Student Consolidation Loans: Potential Effects of Making Fiscal  
Year 2006 Consolidation Loans Exclusively through the Direct Loan
Program (05-DEC-05, GAO-06-195).				 
                                                                 
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?				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-195 					        
    ACCNO:   A42558						        
  TITLE:     Student Consolidation Loans: Potential Effects of Making 
Fiscal Year 2006 Consolidation Loans Exclusively through the	 
Direct Loan Program						 
     DATE:   12/05/2005 
  SUBJECT:   Administrative costs				 
	     Aid for education					 
	     Cost analysis					 
	     Financial analysis 				 
	     Future budget projections				 
	     Loan interest rates				 
	     Loan repayments					 
	     Policy evaluation					 
	     Student loans					 
	     Subsidies						 
	     Consolidation					 
	     Federal Family Education Loan Program		 
	     William D. Ford Federal Direct Loan		 
	     Program						 
                                                                 

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GAO-06-195

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

Student Consolidation Loans 

GAO-06-195

Contents

Letter 1

Summary of Findings 4
Providing Consolidation Loans Exclusively through FDLP Could Yield
Estimated Budgetary Savings of $3.1 Billion in Fiscal Year 2006 4
Savings Estimates Could Change Substantially as a Result of Reestimates of
Subsidy Costs because of Changes in Key Assumptions and Actual Results 5
Effect on FFELP Lenders and Borrowers Difficult to Predict 6
Concluding Observations 6
Agency Comments 7
Appendix I Briefing Slides 8

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

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separately.

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.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 2005.2 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.

1Stafford 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.

2GAO, 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).

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.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:

3Present 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.

           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,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.

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

                              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

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

           o  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.

           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

           o  economic conditions, such as interest rates;

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

           o  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,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.6 On the
           other hand, if consolidation loan volume was higher than expected,
           estimated savings could exceed $3.1 billion.

           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.

           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.

           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 [email protected]. 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

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

5GAO-05-874.

           Effect on FFELP Lenders and Borrowers Difficult to Predict

                            Concluding Observations

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

                                Agency Comments

A  Appendix I: Briefing Slides

(130447)

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

December 2005

STUDENT CONSOLIDATION LOANS

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

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?

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

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