borrowers      receive     a
federal     subsidy        throughout     the period     of their    loans including        a
low interest         rate and make no interest            payments on the loan while
they attend        school.        When the student       completes     or otherwise      leaves
school,     he or she is to start             repayment.      Between fiscal       year 1983
and 1989, the number of Stafford                  program loans guaranteed          each year
increased      from about 3 million            to almost 4.7 million.

The School.

The schools verify         students'    eligibility          and the amount of
financial      aid needed.      There are about 8,000 schools                  participating
in the Stafford        program.      The kinds of schools            participating          in the
program are categorized           by: a-year        public,     2-year private,         4-year
public,     4-year private,       and proprietary           (for profit      trade and
vocational)       schools.

The Lender

Lenders make loans and under the programs'      guaranty      provisions,
must exercise   proper care in making, servicing,     and collecting
them, and follow    the applicable  program requirements.         Lenders
bill  the Department   each quarter  for the federal     interest       subsidy
payment for the loans they hold.       These payments include         the

students'      interest     while they are in school.       Also, during   the life
of the loan,         the lender    receives a special   allowance  payment that
is intended        to provide    it with a near-market     rate of return.    They
file   default       claims with the guaranty     agency, but cannot be
reimbursed       for their    claims until   borrowers   have been at least    180
days delinquent.

There are about 13,000 lenders           participating       in the program.       As
of September 30, 1988, they held about $45.1 billion                     in
outstanding      loans.    Approximately      $89 billion      in guaranteed
student     loan commitments were made since the program began in
1965.     Most of the loans are held by few lenders.                  For example,    25
lenders     had 52 percent     of the $45.1 billion         outstanding,     and one
organization     --the  federally    chartered      Student    Loan Marketing
Association--      had 25 percent     ($11.3 billion)       of the total.       (See
table   2.)

Table 2:    Ten Larqest      Holders    in the   Stafford     Loan Proaram     (as of
Sentember 30. 1988)
(Dollars  in millions)
Loan holder                                          Amount    outstandinq

Student    Loan Marketing     Association                   $11,317.6
Citibank    (New York)                                        1,891.5
California     Student   Loan Finance Corp.                   1,314.0
Chase Manhattan      Bank (New York)                             967.4
Nebraska Higher Education         Loan Program                   837.0
Chemical Bank (New York)                                         729.7
New England Education        Loan Mktg. Corp.                    587.7
Florida    Federal   Savings Bank                                574.0
Marine Midland      Bank (New York)                              506.1
Manufacturers      Hanover Trust Company                         424.3

The Guaranty     Aaencv

The guaranty     agencies   carry out several     tasks,    including:       (1)
issuing    guarantees    on qualifying    loans so that when a borrower
fails   to repay his or her loan due to death,           disability,
bankruptcy,     or default,    the lenders    can be reimbursed        for their

claims:   (2) charging    students     an insurance     premium of up to 3
percent   of the loan;     (3) verifying     that lenders     properly   service
and attempt    to collect     loans before     the agency pays default       claims:
and (4) remitting      to the Department       its portion     of monies the
agencies'    subsequently     collect    from defaulted     borrowers.

If lenders   choose not to make loans to eligible                students--
especially   those attending      schools with high default              rates--the
guaranty   agency must find another          lender     or become the "lender          of
last resort"    itself.   There are 55 guaranty             agencies--state
agencies   or private   nonprofit       organizations--that         administer      the
program in the 50 states,        District      of Columbia,      the Pacific
Islands,   Puerto Rico, and the Virgin            Islands.

The Denartment      of   Education

The Department         of Education    is responsible      for administering      the
Stafford      program and for overseeing          the activities      of the various
participants.          It pays lenders     interest   subsidies,      and reimburses
guaranty      agencies     for up to 100 percent      of lenders'      claims.      To
partially      offset     program costs,     the Department      charges borrowers     a
5 percent      origination      fee and receives     payments from the guaranty
agencies      on collections       from reinsured    defaulted     loans.


Now I would like      to provide    a perspective     on the Stafford   program
in terms of loan growth,        defaults,     and program costs.    The
Department   provided     us with the information       we used to calculate
loan growth,    defaults,    and program costs.        The data cited   for
fiscal  year 1989 are estimates           from the Department.

Loan Growth

The Stafford   program has grown during       the 198Os, especially             since
1983.   The amount of new loans guaranteed2          through     fiscal      year 1989
for the entire    program increased    83 percent      since 1983.          Because
PLUS and SLS loans were basically        just starting      during      this period,
their  growth rates --391 percent     and 1,893 percent,        respectively--
are expected   to be high.     (See table    3.)

Table 3:    Loan Volume     Has Substantiallv      Increased    Since   Fiscal,
Year 1983
(Dollars  in millions)                                                        I
                                 Loans auaranteed
                          Fiscal   year         Fiscal   year      Percent
Tvne of      loan             1983                  1989           increase
Stafford                    $6,537                 $9,581               47
PLUS                            151                    741             391
SLS                             106                 2,113           1,893
Total      program          $6,794                $12,435               83

Default      Growth

Defaults  have risen dramatically.         Overall,     defaults    for the total
program increased     338 percent    in the last     6 years.      Stafford    loans
defaults  went up 266 percent      from fiscal      year 1983 through       fiscal
year 1989, while PLUS and SLS loan increases               were 6,525 percent      and
111,221 percent,    respectively.       (See table     4.)

'Loans guaranteed   represent    commitments made to lenders     by
guaranty  agencies.    However, actual     loan disbursements  would be
less in those instances     where students     decide not to enroll  in
school and the loan was cancelled.
Table 4:    Defaults  Have Dramaticallv              Increased     Since       Fiscal
Year 1983
(Dollars  in thousands)

                        Default navments          to lenders
                     Fiscal                         Fiscal                 Percent
Tvoe of      loan    year 1983                      year 1989              increase

Stafford             $444,022                      $1,623,000                  266
PLUS                       483                          32,000                  a
SLS                        265                         295,000                  a

Total      program   $444,770                      $1,950,000                  338
                                                         I                 .

a Default    rates   for PLUS and SLS loans increased            6,525 percent     and
111,221 percent,       respectively,    over the 6-year period.           However,
these loans were relatively          new and the eligibility         for SLS loans
had been liberalized        within   the last 3 years.         But by all
indications,     default    rates are rising    rapidly      for those two types
of loans.

Although      both loan volume and loan defaults                    have increased
dramatically       over the last 6 years,              the increase        in defaults     has
far exceeded the increase                in loan volume.          For example,        as I
pointed     out earlier,         total     loans increased         83 percent      from fiscal
year 1983 through           1989, while defaults            increased      338 percent--four
times faster       than loan volume.             Also,    for all three kinds of loans,
defaults      substantially         exceeded loan growth during               the last 6
years.       (See table      5.)       The Department       attributes       a large portion
of these default          increases        to the four-fold         increase     in Stafford
loans from 1977 to 1983.

Table 5:   Increases           in Defaults    Greatlv     Exceeded   Increases      in Loan
Volume Since Fiscal            Year 1983

                               Loan                Default            Times
Tme     of     loan            increase            increase           exceeded
Stafford                           47                     266              5.7
PLUS                              391                  6,525              16.7
SLS                            1,893                 111,221              58.8
Total        program               83                     338              4.1

Prouram        Costs

As a portion    of total      program costs3,      defaults    have risen    from
about 10 percent       in fiscal     year 1980 to 36 percent        in 1989.
Interest   subsidies      have decreased      as a portion     of total   costs to
where they were about 60 percent             of the program's      costs in 1989.
Other costs,     including      the Department's      expenses for other claims,
such as death and disability,            have leveled      off to 4 percent     of
program costs in 1989.            (See figure   1.)

  3The default         costs   represent     claim    payment   amounts   to   guaranty
Fisure          1:       Defaults            Are Becomina      A Greater    POrtiOn       of   Procrram

100      Parunt of Pmgnm Costs


  1990          1991       1992       1992      1994   1999   1996   1997   1988   1SBB

  Flsoal Yur

         -         lnmrestsubsidiis
         -1-1      Allottwrmsts
         m         Default payments to agendw


 Students  from proprietary      schools  are receiving     an increasing
 share of Stafford    loans.     The Department    reported   that in fiscal
 year 1983, proprietary      school borrowers    comprised    17 percent   of
 all borrowers    and received    14 percent   of the loan dollars.
 However, 5 years later,       34 percent   of such borrowers     received   30
 percent               of Stafford    loans--double  the 1983 share,     although                     these
 figures               declined    somewhat in 1988.    (See figure  2.)

    Fiuure    2:            Proprietarv  School Borrowers                   Are Receiving   An
    Increasins              Share of Stafford   Loans




      1993                 1984                     1985       1906      1987        1988
      !=lsd    Year

              -       PrupmaJy    school bormwefs
              11-B    Propmaly    schooidonam

    The default       rate for proprietary          school borrowers          is greater     than
    the rate for borrowers           from other schools.              In July 1989 we
    reported4     that while proprietary            school borrowers         comprised      about
    22 percent      of borrowers       who received       their     last loan in 1983, they
    accounted     for 44 percent        of defaults       as of September 30, 1987.
    Over that 4-year period,            student     default      rates   for the five kinds
    of schools      ranged from 10 percent            for 4-year public          and private
    schools,    to 39 percent        for proprietary         schools.       The Department        of
    Education     reported     similar      results     in two recent       studies    of school
    default    rates.      Both studies        determined       which borrowers,       by kind of
    school,   were in default          after    entering     repayment.         The results

    4Guaranteed  Student                            Loans:     Analvsis of Student  Default Rates   At
    7,800 Postsecondarv                             Schools,    GAO/HRD-89-63BR, July 5, 1989.
showed proprietary    school borrowers          had the   highest       default   rates:
40 percent   for 1986; while declining           to   33 percent      for   1987.     (See
figure  3.)

Figure         3:   GAO and Deoartment  Studies   Found That        Pronrietarv
School         Borrowers  Have the Hiahest   Default  Rates

so    Peroent of Dofaulton






      1       ) GA01993~tudy



You asked us to provide      information    about our previous    work on the
Stafford   program.    I have attached     a listing of our recent
products    to my statement.      During the last 4 years,     we have issued
10 products    on this program,     many of which recommended ways to

reduce defaults     and other program costs.         For example,   one report5
contained   30 options    for strengthening     the program and included
suggestions   directed   to the five participants.         Some of these
options   have been incorporated      into legislation     or regulations.
Some of the key suggestions       we made which would reduce default
costs were to:

       --Standardize         policies     for refunding       tuition       and fees to
          students      who fail      to complete      enrollment        periods.        (Action
       --Delay     loan disbursements           to students       and schools        for some
          period     aft&     classes    begin.      (Action      taken.)
       --Require      that lenders        share the default           risk.      (Action     not
       --Increase       guaranty      agencies'     default     risk or restructure             the
          way in which they share this risk.                     (Action      not taken.)
       --Require      that guaranty         agencies    share all default            payments on
           reinsured      loans with the Department.                (Action      not taken.)

A significant       option      which the Congress enacted was extending       the
IRS income tax refund             offset  program.   This program offsets
defaulted      borrowers'       income tax refunds    if they do not have
repayment      arrangements        with the guaranty    agencies.  In the last
three tax years,         this     program has recovered    over $500 million   from
student     loan defaulters.


When the Higher Education Act was reauthorized   in October 1986,
many changes were enacted to address the default   issue.   Among the
more significant changes included  establishing  a loan consolidation

5Guaranteed   Student  Loans:  Potential                Default     and Cost     Reduction
Options,   GAO/HRD-88-52BR, January 7,                 1988.
    program which allows        borrowers     with high student         loan debt to
    stretch    out their    repayment periods         for as many as 25 years,
    compared to normal lo-year           repayment periods         for Stafford     loans.
    This program is designed         to reduce defaults          by allowing     borrowers'
    to make lower monthly payments over longer periods                     of time.
    Another provision       enacted    through     reauthorization        mandated the
    reporting     of student    loan information         to credit     bureaus.     Through
    this provision,       borrowers    who are delinquent          or do not repay their
    student    loans would have this         information      made part of their        credit
    histories,     which should encourage those who may contemplate
    defaulting      to repay.

    The Congress continues            to make legislative         changes directed      at
    reducing     defaults.        Most recently,        as part of the Omnibus Budget
    Reconciliation         Act of 1989 (Public          Law 101-239),    it enacted
    several     major changes --especially            to the SLS program.         For
    example,     one of the most significant              changes is that effective
    January     1, 1990, no SLS loans can be made to borrowers                   (unless
    they were previously            enrolled     at the institution      on date of
    enactment      and had already         received     an SLS loan) attending       schools
    that have default          rates --as     determined    by the Department      of
    Education--     of 30 percent         or more.

    The Department        has also been active          in trying      to reduce defaults.
    One of its most significant             actions     was publishing        regulations     in
    November 1986 creating          specific      requirements       for lenders       and
    guaranty      agencies   to follow      in collecting       delinquent       and defaulted
    loans.      It more recently        issued additional         regulations       in June 1989
    allowing      the Department      to use school default            rate information       to
    initiate      sanctions    against     schools    exceeding      certain     default   rate
    thresholds.         For example,      schools with default           rates above 20
    percent     must develop and submit default              management plans to address
    the causes of defaults,            or face possible        sanctions      by the


Despite     many legislative       and regulatory        changes that have been
made to deal with the default             issue,    there    is still    much to be
done.     We have several        ongoing and planned assignments             that relate
to defaults.       For example,       we plan to initiate         work soon on the
accreditation,      certification,        and eligibility       processes      that
schools     undergo to become eligible           to participate        in the Stafford
program so that students           attending     these schools        can receive   such
 federal    aid.


Mr. Chairman, that concludes my statement.    My colleagues and I
would be happy to answer any questions   you or other Subcommittee
members may have.

ATTACHMENT                                                                 ATTACHMENT

                               RELATED GAO PRODUCTS
Sunplemental  Student    Loans:   Who Are the      Largest  Lenders?
(GAO/HRD-90-72FS,   will   be issued on Feb.       21, 1990).
Sunnlemental  Student   Loans: Who Borrows         and Who Defaults
(GAO/HRD-90-33FS,   Oct. 17, 1989).
Guaranteed    Student  Loans:    Comoarisons  of Single   State and
Multistate    Guaranty  Auencies   (GAO/HRD-89-92,   July 11, 1989).
Guaranteed  Student    Loans:   Analvsis of Student  Default         Rates      at
7,800 Postsecondarv     Schools  (GAO/HRD-89-63BR,  July 5,         1989).
Defaulted    Student  Loans:      Preliminarv  Analysis     of Student  Loan
Borrowers    and Defaulters      (GAO/HRD-88-112BR,     June 14, 1988).
GAO's Views on the Default   Task Force's         Recommendations  for
Reducina Default  Costs in the Guaranteed          Student Loan Proaram
(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
bv Guarantv Aaencies    (GAO/HRD-88-16BR,  Oct. 7, 1987).
Guaranteed    Student Loans:   Lesislative and Resulatorv           Chanaes
Needed to    Reduce Default  Costs (GAO/HRD-87-76,  Sept.          30, 1987).
Defaulted    Student  Loans:     Private  Lender Collection      Efforts      Often
Inadeouate     (GAO/HRD-87-48,    Aug. 20, 1987).
Defaulted  Student   Loans:   Guaranty Acrencies'   Collection         Practices
and Procedures    (GAO/HRD-86-114BR,   July 17, - 1986).