Direct Student Loans: Additional Steps Would Increase Borrowers' 
Awareness of Electronic Debiting and Reduce Federal		 
Administrative Costs (29-MAR-02, GAO-02-350).			 
                                                                 
Since 1999, the Department of Education (Education) has offered a
0.25 percent interest rate reduction to borrowers who agree to an
electronic debit (EDA) program. Borrowers pay a lower interest	 
rate, while the federal government receives fewer late payments. 
Any revenue loss to the federal government from a reduced	 
interest rate would be more than offset by a gain in revenue	 
because some EDA borrowers who had previously paid by check would
stop making periodic payments in excess of their scheduled amount
due. By ceasing to make these prepayments, these borrowers would 
not pay off their loans as soon as they would have without	 
signing up for EDA and, therefore, incur additional interest	 
costs over the life of their loans. Although actual EDA 	 
enrollments have exceeded original estimates, Education lacks	 
data on prepayment patterns after borrowers enroll in the	 
program. Education has not informed borrowers of the cost	 
implications of EDA participation, nor has it systematically	 
informed borrowers of their prepayment options. GAO estimates	 
that Education saved $1.5 million in administrative costs in	 
fiscal year 2001 because it did not have to mail bills to EDA	 
borrowers.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-350 					        
    ACCNO:   A02892						        
  TITLE:     Direct Student Loans: Additional Steps Would Increase    
Borrowers' Awareness of Electronic Debiting and Reduce Federal	 
Administrative Costs						 
     DATE:   03/29/2002 
  SUBJECT:   Advance payments					 
	     Direct loans					 
	     Electronic funds transfer				 
	     Information disclosure				 
	     Late payments					 
	     Loan interest rates				 
	     Loan repayments					 
	     Student loans					 
	     Dept. of Education Direct Loan Servicing		 
	     System						 
                                                                 
	     Dept. of Education Electronic Debit		 
	     Account Program					 
                                                                 
	     William D. Ford Federal Direct Loan		 
	     Program						 
                                                                 

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GAO-02-350
     
                  United States General Accounting Office

GAO

                          Report to the Honorable

James M. Jeffords, U.S. Senate

March 2002

DIRECT STUDENT LOANS

Additional Steps Would Increase Borrowers' Awareness of Electronic Debiting
and Reduce Federal Administrative Costs

GAO-02-350

United States General Accounting Office Washington, DC 20548

March 29, 2002

The Honorable James M. Jeffords United States Senate

Dear Senator Jeffords:

In November 1999, the Department of Education (Education) began offering a
0.25 percent interest rate reduction under the William D. Ford Federal
Direct Loan Program (FDLP) to borrowers who agree to have their monthly loan
payments automatically withdrawn from a bank account via its electronic
debit account (EDA) program. While borrowers would benefit by paying a
reduced interest rate on their loans, the federal government would benefit
from receiving fewer late payments. The Higher Education Act of 1965, as
amended, requires that such interest rate reductions be "cost neutral and in
the best financial interest of the Federal Government" and that Education
offset any higher subsidy costs1 resulting from the interest rate reduction
through reductions in funding for administrative costs.

In a cost justification it submitted to the Congress in August 1999,
Education stated that the loss of revenue to the federal government from
offering the reduced interest rate would be more than offset by a gain in
revenue because some EDA borrowers who had previously paid by check would
stop making periodic payments in excess of their scheduled amount due. By
ceasing to make these prepayments, these borrowers would not pay off their
loans as soon as they would have without signing up for EDA and, therefore,
incur additional interest costs over the life of their loans. Education
assumed about half of the borrowers making prepayments prior to enrolling in
EDA would discontinue making prepayments after enrolling in EDA. Education
found that eliminating these prepayments could potentially extend the time
some borrowers were repaying their loans by

1 Subsidy costs are the net present value, at the time a direct loan is
disbursed, of the cash flows for loan disbursement, repayments of principal,
and payments of interest and other payments by or to the government over the
life of the loan after adjusting for estimated defaults, prepayments, fees,
penalties, and other recoveries. Present value is the worth of the future
stream of returns or costs in terms of money paid immediately-prevailing
interest rates provide the basis for converting future amounts into their
"money now" equivalents.

1-ï¿½ years. In effect, EDA borrowers who stopped prepaying would lose some
portion of their interest savings from the rate reduction. Thus, Education's
analysis appeared to justify savings to the government at additional cost to
some borrowers enrolling in the EDA program, rather than by reducing
administrative costs associated with processing payments by check. Because
of your concern about the possibility that some borrowers would pay
additional interest under EDA, you asked us to determine the following:

* To what extent have assumptions concerning borrower behavior used in
Education's cost justification materialized?

* To what extent has Education informed borrowers of the possible cost
implications of EDA participation and the options that are available to them
for prepaying their loans?

* To what extent has Education achieved administrative cost savings as a
result of the program?

In conducting this work, we interviewed Education officials and collected
and analyzed cost and other pertinent information. To examine the extent to
which Education's cost justification assumptions about borrower behavior-the
percentage of EDA borrowers that would enroll in EDA and the percentage that
would change their prepayment patterns after enrolling-materialized, we
reviewed Education's cost justification, discussed its preparation and
methodology with the Education officials who developed it, and obtained and
analyzed available information about the repayment behavior of borrowers who
have enrolled in the EDA program. To identify the information Education had
provided borrowers about possible cost implications of EDA participation and
prepayment options associated with EDA, we obtained and reviewed all
Education direct loan repayment information available to borrowers. To
estimate administrative cost savings, we reviewed Education and Department
of the Treasury (Treasury) cost data associated with billing EDA and non-EDA
borrowers and processing their payments. We discussed our analysis with
officials at both agencies to ensure that we included all appropriate cost
items. We conducted our work between March 2001 and February 2002 in
accordance with generally accepted government auditing standards.

Results in Brief While actual EDA enrollments have exceeded its original
assumptions, Education lacks readily accessible data showing how borrowers
have changed their prepayment patterns after enrolling in the program. In
its cost justification, Education assumed, on the basis of reported private
sector experiences with electronic debit payments, that 5 percent of direct

loan borrowers would enroll in its EDA program. As of September 2001, the
actual percentage of direct loan borrowers who enrolled in the EDA program
was almost 12 percent. On the other hand, whether Education's other
assumption about borrower behavior has materialized is unknown. Because
private lenders' experiences with EDA-like programs varied widely, Education
assumed a random distribution of borrowers likely to continue to prepay,
with 50 percent of those who had prepaid continuing to do so and 50 percent
discontinuing prepayment. However, Education lacks readily accessible data
needed to determine whether and how EDA borrowers changed their prepayment
patterns. As a result, the extent to which EDA borrowers have been less
likely to prepay is unknown.

Education has not informed borrowers of the possible cost implications of
EDA participation nor has it systematically informed borrowers of their
prepayment options. Specifically, Education has not informed EDA borrowers
that they may pay more interest over the life of the loan than they would
have paid without EDA because only the scheduled payment amount is withdrawn
when EDA is initially established. In May 2001, Education posted information
on the direct loan servicing Web site indicating that EDA borrowers could
mail supplemental payments to the direct loan servicer. However, Education
has not systematically disseminated information about this and other
prepayment options available to all borrowers. Moreover, when we reviewed
Education publications to identify the EDA disclosures made to borrowers, we
found that Education has not updated information to reflect the reduced
interest rate borrowers receive if they repay their loans through EDA, even
though Education began offering the discount in November 1999.

We estimate Education achieved administrative cost savings of about $1.5
million in fiscal year 2001, primarily because it did not have to mail and
generate bills to EDA borrowers. While reviewing Education's cost data to
estimate its administrative cost savings from EDA, we identified an
unrelated potential opportunity for additional administrative cost savings.
The direct loan servicer charges Education a separate fee for servicing
delinquent accounts. Even though the servicer does not take any action to
collect on past due accounts until they are 7 days late, it still assesses
this fee for the first six days any payment is overdue. In addition to
savings to Education, we also identified savings associated with EDA to the
Department of the Treasury, which processes direct loan payments for
Education and incurs most of the associated costs. In fiscal year 2001, we
estimate Treasury saved about $1.2 million because processing payments
electronically, according to Treasury, costs approximately 99 percent less
than processing payments by check.

Background

In this report, we make recommendations that Education take steps to better
inform borrowers of the options available to them to prepay their loans, to
better publicize EDA in order to maximize administrative savings, and to
consider renegotiating certain fees its pays its loan servicer.

In written comments on a draft of this report, the Department of Education
generally agreed with the information presented as well as our conclusions
and recommendations. Education's comments are reprinted in Appendix I.
Education also provided technical comments, which we incorporated where
appropriate.

The FDLP legislation was enacted in August 1993 as part of a broader reform
of the federal student loan programs. The first direct loans were made in
fiscal year 1994. FDLP makes it possible for students and their families to
borrow directly from the federal government through the colleges or other
postsecondary institutions the students attend. As of September 30, 2001,
about 3.6 million borrowers were repaying more than $45 billion in direct
loans. Education services FDLP loans through a contract with Affiliated
Computer Services, Inc. (ACS), an information technology systems and
services company. As prime contractor, ACS has overall responsibility for
FDLP loan servicing. ACS has a subcontract with Academic Financial Services
Association Data Corporation (AFSA), under which AFSA has the main
responsibility for FDLP loan-servicing operations. 2 Education has an
interagency agreement with Treasury for processing direct loan payments.
Treasury, in turn, has agreements with and compensates certain commercial
banks for processing both paper and electronic payments made by the public
to federal agencies. Treasury bills federal agencies only for those services
that it considers outside the basic level of service negotiated with the
designated commercial banks. In fiscal year 2000, Treasury charged Education
$26,353 for these ancillary services. Specifically, this amount was charged
for the cost of shipping reports and other material by overnight mail to
Education.

In February 1998, Education implemented EDA to allow FDLP borrowers to have
their loan payments automatically withdrawn from a bank account each month.
Then, in November 1999, Education began offering a 0.25-percentage point
reduction in the interest rate to borrowers who agreed to

2 AFSA also provides student loan servicing for banks and secondary markets
under the Federal Family Education Loan Program-the largest federal student
loan program.

repay their loans this way. The number of borrowers who made their loan
payment through EDA went from 40,023 in October 1999, before the discount
went into effect, to 364,704 in September 2001.

The cost justification model Education developed used eight key assumptions.
These assumptions included such things as the interest rate charged to
borrowers, the number of outstanding loans, and two assumptions concerning
borrower behavior-estimates of how many borrowers would likely enroll in the
program once it was established and the likelihood that borrowers would
continue to prepay their loans after enrollment. As the basis for developing
these assumptions, Education relied on a variety of factors, including
prevailing Treasury interest rates, private sector experiences with
electronic debit repayments, conventions economists generally use in the
absence of data, and analysis of its student loan portfolio. Table 1 shows
the eight key assumptions used in Education's cost justification model and
the basis of each assumption.

  Table 1: Key Assumptions Used in Education's Cost Justification Model and
                                Their Basis

                       Assumption Basis of assumption

Borrower interest rate-Average loan interest rate across all borrower
cohorts in the FDLP.

Analysis of loan portfolio data maintained in the National Student Loan Data
System (NSLDS), and the Direct Loan Servicing System (DLSS), and interest
rates published by Treasury.

Discount rate-Interest rate used to calculate the net present valuea of FDLP
student loans over time.

         Average rate for credit accounts as published by Treasury.

EDA  program  enrollment  rate -Rate  at  which  FDLP  borrowers  Behavioral
assumption made  by Education  based upon would  enroll in the  EDA program.
reported private sector experience.

Continued borrower  prepayment-Percent of FDLP  borrowers likely to continue
to prepay their loans.

Behavioral assumption made by Education under conditions of uncertainty.
Education assumed a random distribution in light of mixed results reported
by private sector lenders. Borrowers whose student loan payment histories
showed they were ahead of schedule in their loan payments were identified as
borrowers who were prepaying.

Average total time to maturity-Average time in years to loan maturity for
borrowers both assumed to continue and assumed to discontinue prepaying
under EDA.

Analysis of loan portfolio data maintained in the NSLDS and the DLSS.

Time since entering repayment-Average time in years since a borrower entered
loan repayment.

       Analysis of loan portfolio data maintained in NSLDS and DLSS.

Average balance for loans-Average outstanding FDLP borrower Analysis of loan
portfolio data maintained in NSLDS and DLSS. loan balances.

Number of  loans outstanding-Actual total  number of outstanding Analysis of
loan portfolio data maintained in NSLDS and DLSS. FDLP loans.

aNet present value is the worth of the future stream of returns or costs in
terms of money paid immediately. In calculating net present value, the
discount rate provides the basis for converting future amounts into their
"money now" equivalents.

Borrowers have the right to prepay their loans.3 If a borrower repays any
amount in excess of the amount due, the excess amount is a prepayment. Loan
repayments, including prepayments, are credited first to any accrued charges
or collection costs and then to outstanding interest and principal. Because
prepayments generally reduce a borrower's principal balance outstanding, the
amount of interest that accrues in subsequent months is also reduced,
decreasing the amount of interest the borrower pays over the life of the
loan. Borrowers who pay by check can easily make repayments in excess of the
amount due, for example, by rounding up their repayment, but EDA borrowers
have to take extra steps to prepay because only the scheduled repayment
amounts are withdrawn from EDA borrowers' accounts. In practice, the amount
due without regard to the 0.25 percent discount is withdrawn. Therefore, EDA
borrowers do not receive a reduction in the amount they repay each month,
but more of

3 20 U.S.C. 1077(a)(2)(F)

While More than Twice as Many Borrowers Enrolled in EDA than Education
Assumed, the Extent to Which They Have Continued to Prepay Their Loans Is
Unknown

each repayment is applied to the principal balance and they will repay their
loans faster as a result.

A variety of factors can affect a borrower's decision about whether to
prepay a loan. Given that FDLP interest rates for direct loans cannot exceed
8.25 percent and the interest paid is tax deductible for borrowers who do
not exceed certain income limits, prepaying may not be the best option for
all borrowers. For instance, borrowers who have recently entered the
workforce when they begin repaying their loans may not have sufficient
resources to prepay their loans. Rather than prepay their direct student
loans, some borrowers may also decide to instead repay any higher-interest
debt they have accumulated, for which interest paid is not tax deductible,
such as credit card debt.

While more than twice as many borrowers have enrolled in the EDA program
than originally assumed, the percentage of EDA borrowers who have continued
to make prepayments remains unknown. In developing its cost justification of
the EDA program, Education assumed that a certain percentage of borrowers
would likely enroll in the program and that a certain percentage of these
borrowers would continue to prepay their loans. Education based these
assumptions on reported private sector experiences with electronic debit
repayments and on conventions economists use in the absence of data.
Education lacks data showing borrowers' prepayment patterns before and after
enrolling in the program, thus it cannot determine the extent to which its
assumption has materialized.

Education's assumption that 5 percent of direct loan borrowers would enroll
in the EDA program was an estimate based on the experiences of large,
national private sector guaranteed loan lenders' programs similar to EDA. As
of September 2001, the actual percentage of EDA enrollees is closer to 12
percent, which, according to Education's cost justification, would increase
the savings to the government to over $19 million.4 Table 2 shows government
savings at the originally assumed 5 percent enrollment rate and our
estimates of the savings that Education's cost justification model would
project if higher EDA enrollment rates were to materialize, keeping the
prepayment assumption constant.

4 As of September 2001, 424,209 borrowers were enrolled in EDA.

Table 2:  Estimated Government Subsidy Cost  Savings with Different Rates of
EDA Enrollment

                     Enrollment rate Government savings

                           5 percent $7.2 million

                          12 percent $19.1 million

                          20 percent $31.5 million

Source: Education's cost justification model and GAO analysis based on the
model.

Education also obtained information from private sector lenders on their
experiences with continued prepayment by borrowers after enrolling in
EDA-like programs. Private lenders reported mixed results. For example, one
lender reported that 20 percent of borrowers who previously prepaid
continued to prepay after enrolling in such a program while another lender
reported that 80 percent continued prepaying, according to Education
officials. Given the wide variance in reported experience, Education
officials concluded that they could not make an assumption based on these
data. Therefore, Education assumed a random distribution of borrowers likely
to continue to prepay, with 50 percent of those who had prepaid continuing
to do so and 50 percent discontinuing prepayment.

While we were able to determine the extent to which Education's assumption
about EDA enrollment materialized, we were unable to determine the extent to
which its assumption for continued borrower prepayment materialized.
Limitations in Education's Direct Loan Servicing System prevented us from
obtaining data on borrower history of repayment activity. Education can
identify borrowers who are paying their loans ahead of schedule and,
therefore, likely to be prepaying. However, it cannot identify EDA
participants from this data and it lacks trend data showing how frequently
and by how much borrowers prepay their loans. Individual borrower payment
activity data are available for only the most recent 2 months. Given that
borrowers change their prepayment patterns at their convenience throughout
their loan repayment period, these data would not have covered a long enough
time period to determine how prepayment patterns have changed. Consequently,
we could not compare the overall patterns of borrowers' prepayment behavior
before or after enrolling in the EDA program.

Education Has Not Informed Borrowers about the Possible Cost Implications of
EDA Participation or Prepayment Options

Education has not informed borrowers of the possible cost implications of
EDA participation nor has it systematically informed borrowers of their
prepayment options. Education has not told borrowers that because repayment
through EDA may take longer, they may incur more interest cost over the life
of the loan than if they previously prepaid without EDA. While Education has
made some information available to borrowers online about where to send
supplemental repayments, it has not systematically informed all borrowers of
their prepayment options. Further, Education has not updated its borrower
publications to inform borrowers of the option and benefits of repaying
their loans through EDA.

Borrowers Are Not Informed about Cost Implications of EDA Participation

Education has not taken steps to inform EDA borrowers that-even with a
reduced interest rate-they could pay more interest over the life of the
loan. This could happen if prior to enrolling in EDA, they made repayments
that exceeded the scheduled amount due, but after enrolling paid only the
amount due. When borrowers establish an EDA, there is no place on the
application form to designate an amount in addition to the scheduled payment
to be withdrawn each month. To continue their prepayments, such borrowers
would have to send a check for any prepayment or make arrangements to
continue making prepayments through EDA.

Borrowers Are Not Systematically Informed of Their Prepayment Options

The Higher Education Act of 1965, as amended, requires that student loan
borrowers be informed that they may prepay all or part of their loans at any
time without penalty, but it does not require the disclosure of specific
prepayment options. In documents such as the master promissory note and
borrower publications, Education informs borrowers that they may prepay
their loans. In May 2001, after we began our work, Education added
information to the direct loan servicing Web site indicating where EDA
borrowers wishing to prepay their loans could send supplemental payments.
While this information may help borrowers with Internet access, Education
has not disclosed this information in EDA brochures, the EDA application, or
the confirmation notice sent to borrowers who establish EDAs. Further,
Education does not inform EDA borrowers that they may make routine
prepayments, by contacting the direct loan servicer at any time and
increasing the amount withdrawn from their bank account each month.

In addition to not disclosing prepayment options, Education had not updated
two of its borrower publications to fully reflect the option borrowers have
to repay through EDA. One publication, Exit Counseling

Use of EDAs Generated Estimated Administrative Cost Savings of More than
$2.7 Million in Fiscal Year 2001 for Education and Treasury

Guide for Borrowers, does not provide details about how EDA works, the
advantages of EDA for making loan payments, or the reduced interest rate EDA
borrowers receive.5 The other publication, Repayment Book, which is
available to help borrowers understand and select from the available
repayment plans, makes no reference to EDA.

Education and Treasury achieved administrative cost savings because EDAs
reduced the costs associated with billing and processing payments. Education
saved an estimated $1.5 million in fiscal year 2001 as a result of
generating and mailing fewer bills to EDA borrowers. Additional savings are
also possible with respect to costs associated with servicing past due
accounts. Treasury, which processes direct loan payments and incurs most of
the associated processing costs, saved an estimated $1.2 million in fiscal
year 2001.

Education Saved on Administrative Costs by Not Sending Monthly Billing
Statements to EDA Borrowers

As a result of EDA, Education reduces administrative costs associated with
generating and mailing billing statements to borrowers. According to our
review of Education cost data, in fiscal year 2001, Education saved about
$1.5 million or $0.39 per month for each borrower who used EDA. This savings
includes the cost of things such as the paper billing statement, the mailing
envelope, and postage. Through EDA, Education avoided sending out more than
3.6 million billing statements over the course of fiscal year 2001. The
other administrative costs Education incurs for servicing direct loan
accounts are the same for all borrowers, regardless of their payment method.
Table 3 shows the specific costs Education incurs for routine servicing of
FDLP accounts. EDA should result in additional administrative cost savings
by reducing the potential for late payments and accompanying collection
efforts, according to an Education official.

5 FDLP schools are responsible for ensuring that borrowers who are
graduating, withdrawing, or otherwise ceasing to attend school at least half
time, receive exit counseling.

Table 3:  FY 2001  Monthly Costs Associated  with Routine Servicing  of FDLP
Accounts by Payment Method (per borrower)

Non-EDA EDA account account

aIncludes two
envelopes per
statement mailed.
Beginning in May 2001,
the cost of envelopes
was reduced from
$0.094 to $0.074. In
July 2001, the cost of
envelopes was further reduced to $0.054.

Some of the administrative savings Education achieves with EDA are offset
with expenses that Education incurs at Treasury. Education pays Treasury for
processing EDA applications. In fiscal year 2000, Treasury charged Education
about $128,900 for processing 253,000 EDA applications.

In the course of doing our work, we identified a potential opportunity for
additional administrative cost savings unrelated to EDA. Education adheres
to a price structure for servicing delinquent accounts that may not be
appropriate. Currently, the direct loan servicer assesses Education a
separate fee for each day a borrower's account is at least 1 day past due.
This fee applies to all late direct loan payments, but because EDA payments
are credited on the due date-provided sufficient funds are available in the
borrower's bank account-this fee would generally not apply to EDA borrowers.
The late fee Education is assessed for past due accounts covers additional
work the direct loan servicer performs, such as sending second billing
statements to borrowers, and making reminder phone calls. These collection
activities occur at regularly scheduled intervals as part of Education's
default prevention initiatives.

As previously stated, Education is assessed a fee for each day a borrower's
account is at least 1 day past due. Education officials stated that this
contract provision has been in place since FDLP implementation. In the past,
the direct loan servicer sent late payment notices to borrowers as soon as
payments were one day late. However, according to Education officials,
borrowers who had already mailed their payments found these notices
confusing. As a result, Education decided to delay late payment notification
to allow additional time to receive those payments made by borrowers close
to or on the due date. Presently, the direct loan servicer's first
collection activity-sending a second billing statement-does not

take place until a payment is 7 days late. However, Education is still
assessed fees on payments that arrive 1 to 6 days late. In fiscal year 2001,
Education paid $12.2 million or about $0.05 per day for each account that
was at least 1 day past due. Because of limitations of data in the DLSS,
Education is unable to determine the extent to which it is paying this fee
each month for payments received between 1 and 6 days late.

Treasury Achieved Savings by Processing Loan Payments Electronically

Conclusions

In fiscal year 2001, we estimate Treasury, which has an interagency
agreement with Education to process direct loan payments, saved about $1.2
million as a result of EDA. These savings are based on the dollar volume of
payments received. Treasury estimates that processing payments
electronically costs less than 1 percent of the cost of processing paper
payments. For example, it costs about $16 to process $1 million through EDA;
processing the same amount in paper payments costs about $1,897. According
to officials from Treasury's Financial Management Service, Treasury
processes payments for federal agencies to ensure efficient and timely
processing of payments, and because Treasury can achieve economies of scale
by providing this service throughout the federal government.

Regardless of the conclusions Education reached in its cost justification,
borrowers who enroll in EDA will benefit from paying a reduced interest rate
on their loans and the federal government will achieve administrative cost
savings. Data limitations make it difficult to assess whether borrowers have
changed their prepayment behavior as Education assumed in its cost
justification, and thus, the extent of the benefit for both borrowers and
the federal government is unknown. Even if data were available and showed
borrowers' had changed their behavior, it would not tell us that this
behavior changed as a result of entering EDA. Rather, borrowers could be
making sound economic decisions such as choosing to prepay a higher rate
loan rather then their federal student loan. By fully informing borrowers of
the consequences of paying through EDA as well as their prepayment options,
Education could ensure that borrowers have all the information they need to
make sound economic choices. However, the limited disclosures Education
currently makes to borrowers concerning their prepayment options under EDA
are not sufficient to ensure that borrowers have all essential information
to make informed decisions. Education does not make clear that, in spite of
the 0.25 percentage-point interest rate reduction, borrowers might incur
more interest cost over the life of their loans under EDA than they would if
they

continued to sometimes make payments in excess of the scheduled amount due.

Although Education did not include estimated administrative cost savings
associated with EDA in conducting its cost justification, clearly, these
savings would help offset the expense of offering borrowers a reduced
interest rate. EDA can further reduce administrative costs associated with
loan processing if more borrowers use it. Education has not promoted the
benefits of EDA to borrowers as much as possible to maximize administrative
cost savings to the federal government. Promoting the benefits of EDA to
borrowers when they are considering their repayment options could achieve
even greater administrative cost savings if more borrowers were to
participate in EDA as a result. Moreover, EDAs should reduce the amount of
higher fees that Education incurs for servicing past due accounts, because
EDA payments are generally credited on time.

Although not related to EDA, Education may be able to achieve additional
administrative cost savings. At present, Education is paying a fee for
servicing EDA and non-EDA accounts that are at least 1 day past due. We
believe that those fees may be unjustified because no action is taken to
collect late payments until they are 7 days past due.

                               Recommendations

To help make the EDA program more useful and understandable to borrowers and
take greater advantage of its potential savings to the taxpayer, we are
making several recommendations to the secretary of education.

* To better publicize EDA and help Education achieve additional
administrative cost savings, we recommend updating the Exit Counseling Guide
for Borrowers to reflect the repayment incentives for direct loan borrowers
who repay their loans through EDA as well as borrowers' prepayment options.

* To address concerns that borrowers may unknowingly pay more total interest
over the life of their loans by not making prepayments if they make their
loan payments through EDA, we recommend Education take steps to inform EDA
borrowers about steps they can take to prepay their loans. Such steps could
include modifying EDA applications to allow borrowers interested in
prepaying their loans to designate withdrawal amounts in excess of their
scheduled payments when they initially complete the EDA application.

* To ensure that the fees Education pays for servicing delinquent accounts
appropriately reflect current collection activity practices, we recommend

Education consider renegotiating the fee provision in its contract with the
direct loan servicer to eliminate the servicing fee for accounts with
payments less than 7 days late.

In comments we obtained, Education generally agreed with the information
presented in the report. In response to our recommendation, Education said
that it would explore updating the Exit Counseling Guide for Borrowers and
explore taking other steps to better inform borrowers of their prepayment
options. In addition, Education said it would consider renegotiating the
direct loan servicing contract to move in the direction of paying for
results rather than processes. Education also provided technical comments,
which we incorporated where appropriate.

We are sending copies to the secretary of education, the secretary of the
treasury, and the director of the Office of Management and Budget and will
also make copies available to others on request. This report is also
available on GAO's home page at http://www.gao.gov.

If you or your staff have any questions or wish to discuss this material
further, please call me at (202) 512-8403 or Jeff Appel at (202) 512-9915.
Other staff who made key contributions to this report include Barbara Alsip,
Joel Marus, Scott McNabb, and Debra Prescott.

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

Agency Comments

Page 15 GAO-02-350 Direct Student Loans

Appendix I: Comments from the Department of Education

              (130028) Page 16 GAO-02-350 Direct Student Loans

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