This is the accessible text file for GAO report number GAO-06-195 
entitled 'Student Consolidation Loans: Potential Effects of Making 
Fiscal Year 2006 Consolidation Loans Exclusively through the Direct 
Loan Program' which was released on January 5, 2006. 

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Report to the Ranking Minority Member, Committee on Education and the 
Workforce, House of Representatives: 

United States Government Accountability Office: 

GAO: 

December 2005: 

Student Consolidation Loans: 

Potential Effects of Making Fiscal Year 2006 Consolidation Loans 
Exclusively through the Direct Loan Program: 

GAO-06-195: 

GAO Highlights: 

Highlights of GAO-06-195, a report to the Ranking Minority Member, 
Committee on Education and the Workforce, House of Representatives: 

Why GAO Did This Study: 

Under the Federal Family Education Loan Program (FFELP) and the Federal 
Direct Loan Program (FDLP), the government guarantees and makes 
consolidation loans to help borrowers manage their student loan debt. 
By combining loans into one and extending repayment, monthly repayments 
are reduced. Unlike other student loans, consolidation loans carry a 
fixed interest rate. Recently, trends in interest rates and 
consolidation loan volume have increased overall federal costs, leading 
Congress to consider cost reduction proposals. Under the Federal Credit 
Reform Act, the government calculates, for budgetary purposes, the net 
cost, or “subsidy cost,” of extending or guaranteeing credit over the 
life of loans. Agencies generally reestimate, subsidy costs annually to 
include actual results and adjust future program estimates. 

GAO was asked to provide information on the budgetary effects of making 
consolidation loans exclusively through FDLP. We developed information 
to answer the following questions: (1) What would be the estimated 
budgetary effect of providing consolidation loans exclusively through 
FDLP in fiscal year 2006? (2) To what extent and for what reasons might 
this estimated budgetary effect change as subsidy costs are reestimated 
in future years? (3) How might FFELP lenders and borrowers be affected 
if consolidation loans were made exclusively through FDLP? 

What GAO Found: 

Providing consolidation loans exclusively through FDLP in fiscal year 
2006 could yield estimated budgetary cost savings of about $3.1 
billion, based on subsidy cost estimates in the President’s fiscal year 
2006 budget, but actual savings would remain unknown until all loans 
made in fiscal year 2006 are repaid. In addition, federal 
administrative costs, which are not included in subsidy cost estimates, 
would likely increase and offset estimated subsidy cost savings by 
about $46 million over the life of the loans, based on Department of 
Education (Education) estimates, because FDLP administrative costs are 
higher than those of FFELP. Tax revenues, which could affect estimated 
savings, are also excluded from subsidy cost estimates. The $3.1 
billion estimated savings result from

* avoiding an estimated subsidy cost of $2.5 billion for providing a 
projected volume of $25.5 billion in FFELP consolidation loans, and 
* an estimated gain to the federal government of $620 million if the 
projected FFELP consolidation loan volume of $25.5 billion were made 
through FDLP rather than through FFELP. 

The $2.5 billion estimated subsidy costs for FFELP consolidation loans 
is based in part on the fact that the government-guaranteed minimum 
yield provided to FFELP lenders, which varies based on market interest 
rates, was projected to be higher over the life of the loans than the 
fixed interest rate borrowers would pay. For FDLP loans, the fixed 
interest rate borrowers would pay was projected to be higher than the 
rate Education would pay to finance its lending, a fact that, in 
combination with other assumptions, resulted in a gain to the 
government for these loans. 

The estimated subsidy cost savings from providing consolidation loans 
exclusively through FDLP could change significantly because of changes 
in assumptions underlying subsidy cost estimates. Key assumptions 
include (1) economic conditions, such as interest rates; (2) loan 
performance, such as the portion of loans that default; and (3) loan 
volume. 

In estimating consolidation loan subsidy costs, Education must make 
assumptions about cash flows generated many years in the future. Such 
assumptions are periodically revised as new data about the assumptions 
and actual loan volume and costs incurred are known. As a result, 
subsequent subsidy cost reestimates could change substantially from 
initial estimates, thereby substantially changing the estimated 
budgetary effect. The actual impact on lenders and borrowers of making 
consolidation loans exclusively through FDLP is difficult to predict, 
but according to lenders, consolidating all loans through FDLP would 
reduce lender revenues and borrower benefits, such as on-time repayment 
incentives. These potential impacts could be somewhat offset, however, 
by other factors. For example, some lenders told us that they would 
consider providing nonconsolidation loan borrowers alternative 
repayment options and other incentives to encourage them not to 
consolidate their loans. If successful, lenders would continue to earn 
income from loans not consolidated. 

What GAO Recommends: 

www.gao.gov/cgi-bin/getrpt?GAO-06-195. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Cornelia Ashby at (202) 
512-8403 or ashbyc@gao.gov. 

[End of section] 

Contents: 

Letter: 

Summary of Findings: 

Providing Consolidation Loans Exclusively through FDLP Could Yield 
Estimated Budgetary Savings of $3.1 Billion in Fiscal Year 2006: 

Savings Estimates Could Change Substantially as a Result of Reestimates 
of Subsidy Costs because of Changes in Key Assumptions and Actual 
Results: 

Effect on FFELP Lenders and Borrowers Difficult to Predict: 

Concluding Observations: 

Agency Comments: 

Appendix I: Briefing Slides: 

Abbreviations: 

FCRA: Federal Credit Reform Act: 

FDLP: William D. Ford Federal Direct Loan Program: 

FFELP: Federal Family Education Loan Program: 

PLUS: Parent Loans for Undergraduate Students: 

United States Government Accountability Office: 

Washington, DC 20548: 

December 5, 2005: 

The Honorable George Miller: 
Ranking Minority Member: 
Committee on Education and the Workforce: 
House of Representatives: 

Dear Mr. Miller: 

The federal government makes consolidation loans available to help 
borrowers manage their student loan debt. By combining multiple federal 
student loans into one and extending the repayment period, 
consolidation loans can reduce borrowers' monthly payments. Current 
provisions also allow consolidation loan borrowers to lock in a fixed 
interest rate, unlike other federal student loans, such as Stafford 
loans and Parent Loans for Undergraduate Students (PLUS), which carry 
interest rates that vary from year to year based on statutory 
formulas.[Footnote 1] As we previously reported, the annual volume of 
consolidation loans has increased significantly in recent years, rising 
from $12 billion in fiscal year 2000 to over $68 billion in fiscal year 
2005.[Footnote 2] Consolidation loans are available under both of the 
Department of Education's (Education) two major student loan programs, 
the Federal Family Education Loan Program (FFELP) and the William D. 
Ford Federal Direct Loan Program (FDLP). 

While both FFELP and FDLP offer consolidation loans, the federal 
government's role in FFELP differs significantly from its role in FDLP. 
Under FFELP, students or their parents borrow from private lenders, 
such as banks, and the federal government guarantees the lenders a 
statutorily specified minimum yield that is tied to, and varies with, 
money market financial instruments. When the fixed interest rate paid 
by consolidation loan borrowers is lower than the minimum yield 
guaranteed to lenders, the government pays lenders the difference--a 
subsidy called special allowance payments. Additionally, the federal 
government guarantees repayment of loans if borrowers default. Under 
FDLP, students or their parents borrow money directly from, and repay 
loans to, the federal government. Education uses contractors to carry 
out the direct loan program. 

Although the method for calculating estimated federal budgetary costs 
of consolidation loans is the same for FFELP and FDLP, the differences 
between the federal government's role in one loan program and its role 
in the other affect these cost estimates. Under the Federal Credit 
Reform Act (FCRA) of 1990, agencies are required to estimate, for 
purposes of the budget, the net cost, called the subsidy cost, of 
extending or guaranteeing credit over the life of a loan. Agencies are 
required to calculate the subsidy cost to the government based on the 
net present value of all estimated cash flows, excluding administrative 
costs, over the life of the loan.[Footnote 3] When the present value of 
the cash outflows is greater than the present value of the cash 
inflows, the difference is shown as a subsidy cost in the federal 
budget. When the present value of the cash inflows is greater than the 
present value of the cash outflows, the difference is shown as a 
"negative subsidy," or gain to the government. Agencies generally 
update or revise subsidy cost estimates, called reestimates, annually 
to take into account changes in estimated loan performance (e.g., rates 
of borrower loan default), actual program costs incurred, and new 
forecasts of future economic conditions, such as interest rates. 

Recent trends in interest rates and consolidation loan volumes have 
affected consolidations loan costs in the FFELP and FDLP programs in 
different ways, but overall estimated federal budgetary costs of 
consolidation loans have increased. This has led Congress to consider 
changes in the two programs that could reduce federal costs. One 
alternative, about which you asked us to provide information, is to 
make consolidation loans available to borrowers only through FDLP. To 
shed light on this potential alternative, we developed information to 
address the following questions: 

1. What would be the estimated budgetary effect of providing 
consolidation loans exclusively through FDLP in fiscal year 2006? 

2. To what extent and for what reasons might this estimated budgetary 
effect change as subsidy costs are reestimated in future years? 

3. How might FFELP lenders and borrowers be affected if consolidation 
loans were made exclusively through FDLP? 

On October 31, 2005, we briefed your staff on the results of our work 
based on the briefing slides we include in appendix I. The purpose of 
this letter is to officially transmit the slides we used to brief your 
staff. 

To determine the estimated budgetary effects of providing consolidation 
loans exclusively through FDLP in fiscal year 2006, we reviewed cost 
estimates contained in the budget of the United States government for 
fiscal year 2006 as well as more detailed cost information prepared by 
Education on subsidy and administrative cost estimates and projected 
consolidation loan volume. On the basis of our review of the 
documentation for these data, we determined that the data were 
sufficiently reliable for the purpose of our review. We also 
interviewed officials from Education and the Congressional Budget 
Office to discuss and obtain information about the development of 
subsidy and administrative cost estimates for consolidation loans. To 
determine how these estimated budgetary effects could change and the 
reasons for such changes as subsidy costs are reestimated in future 
years, we analyzed original subsidy cost estimates and reestimates for 
several prior loan cohorts, reviewed analyses developed for a recent 
GAO report,[Footnote 4] reviewed budget documents, and interviewed 
Education officials to gather information on the reasons why subsidy 
cost estimates have changed in the past. To determine how lenders and 
borrowers might be affected if all loans were consolidated through 
FDLP, we interviewed or obtained written comments from several large 
FFELP lenders; the Consumer Bankers Association, a national trade 
association for financial institutions; the Education Finance Council, 
a nonprofit trade association for state-based student loan secondary 
market organizations; Education; and college student aid officials. We 
conducted our work from January 2005 to October 2005 in accordance with 
generally accepted government auditing standards. 

Summary of Findings: 

Providing consolidation loans exclusively through FDLP in fiscal year 
2006 could yield estimated budgetary cost savings of about $3.1 
billion, based on subsidy cost estimates in the President's fiscal year 
2006 budget. However, actual savings would remain unknown until all 
loans made in fiscal year 2006 are repaid and actual interest rates 
over the life of the loans are known. The estimated savings could 
change substantially as future reestimates of subsidy costs incorporate 
actual results as well as reflect changes in key assumptions about the 
future, such as interest rates, loan performance, and loan volume. The 
actual impact on lenders and borrowers is difficult to predict. 
However, according to lenders, consolidating all loans through FDLP 
would reduce lender revenue and certain borrower benefits provided by 
FFELP lenders. 

We provided Education with a copy of our draft report for review and 
comment. Education reviewed the report and did not have any comments. 

Providing Consolidation Loans Exclusively through FDLP Could Yield 
Estimated Budgetary Savings of $3.1 Billion in Fiscal Year 2006: 

Providing consolidation loans exclusively through FDLP in fiscal year 
2006, based on figures in the President's budget for fiscal year 2006, 
could yield estimated budgetary cost savings of about $3.1 billion, but 
actual savings would remain unknown until all loans made in fiscal year 
2006 are repaid. These estimated budgetary cost savings result from: 

* avoiding an estimated subsidy cost of $2.5 billion for providing a 
projected volume of $25.5 billion in FFELP consolidation loans, and: 

* an estimated gain to the federal government of $620 million if the 
projected FFELP consolidation loan volume of $25.5 billion were made 
through FDLP rather than through FFELP. 

The $2.5 billion subsidy cost estimate in the President's budget for 
fiscal year 2006 for FFELP consolidation loans is based in part on the 
fact that the government-guaranteed yield provided to FFELP lenders was 
projected to be higher than the fixed interest rate consolidation loan 
borrowers would pay, resulting in special allowance payments to lenders 
over the entire life of these loans. For FDLP loans, the fixed interest 
rate consolidation loan borrowers would pay was projected to be higher 
than the interest rate Education would pay to finance its lending, 
which, in combination with other assumptions underlying Education's 
estimate, resulted in a gain to the government for these loans. Federal 
administrative costs, which are not included in subsidy cost estimates, 
would likely increase and offset estimated subsidy cost savings by 
about $46 million over the life of the loans, based on Education's most 
recent estimates, because FDLP administrative costs are higher than 
those of FFELP per $100 of loans made. Tax revenues, which could affect 
estimated savings, are also excluded from subsidy cost estimates. 

Savings Estimates Could Change Substantially as a Result of Reestimates 
of Subsidy Costs because of Changes in Key Assumptions and Actual 
Results: 

The estimated savings from providing consolidation loans exclusively 
through FDLP could change significantly because of changes in key 
assumptions underlying subsidy cost estimates and actual results. Key 
assumptions include: 

* economic conditions, such as interest rates; 

* loan performance, such as the portion of loans that default; and: 

* loan volume. 

In estimating subsidy costs for a loan cohort, Education must make 
assumptions about cash flows that are generated many years in the 
future. Estimated subsidy costs are periodically revised as new 
information about the assumptions and actual loan volume and costs 
incurred are known. As a result, subsequent subsidy cost estimates 
(i.e., reestimates) for a cohort of loans could change substantially 
from initial estimates, and actual costs would remain unknown until all 
loans made in fiscal year 2006 are repaid and actual interest rates 
over the life of the loans are known. As we recently reported,[Footnote 
5] for example, the low interest rates that persisted over the last few 
years were below levels previously forecasted. Subsequent subsidy cost 
reestimates of prior consolidation loan cohorts varied from original 
estimates as a result. Estimated savings could further be affected by 
revised assumptions concerning loan performance, including changes to 
estimated rates of borrower defaults and loan prepayments. Moreover, 
estimated cost savings are sensitive to assumptions concerning the 
volume of consolidation loans that would be made in 2006. As interest 
rates reached historic lows in recent years, FFELP lenders aggressively 
marketed consolidation loans. Without such aggressive marketing, 
borrower demand for consolidation loans might decrease. If fewer FFELP 
borrowers consolidated loans through FDLP than estimated, the gain to 
the federal government would be reduced. For example, if only 75 
percent of the projected FFELP consolidation volume of $25.5 billion in 
fiscal year 2006 were made through FDLP, estimated subsidy cost savings 
would decline from about $3.1 billion to about $2.9 billion.[Footnote 
6] On the other hand, if consolidation loan volume was higher than 
expected, estimated savings could exceed $3.1 billion. 

Effect on FFELP Lenders and Borrowers Difficult to Predict: 

Although the actual impact on FFELP lenders and borrowers of providing 
consolidation loans exclusively through FDLP is difficult to predict, 
major FFELP consolidation loan lenders informed us that it would reduce 
lender revenues, the total volume of consolidation loans originated, 
and certain borrower benefits, such as repayment incentives provided by 
lenders, including lower interest rates, for on-time borrower 
repayments. These potential impacts could, however, be somewhat offset 
by such changes as (1) increased earnings for holders of FFELP 
unconsolidated loans retained as a result of decreased demand for 
consolidation loans, and (2) lenders providing nonconsolidation loan 
borrowers alternative repayment options and other incentives to 
encourage them not to consolidate their loans, as suggested by some 
FFELP lenders we contacted. Lenders would continue to earn income from 
loans not consolidated. 

Concluding Observations: 

On the basis of subsidy cost estimates presented in the President's 
budget for fiscal year 2006, an estimated $3.1 billion could be saved 
if all consolidation loans made in fiscal year 2006 were made 
exclusively through FDLP. The estimated effect, however, remains 
sensitive to the assumptions used in estimating subsidy costs and will 
likely change as Education updates assumptions and revises subsidy cost 
estimates to reflect actual program results. Actual savings would 
remain unknown until all the loans made in fiscal year 2006 were 
repaid, actual interest rates over the life of loans were known, and an 
analysis of what FFELP consolidations would have cost was completed. 
With respect to potentially making all consolidation loans exclusively 
through FDLP, Congress would need to consider not only the potential 
budgetary effects for fiscal year 2006, but the budgetary effects for 
fiscal years 2007 and beyond. In fiscal year 2007 and beyond, FFELP and 
FDLP subsidy cost estimates could vary significantly from those of 
prior cohorts because of potential legislative as well as economic 
changes affecting the programs. For example, proposed legislation 
introduced in the 109th Congress has included changes to borrower 
interest rates and provisions concerning lender yields for both 
consolidation and other types of federal student loans, as well as 
changes in fees paid by FFELP lenders to the government. These 
potential changes could significantly affect consolidation loan subsidy 
cost estimates and, thereby, the estimated budgetary effect of 
providing consolidated loans exclusively through FDLP. 

Agency Comments: 

We provided Education with a copy of our draft report for review and 
comment. Education reviewed the report and did not have any comments. 

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

If you or your staff have any questions about this report, please 
contact me at (202) 512-7215 or ashbyc@gao.gov. Contact points for our 
Offices of Congressional Relations and Public Affairs may be found on 
the last page of this report. Key contributors to this report were Jeff 
Appel, Assistant Director; Susan Chin, Analyst in Charge; and Chuck 
Novak. 

Sincerely yours, 

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

[End of section] 

Appendix I: Briefing Slides: 

[See PDF for images] 

[End of slide presentation] 

[End of section] 

FOOTNOTES 

[1] Stafford loans may be either "subsidized" or "unsubsidized." 
Subsidized loans are awarded based on a student's financial need, and 
the federal government pays the interest on behalf of students while 
they are attending school and during a brief grace period when the 
student first leaves school. Unsubsidized and PLUS loans are available 
to borrowers regardless of financial need, and borrowers are 
responsible for interest payments during the life of the loan. 

[2] GAO, Student Loan Programs: As Federal Costs of Loan Consolidation 
Rise, Other Options Should Be Examined, GAO-04-101 (Washington, D.C.: 
Oct. 31, 2003), and Student Loan Programs: Lower Interest Rates and 
Higher Loan Volume Have Increased Federal Consolidation Loan Costs, GAO-
04-568T (Washington, D.C.: Mar. 17, 2004). 

[3] Present value is the worth of future streams of returns or costs 
for a program in terms of money paid immediately. In calculating 
present value, future amounts are converted into their "money now" 
equivalents using a discount rate. The discount rate is determined by 
the Office of Management and Budget and is generally the average annual 
interest rate for marketable zero-coupon U.S. Treasury securities with 
the same maturity from the date of disbursement as the cash flow being 
discounted. 

[4] GAO, Federal Student Loans: Challenges in Estimating Federal 
Subsidy Costs, GAO-05-874 (Washington. D.C.: Sept. 29, 2005). 

[5] GAO-05-874. 

[6] Cost analysis includes impact of reduced consolidation loan volume 
on the costs of loans not consolidated. 

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