Student Loan Programs: Lower Interest Rates and Higher Loan	 
Volume Have Increased Federal Consolidation Loan Costs		 
(17-MAR-04, GAO-04-568T).					 
                                                                 
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.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-568T					        
    ACCNO:   A09512						        
  TITLE:     Student Loan Programs: Lower Interest Rates and Higher   
Loan Volume Have Increased Federal Consolidation Loan Costs	 
     DATE:   03/17/2004 
  SUBJECT:   Administrative costs				 
	     Debt						 
	     Loan interest rates				 
	     Student financial aid				 
	     Student loans					 
	     Subsidies						 
	     Cost growth					 
	     Consolidation					 
	     Dept. of Education Federal Family			 
	     Education Loan Program				 
                                                                 
	     Dept. of Education William D. Ford 		 
	     Direct Loan Program				 
                                                                 

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GAO-04-568T

United States General Accounting Office

GAO Testimony

Before the Committee on Education and the Workforce, House of
Representatives

For Release on Delivery

Expected at 10:30 a.m. EST STUDENT LOAN

Wednesday, March 17, 2004

PROGRAMS

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

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

GAO-04-568T

Mr. Chairman and Members of the Committee:

Thank you for inviting me here today to discuss issues related to
consolidation loans and their cost implications for taxpayers and
borrowers. 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. FFELP
consolidation loans comprised about 84 percent of the fiscal year 2003
consolidation loan volume, while FDLP consolidation loans accounted for
the remaining 16 percent.

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.

My testimony today will focus 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. My
comments are based on the findings from our October 2003 report for this
Committee, Student Loan Programs: As Federal Costs of Loan Consolidation
Rise, Other Options Should Be Examined (GAO-04-101, October 31, 2003).
Those findings were based on review and analysis of data from a variety of
sources, including officials from Education's Office of Federal Student
Aid and Budget Service, and representatives of FFELP

lenders; a sample of student loan data extracted from Education's National
Student Loan Data System (NSLDS)-a comprehensive national database of
student loans, borrowers, and other information; relevant cost analyses
prepared by Education; and statutory, regulatory and other published
information. For this testimony, we updated our numbers to reflect recent
estimates made by the Department of Education. Our work was conducted in
accordance with generally accepted government auditing standards.

In summary:

o  	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.

o  	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.

In our prior report, we recommended that the Secretary of Education assess
the advantages of consolidation loans for borrowers and the government in
light of program costs and identify options for reducing federal costs.
Education agreed with our recommendation.

                                   Background

Consolidation loans differ from other loans in the FFELP and FDLP programs
in that they enable borrowers who have multiple loans- possibly from
different lenders, different guarantors,1 and even from different loan
programs-to combine their loans into a single loan and make one monthly
payment. By obtaining a consolidation loan, borrowers can lower their
monthly payments by extending the repayment period longer than the maximum
10 years generally available on the underlying loans. Maximum repayment
periods allowed vary by the amount of the consolidation loan (see table
1). Consolidation loans also provide borrowers with the opportunity to
lock in a fixed interest rate on their student loans, based on the
weighted average of the interest rates in effect on the loans being
consolidated rounded up to the nearest one-eighth of 1 percent, capped at
8.25 percent. Borrowers can qualify for consolidation loans regardless of
financial need. Loans eligible for inclusion in a consolidation loan must
be comprised of at least one eligible FFELP or FDLP loan, including
subsidized and unsubsidized Stafford loans, PLUS loans,2 and, in some
instances, consolidation loans. Both subsidized and unsubsidized Stafford
loans, and PLUS loans are variable rate loans. Other types of federal
student loans made outside of FFELP and FDLP, which may carry a variable
or fixed borrower interest rate, are also eligible for

1State and nonprofit guaranty agencies receive federal funds to play the
lead role in administering many aspects of the FFELP program, including
reimbursing lenders when loans are placed in default and initiating
collection work.

2Both subsidized and unsubsidized Stafford loans are available to
undergraduate and graduate students. The interest rates borrowers pay on
these loans adjust annually, based on a statutorily established
market-indexed rate setting formula, and may not exceed 8.25 percent. To
qualify for a subsidized Stafford loan, a student must establish financial
need. The federal government pays the interest on behalf of subsidized
loan borrowers while the student is in school. Students can qualify for
unsubsidized Stafford loans regardless of financial need. Unsubsidized
loan borrowers are responsible for all interest costs. PLUS loans are
variable rate loans that are available to parents of dependent
undergraduate students. The interest rates on these loans adjust annually,
based on a statutorily established market-indexed rate setting formula,
and may not exceed 9 percent. Parents can qualify for PLUS loans
regardless of financial need.

inclusion in a consolidation loan, including Perkins loans, Health
Professions Student loans, Nursing Student Loans, and Health Education
Assistance loans (HEAL).3

Table 1: Consolidation Loan Repayment Periods, by Loan Amount

Source: Higher Education Act, Congressional Research Service, and
Education.

The Federal Credit Reform Act (FCRA) of 1990 helps define federal costs
associated with consolidation loans and was enacted to require agencies,
including Education, to more accurately measure federal loan program
costs. Under FCRA, Education is required to estimate the long-term cost to
the government of a direct loan or a loan guarantee-generally referred to
as the subsidy cost. Subsidy cost estimates are calculated based on the
present value of estimated net cash flows to and from the government that
result from providing loans to borrowers.4 For FFELP consolidation loans,
cash flows include, for example, fees paid by lenders to the government5
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

3Perkins Loans are fixed rate loans for both undergraduate and graduate
students with exceptional financial need. Perkins loans are made directly
by schools using funds contributed by the federal government and schools;
borrowers must repay these loans to their school. The Health Professions
Student Loans and Nursing Student Loans are fixed rate loans for borrowers
who pursue a course of study in specified health professions. The HEAL
program provided loans to eligible graduate students in specified health
professions. HEAL was discontinued on September 30, 1998.

4Present value is the value today of the future stream of benefits and
costs, discounted using an appropriate interest rate (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).

5For consolidation loans, FFELP loan holders must pay, on a monthly basis,
a fee calculated on an annual basis equal to 1.05 percent of the unpaid
principal and accrued interest on the loans in their portfolio.

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. Unlike FFELP, FDLP involves no guaranteed
yields or special allowance payments to lenders because the program is a
direct loan program. The subsidy costs of FDLP consolidation loans are
also affected by the interest Education must pay to Treasury to finance
its lending activities. Another type of cost pertaining to consolidation
loans is administration, which includes such items as expenses related to
originating and servicing direct loans.6

In estimating loan subsidy costs, Education first estimates the future
economic performance (net cash flows to and from the government) of direct
and guaranteed loans when preparing its annual budgets. These first
estimates establish the subsidy estimates for the current-year originated
loans. The data used for the first estimates are reestimated in later
years to reflect any changes in actual loan performance and expected
changes in future performance. Reestimates are necessary because
projections about interest and default rates and other variables that
affect loan program costs change over time. Any increase or decrease in
the estimated subsidy cost results in a corresponding increase or decrease
in the estimated cost of the loan program for both budgetary and financial
statement purposes.

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. Over four-fifths of the fiscal year
2003 loan volume is in FFELP. While overall volume rose in 2003, the
trends differed by program. FDLP consolidation loan volume for fiscal year
2003 decreased, but loan volume in the larger FFELP increased, resulting
in total consolidation loan volume of well 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

6Under FFELP, a large portion of the administration cost is borne by the
private lender. The federal government pays many of these costs in its
subsidy payment to lenders- specifically, in the 2.64 percent add on paid
over and above the 3-month rate on commercial paper.

Borrowers' Rates Have Dropped, and Loan Volume Has Risen

borrowers to consolidate their variable rate student loans at a low, fixed
rate. Figure 1 shows the relationship between these two factors. When
interest rates are low, some borrowers may find it in their economic
selfinterest to consolidate their loans so that they can lock in a low
fixed interest rate for the life of the loan, as opposed to paying
variable rates on their existing loans, regardless of whether they need a
consolidation loan to avoid difficulty in making loan repayments and avert
default.

Figure 1: Consolidation Loan Volume Increased Dramatically as Borrower
Interest Rates Fell from Fiscal Year 2001 to Fiscal Year 2003

                       Loan volume (billions of dollars)

Borrowers rate (percent) 10

40 8

30 6

20 4

10 2

00 1998 1999 2000 2001 2002 2003 Fiscal year

Loan volume

Borrower's rate

Source: GAO analysis based on data provided by Education's Budget Service.

Underscoring the potential attractiveness of these loans to potential
borrowers, many lenders, including newer loan companies that are
specializing in consolidation loans, have aggressively marketed
consolidation loans to compete for consolidation loan business as well as
to retain the loans of their current customers. Their marketing techniques
have included mass mailings, telemarketing, and Internet pop-ups to
encourage borrowers to consolidate their loans. This increased marketing
effort has likely contributed to the record level of consolidation loan
volume.

Changes in Interest Rates and Loan Volume Affect FFELP and FDLP Costs in
Different Ways, but in the Aggregate, Estimated Costs Increased

While the estimated future costs for consolidation loans can vary greatly
from year to year, low interest rates and recent loan volume changes have
resulted in substantial increases in overall costs to the federal
government. However, in light of the differences between how FFELP and
FDLP operate, the subsidy costs within these two programs were affected in
very different ways. For FFELP, the result was a substantial increase. For
FDLP, the result was a narrowing of the net difference between the
estimated interest payments paid by consolidated loan borrowers to
Education and the costs paid by Education to Treasury to finance direct
loans.

FFELP Subsidy Costs Affected by Increased Special Allowance Payments to Lenders
and Increased Loan Volume

Estimated subsidy costs for FFELP consolidation loans rose from $0.651
billion for loans made in fiscal year 2002 to $2.135 billion for loans
made in fiscal year 2003. The increase is largely due to the higher
interest subsidies the government is expected to pay to lenders to ensure
they receive a guaranteed rate of return on student loans and the result
of greater loan volume. The interest subsidy, which is called a special
allowance payment (SAP), is based on a formula specified in law and paid
by Education to lenders on a quarterly basis when the "guaranteed lender
yield" exceeds the borrower rate. This guaranteed lender yield is
currently based on the average 3-month commercial paper7 interest rate
plus an additional 2.64 percent. When this guaranteed yield is higher than
the amount of interest being paid by borrowers, Education makes up the
difference. If the borrower's interest rate exceeds the guaranteed lender
yield, Education does not pay a SAP, and the lender receives the borrower
rate.

Education's estimate of $2.135 billion in subsidy costs for FFELP
consolidation loans made in fiscal year 2003 is based on the assumption
that the guaranteed lender yield will rise over the next several years,
reflecting Education's assumption that market interest rates are likely to
rise from the historically low levels experienced in fiscal year 2003. The
effect of this rise is shown in figure 2, where the bottom line shows the
fixed borrower rate for a FFELP consolidation loan made in the first 9
months of fiscal year 2003, and the top line shows Education's estimated

7Commercial paper is short-term, unsecured debt with maturities up to 270
days. It is issued in the form of promissory notes, primarily by
corporations. Many companies use commercial paper to raise cash for
current transactions and many find it to be a lower-cost alternative to
bank loans.

values for the guaranteed lender yield over time. In fiscal year 2003,
market interest rates were such that the guaranteed lender yield
established under the SAP formula was actually below the borrower rate.
Lenders, therefore, received only the rate paid by borrowers; no SAP was
paid. However, in future years, when the guaranteed lender yield is
expected to increase and be above the borrower rate, Education would have
to make up the difference in the form of a SAP. As figure 2 shows,
Education's assumptions would call for lenders to receive a SAP over most
of the life of the consolidation loans made in fiscal year 2003.

Figure 2: Illustration of Estimated SAP Paid to Holders of FFELP
Consolidation Loans Originated in Fiscal Year 2003

Interest

                                       8

                                       7

                                       6

                                       5

                                       4

                                       3

                                       2

                                       1

0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Fiscal year

Source: GAO analysis based on data provided by Education's Budget Service.

aThe estimated lender yield, which is based on the average 3-month
commercial paper rates, as provided by the Office and Management and
Budget, does not vary much after fiscal year 2007 since the projected
commercial paper rates do not vary much after fiscal year 2007. The actual
lender yield could vary from these projections depending on future
interest rates.

bThis borrower rate is for a consolidation loan originated from October to
June of fiscal year 2003 and whose underlying loans are Stafford loans
disbursed after July 1, 1998, and in repayment at time of consolidation.

An increase in loan volume also played a role in the subsidy cost increase
from fiscal years 2002 to 2003. However, the effect of the increased loan
volume was not as large as that of the higher interest subsidies the
government is expected to pay to lenders in the future.

FDLP Loans also Affected Subsidy costs can occur within FDLP as well, but
in a different way.

by Changing Interest Rates 	FDLP's consolidation program is a direct loan
program and, therefore, involves no guaranteed yields to private lenders.
Still, the program has potential subsidy costs if the government's cost of
borrowing is higher than the interest rate borrowers are paying. The
government's cost of

borrowing is determined by the interest rate Education pays Treasury to
finance direct student loans, which is equivalent to the discount rate.8
The difference between borrowers' rates and the discount rate-called the
interest rate spread-is a key driver of subsidy estimates for FDLP loans.
When the borrower rate is greater than the discount rate, Education will
receive more interest from borrowers than it will pay in interest to
Treasury to finance its loans, resulting in a positive interest rate
spread- or a gain (excluding administrative costs) to the government.
Conversely, when the borrower rate is less than the discount rate,
Education will pay more in interest to Treasury than it will receive from
borrowers, which will result in a negative interest rate spread-or a cost
to the government.

For FDLP consolidation loans made in fiscal years 2002 and 2003, no such
negative interest rate spreads were incurred in either year, based on the
methodology Education uses to determine these costs. In both years,
borrower interest rates for FDLP consolidation loans were somewhat higher
than the discount rate, resulting in a net gain to the government.
However, while Education continued to benefit from lending at interest
rates higher than its cost of borrowing for FDLP consolidation loans made
in fiscal year 2003, the size of this benefit declines from $571 million
in fiscal year 2002 to $543 million in fiscal year 2003.

The smaller net gain that occurred in fiscal year 2003 reflects both a
decrease in the loan volume and a narrowed difference between the discount
rate and the borrower rate. Loan volume in fiscal year 2003 was $6.7
billion, a decrease from $8.8 billion in fiscal year 2002. In fiscal year
2003, this difference narrowed in part because borrower rates dropped more
than the discount rate. The borrower rates for FDLP consolidation loans
dropped 1.2 percentage points, from 6.3 percent in fiscal year 2002 to 5.1
percent in fiscal year 2003. The discount rate, on the other hand, dropped
by only 0.88 percentage points, from 4.72 percent in fiscal year 2002 to
3.84 percent in fiscal year 2003. The resulting interest rate spread
decreased from 1.59 percent to 1.22 percent (see table 2). In other words,
each $100 of consolidated FDLP loans made in fiscal year 2002, will result
in $1.59 more in interest received by Education than it will pay out in
interest to the Treasury. A similar loan originated in fiscal year 2003,
however, will generate only $1.22 more in interest for the government.

8While the discount rate is the interest rate used to calculate the
present value of the estimated future cash flows to determine subsidy cost
estimates, it is also generally the same rate at which interest is paid by
Education on the amounts borrowed from Treasury to finance the direct loan
program.

Table 2: Interest Rate Spread for FDLP Consolidation Loans Originated in
Fiscal Years 2002 and 2003

                     Borrower Discount Interest rate       Estimated interest 
                                                                     payments 
         Fiscal year     rate     rate        spread   for each $100 of loans 
                2002    6.31%    4.72%         1.59%     1.59% x $100 = $1.59 
                2003    5.06%    3.84%         1.22%     1.22% x $100 = $1.22 

      Source: GAO analysis of data provided by Education's Budget Service.

Administration Costs also Increase, Mainly because of Loan Volume

Concluding Observations

Loan volume affects administrative costs, in that cost is in part a
function of the number of loans originated and serviced during the year.
As a result, when loan volume increases, administration costs also
increase. Education's current cost accounting system does not specifically
track administration costs incurred by each of the student loan programs.
Consequently, we were unable to determine the total administration costs
incurred by consolidation loan programs or any off-setting administrative
cost reductions associated with the prepayment of loans underlying
consolidation loans. However, based on available Education data, we were
able to determine some of the direct costs associated with the
origination, servicing, and collection of FDLP consolidation loans. For
fiscal year 2002, these costs totaled roughly $52.3 million. This does not
include overhead costs, which include costs incurred for personnel, rent,
travel, training, and other activities related to maintaining program
operations. For fiscal year 2003, the estimated costs for the origination,
servicing, and collection of FDLP consolidation loans is projected to
increase to $59.5 million. While we similarly were unable to determine
Education's administration costs directly related to FFELP consolidation
loans, they are likely to be smaller than for FDLP consolidation loans.
This is because a large portion of FFELP administration cost is borne
directly by lenders, who make and service the loans. The special allowance
payments to lenders, which rise and fall as interest rates change, are
designed to ensure that lenders are compensated for administration and
other costs and provided with a reasonable return on their investment so
that they will continue to participate in the program.

As the discussion of both FFELP and FDLP loans shows, interest rates have
a strong effect on whether subsidy costs occur and how large they are. The
movement of subsidy costs for consolidation loans made in future years
will depend heavily on what happens to interest rates. As we have shown,
subsidy cost estimates for FFELP consolidation loans can increase

substantially, depending on how much the guaranteed lender yield rises
above the fixed rate paid by borrowers, which, in turn, requires the
federal government to pay subsidies to lenders. Conversely, if borrowers
obtained consolidation loans with a fixed interest rate at a time when
rates were expected to decrease in the future, federal subsidy costs could
be lower, than is currently the case, because the borrower rate could
exceed the rate guaranteed to lenders, and the federal government might
not be required to pay lender subsidies. For FDLP consolidation loans,
allowing borrowers to lock in a low fixed rate might result in decreased
federal revenues if the variable interest rates on those loans borrowers
converted to a consolidation loan would have otherwise increased in the
future. The exact effects of FDLP consolidation loans, however, depend on
a number of factors, including the length of loan repayment periods,
borrower interest rates, and discount rates.

We noted in our prior report9 that borrowers' choices between obtaining a
fixed rate consolidation loan or retaining their variable rate loans can
significantly affect federal costs. While consolidation loans may be an
important tool to help borrowers manage their educational debt and thus
reduce the cost of student loan defaults, the surge in the number of
borrowers consolidating their loans suggests that many borrowers who face
little risk of default are choosing consolidation as a way of obtaining
low fixed interest rates-an economically rational choice on the part of
borrowers. If borrowers continue to consolidate their loans in the current
low interest rate environment, and interest rates rise, the government
assumes the cost of larger interest subsidies. Providing for these larger
interest subsidies on behalf of a broad spectrum of borrowers may outweigh
any government savings associated with the reduced costs of loan defaults
for the smaller number of borrowers who might default in the absence of
the repayment flexibility offered by consolidation loans.

In our October 2003 report, we also discussed the extent to which
repayment options other than consolidation loans allow borrowers to
simplify loan repayment and reduce repayment amounts. We found that other
repayment options that allow borrowers to make a single payment to cover
multiple loans and smaller monthly payments are now available for some
borrowers under both FFELP and FDLP, but these alternatives are not
available to all borrowers. In that report, we concluded that
restructuring the consolidation loan program to specifically target

9GAO-04-101.

borrowers who are experiencing difficulty in managing their student loan
debt and at risk of default, and/or who are unable to simplify and reduce
repayment amounts by using existing alternatives, might reduce overall
federal costs by reducing the volume of consolidation loans made. In
addition, making the other nonconsolidation options more readily available
to borrowers might be a more cost-effective way for the federal government
to provide borrowers with repayment flexibility while reducing federal
costs. An assessment of the advantages of consolidation loans for
borrowers and the government, taking into account program costs and the
availability of, and potential change to, existing alternatives to
consolidation, and how consolidation loan costs could be distributed among
borrowers, lenders, and the taxpayers, would be useful in making decisions
about how best to manage the consolidation loan program and whether any
changes are warranted.

In our October 2003 report, we recommended that the Secretary of Education
assess the advantages of consolidation loans for borrowers and the
government in light of program costs and identify options for reducing
federal costs. We suggested options that 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. We also
noted that, 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. Furthermore, if Education determines that statutory changes are
needed to implement more cost-effective repayment options, we believe it
should seek such changes from Congress. Education agreed with our
recommendation.

Mr. Chairman, this concludes my prepared statement. I would be pleased to
respond to any questions that you or other members of the Committee may
have.

GAO Contact and 	For further contacts regarding this testimony, please
call Cornelia M. Ashby at (202) 512-8403. Individuals making key
contributions to this

Acknowledgments 	testimony include Jeff Appel, Susan Chin, Cindy Decker,
and Julianne Hartman-Cutts.

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