Student Loan Programs:

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

GAO-04-101: Published: Oct 31, 2003. Publicly Released: Dec 1, 2003.

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Cornelia M. Ashby
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The federal government makes consolidation loans available to help borrowers manage their student loan debt. By combining loans into one 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--and are available to borrowers regardless of financial need. GAO was asked to examine (1) how consolidation borrowers differ from nonconsolidation borrowers; (2) how federal costs have been affected by recent interest rate and loan volume changes; and (3) the extent to which repayment options--other than consolidation--are available to help simplify and reduce loan repayments.

On average, consolidation loan borrowers, over the 1987 to 2002 period, had higher levels of student loan debt, higher incomes, and larger loan repayments than did nonconsolidation borrowers. For example, the average student loan debt among consolidation borrowers prior to consolidating their loans was about $22,000 versus about $10,000 for nonconsolidation borrowers. As a group, they defaulted less often on their consolidation loans than borrowers who did not consolidate their loans. Recent trends in interest rates and consolidation loan volumes have affected consolidations in 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)--in different ways, but in the aggregate, estimated subsidy and administration costs have increased. Subsidy costs for FFELP consolidation loans grew from $1.3 billion for loans made in fiscal year 2002 to nearly $3 billion for loans made in fiscal year 2003. Lower interest rates available to borrowers in fiscal year 2003 increased these costs because FFELP consolidation loans carry a government guaranteed rate of return to lenders that is projected to be higher than the fixed interest rate consolidation loan borrowers pay. Higher loan volumes also added to the estimated subsidy costs. Interest rates and loan volume also affected costs for FDLP consolidation loans, but in a different way. Because the interest rate the government charges borrowers has been somewhat greater than the interest rate that Education pays to finance its lending, consolidation loans have generated a net gain for the government in recent years. Lower rates paid by borrowers and reduced loan volume from recent record highs, however, reduced the net gain to $286 million for loans made in fiscal year 2003, down from $460 million the year before. While administration costs are not specifically tracked for either loan program, available evidence indicates that these costs have also risen. Alternatives to consolidation, such as the ability to make a single repayment to cover multiple loans and obtain extended repayment terms, now give some borrowers opportunities to simplify and reduce loan repayments, but not all borrowers can use them. As a result, consolidation loans may be the only option for some borrowers to simplify and reduce repayments. Borrowers' repayment choices--whether to obtain a consolidation loan or use other alternatives--have consequences for federal costs. While consolidation loans may remain an important tool to help borrowers, overall federal costs in providing for consolidation loans may exceed federal savings from reduced defaults. An assessment of the advantages of consolidation loans for borrowers and the government, taking into account program costs and how costs could be distributed among borrowers, lenders, and the taxpayers, would be useful for decisionmakers.

Recommendation for Executive Action

  1. Status: Closed - Implemented

    Comments: Subsequent to our report, the Department proposed expanding alternatives to consolidation loans to more borrowers. In particular, the President's fiscal year 2006 budget request included a proposal to help borrowers manage their debt with more flexible extended repayment plans for all student loans based on the current Direct Loan model. The Department also proposed moving to a variable interest rate for consolidation loan borrowers, allowing borrowers to reconsolidate on multiple occasions, and increasing lender fees on new consolidation loans--all of which would require statutory changes.

    Recommendation: The Secretary of Education should assess the advantages of consolidation loans for borrowers and the government in light of program costs and identify options for reducing federal costs. Options could include targeting the program to borrowers at risk of default, extending existing consolidation alternatives to more borrowers, and changing from a fixed to a variable rate the interest charged to borrowers on consolidation loans. In conducting such an assessment, Education should also consider how best to distribute program costs among borrowers, lenders, and the taxpayers and any tradeoffs involved in the distribution of these costs. If Education determines that statutory changes are needed to implement more cost-effective repayment options, it should seek such changes from Congress.

    Agency Affected: Department of Education


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