Student Loan Programs:

Lower Interest Rates and Higher Loan Volume Have Increased Federal Consolidation Loan Costs

GAO-04-568T: Published: Mar 17, 2004. Publicly Released: Mar 17, 2004.

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Cornelia M. Ashby
(202) 512-8403


Office of Public Affairs
(202) 512-4800

Consolidation loans, available under the Department of Education's (Education) two major student loan programs--the Federal Family Education Loan Program (FFELP) and the William D. Ford Direct Loan Program (FDLP)--help borrowers manage their student loan debt. By combining multiple loans into one loan and extending the repayment period, a consolidation loan reduces monthly repayments, which may lower default risk and, thereby, reduce federal costs of loan defaults. Consolidation loans also allow borrowers to lock in a fixed interest rate, an option not available for other student loans. Consolidation loans under FFELP and FDLP accounted for about 48 percent of the $87.4 billion in total new student loan dollars that originated during fiscal year 2003. Two main types of federal cost pertain to consolidation loans. One is "subsidy"--the net present value of cash flows to and from the government that result from providing these loans to borrowers. For FFELP consolidation loans, cash flows include, for example, fees paid by lenders to the government and a special allowance payment by the government to lenders to provide them a guaranteed rate of return on the student loans they make. For FDLP consolidation loans, cash flows include borrowers' repayment of loan principal and payments of interest to Education, and loan disbursements by the government to borrowers. The subsidy costs of FDLP consolidation loans are also affected by the interest Education must pay to the Department of Treasury (Treasury) to finance its lending activities. The second type of cost is administration, which includes such items as expenses related to originating and servicing direct loans. This testimony focuses on two key issues: (1) recent changes in interest rates and consolidation loan volume and (2) how these changes have affected federal costs for FFELP and FDLP consolidation loans.

Recent years have seen a drop in interest rates for student loan borrowers along with dramatic overall growth in consolidation loan volume. From July 2000 to June 2003, the interest rate for consolidation loans dropped by more than half, with consolidation loan borrowers obtaining rates as low as 3.50 percent as of July 1, 2003. From fiscal year 1998 through fiscal year 2003, the volume of consolidation loans made (or "originated") rose from $5.8 billion to over $41 billion. The dramatic growth in consolidation loan volume in recent years is due in part to declining interest rates that have made it attractive for many borrowers to consolidate their variable rate student loans at a low, fixed rate. Recent trends in interest rates and consolidation loan volume have affected the cost of the FFELP and FDLP consolidation loan programs in different ways, but in the aggregate, estimated subsidy and administration costs have increased. For FFELP consolidation loans, subsidy costs grew from $0.651 billion for loans made in fiscal year 2002 to $2.135 billion for loans made in fiscal year 2003. Both higher loan volumes and lower interest rates available to borrowers in fiscal year 2003 increased these costs. Lower interest rates increase these costs because FFELP consolidation loans carry a government-guaranteed rate of return to lenders that is projected to be higher than the fixed interest rate paid by consolidation loan borrowers. When the interest rate paid by borrowers does not provide the full guaranteed rate to lenders, the federal government must pay lenders the difference. FDLP consolidation loans are made by the government and thus carry no interest rate guarantee to lenders, but changing interest rates and loan volumes affected costs in this program as well. In both fiscal years 2002 and 2003, there was no net subsidy cost to the government because the interest rate paid by borrowers who consolidated their loans was greater than the interest rate Education must pay to the Treasury to finance its lending. However, the drop in loan volume and interest rates that occurred in fiscal year 2003, contributed to cutting the government's estimated net gain from $570 million in fiscal year 2002 to $543 million for loans made in fiscal year 2003. Administration costs are not specifically tracked for either consolidation loan program, but available evidence indicates that these costs have risen, primarily reflecting increased overall loan volumes.

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