Department of Education Student Loans. The student loan programs provide students and their families with Federal loans to help meet postsecondary education costs. Student loans meet an important Administration strategic goal to help ensure the affordability, accessibility and accountability of higher education, and to better
STUDENT LOANS OVERVIEW
prepare students and adults for employment and future learning. With passage of the Student Aid and Fiscal Responsibility Act (SAFRA) of 2010, the Federal Family Education Loan (FFEL) program ceased making new loans as of July 1, 2010. (However, the billions of FFEL loans outstanding will continue to flow through the system and be serviced by lenders.) As of July 1, 2010, all Subsidized and Unsubsidized Stafford Loans, PLUS, and Consolidation Loans are originated in the Direct Loan program. The combined FFEL and Direct Loan new loan volume in FY 2010 was approximately $104 billion. New loan volume typically reflects new student loan demand, and therefore does not include Consolidation volume, which relates to students consolidating prior existing loans. (Consolidation volume would be included when reporting total student loan volume.) New volume in the Direct Loan program is estimated to be $116 billion in FY 2011 and $124 billion in FY 2012. This represents a substantial increase from the combined new FFEL and Direct Loan volume of $33 billion in FY 2000. In FY 2012, total loan volume in the Direct Loan program (including Consolidations) is estimated to be $147 billion, accounting for nearly 78 percent of all postsecondary aid available from the Department of Education.
The Higher Education Reconciliation Act (HERA) of 2005 (P.L. 109-171), signed into law on February 8, 2006, and the College Cost Reduction and Access Act (CCRAA) (P.L. 110-84), which became law on September 27, 2007, made substantial changes to the FFEL and Direct Loan programs. Many of the changes are discussed within the following program descriptions.
In addition, due to the deteriorating credit conditions during 2008, Congress passed the Ensuring Continued Access to Student Loans Act (ECASLA) of 2008 (P.L. 110-227), which was signed into law on May 7, 2008. This law allowed the Department of Education to provide access to capital needed by private lenders to make Federal student loans. ECASLA also increased Unsubsidized Stafford loan amounts in both the FFEL and Direct Loan programs. Given the continued concerns around capital liquidity, the ECASLA authority was extended for the 2009-2010 academic year. Using this authority, the Department established four programs designed to ensure the availability of student loans. This original need for ECASLA was eliminated after passage of SAFRA in 2010, whereby all new student loans now occur in the Direct Loan program. Other activity in ECASLA-related financing accounts will continue.
Federal Student Loans
Federal student loans were initiated under the FFEL program beginning in 1965. The Direct Loan program has operated since July 1, 1994. Because funding for the loan programs is provided on a permanent indefinite basis, for budget purposes student loans are considered separately from other Federal student financial assistance programs. However, as part of the overall Federal effort to expand access to higher education, student loans should be viewed in combination with these other programs. Since all new loans now originate as Direct Loans, this program description primarily highlights the operations of the Direct Loan program.
Generally, loan capital in the FFEL program was provided by private lenders, facilitated by the Federal guarantee on the loans. The Government also promised interest subsidies to lenders for certain situations, as well as most costs associated with loan defaults and other write-offs. In addition, State and private nonprofit guaranty agencies acted as agents of the Federal Government, providing a variety of services including collection of some defaulted loans, default avoidance activities, and counseling to schools, students, and lenders. The Government continues to provide substantial payments to these FFEL guaranty agencies.
STUDENT LOANS OVERVIEW
transition to Direct Loans in FY 2011, the Secretary plans to execute Voluntary Flexible Agreements (VFA) with guaranty agencies to develop, implement, and evaluate alternative ways of fulfilling guaranty agency legal obligations. The VFA arrangements are intended to facilitate a more efficient use of guaranty agencies.
The VFAs, which are required by law to be cost-neutral, will focus on enhancing the integrity of the student loan programs and eliminating redundancy and unneeded or ineffective activities. The Department expects to solicit VFA proposals from guaranty agencies in FY 2011 and negotiate and execute agreements after these proposals have been reviewed. Joint proposals from two or more agencies may be submitted.
The Direct Loan program was created by the Higher Education Amendments of 1992 as a pilot program and expanded by the Student Loan Reform Act of 1993. Under this program, loan capital is provided by the Federal Government while loan origination and servicing is handled by postsecondary institutions and private sector companies under contract with the Department. The Direct Loan program began operation in academic year 1994-1995 with 7 percent of overall loan volume. It now accounts for all new loan volume as of July 1, 2010.
Four types of loans are available: Subsidized Stafford, Unsubsidized Stafford, PLUS, and Consolidation. Financial need is required for a student to receive a subsidized Stafford loan, where the Federal Government pays the interest during in-school, grace, and deferment periods. The other three loan types are available to borrowers at all income levels. Loans can be used only to meet qualified educational expenses.
The CCRAA of 2007 included a phased interest rate reduction for new undergraduate Subsidized Stafford Loans, with fixed interest rates dropping from 6.8 percent to 6.0 percent on July 1, 2008, to 5.6 percent on July 1, 2009, 4.5 percent on July 1, 2010, and 3.4 percent on July 1, 2011. Rates for Stafford loans to graduate and professional students and for all new loans originated on or after July 1, 2012, are 6.8 percent. For all subsidized Stafford loans, interest payments are fully subsidized by the Government while a student is in school and during grace and deferment periods. However, under the proposed FY 2012 budget policy, only undergraduate students would continue to receive this in-school interest subsidy.
Graduate and professional students would no longer be eligible. The borrower interest rate on all Unsubsidized Stafford loans was fixed at 6.8 percent as of July 1, 2006. The fixed borrower interest rate on Direct PLUS loans made on or after July 1, 2006,
is 7.9 percent.
Although no new loans will originate in the FFEL program, those FFEL loans that are outstanding will continue to be serviced by lenders. In the FFEL program, lenders may receive an interest subsidy, called a special allowance, from the Government to ensure a guaranteed rate of return on their loans. Special allowance payments vary by loan type, are determined quarterly, and are based on current borrower interest rates and market-yield formulas. For periods when the borrower interest rate exceeds the special allowance rate on loans made on or after April 1, 2006, lenders remit the difference back to the Government; lenders retain such difference on loans made on or before April 1, 2006. Special allowance rates differ for for-profit and not-for-profit loan holders on some loans. For Stafford and Unsubsidized Stafford loans made on or after October 1, 2007, for example, the Federal Government must pay lenders a special allowance if the average 3-month commercial paper rate for a given quarter plus 1.79 percent for for-profit holders, or 1.94 percent for not-for-profit holders, is higher than the current interest rate charged to borrowers. The guarantee percentage paid to lenders on most defaults
STUDENT LOANS OVERVIEW
(for loans disbursed as of July 1, 2006) is 97 percent of unpaid loan principal (including any accrued interest on the full loan principal).
Consolidation loans allow borrowers to combine other loans made under Title IV of the Higher Education Act—FFEL, Direct Loans, and Perkins Loans as well as some loans made under the Public Health Service Act—into one loan, thereby eliminating multiple monthly payments during the repayment term. The interest rate for new Direct
Consolidation loans equals the weighted average of the interest rate on the loans consolidated, rounded up to the nearest 1/8 of 1 percent. Interest rates for all new Direct Consolidation Loans are capped at 8.25 percent.
Direct Loan borrowers are charged an origination fee equal to 1 percent of principal. Loan limits apply as shown in the “loan maximum” table on page S-10. Borrowers in both FFEL and Direct Loan programs may be offered financial incentives to encourage prompt repayment. Loans may be discharged when borrowers die, are totally and permanently disabled, or, under limited circumstances, declare bankruptcy.
Under both programs, new borrowers after October 1, 1998, who are employed as teachers in schools serving low-income populations for 5 consecutive, complete school years, qualify for up to $5,000 in loan forgiveness; this benefit is increased to $17,500 for mathematics, science, and special education teachers considered highly qualified under criteria established in the No Child Left Behind Act of 2001. In addition, the CCRAA of 2007 established a public-service loan forgiveness program for nonprofit and public-sector employees. Eligible borrowers who have worked for 10 years while making payments on their student loan will have any remaining loan balance forgiven. This benefit is only available in the Direct Loan program, though FFEL borrowers may access the benefit by taking out a Direct Consolidation Loan, which is available for all borrowers, regardless of when they took out their loans.
FFEL borrowers may choose from among four repayment plans. Repayment periods under standard, graduated, and income-sensitive repayment may not exceed 10 years. An extended repayment plan of up to 25 years is available for new borrowers with outstanding loans totaling more than $30,000. FFEL borrowers may change repayment plans annually. Qualifying student borrowers may also choose an income-based repayment (IBR) plan under which FFEL loans (except Parent PLUS) are paid according to the borrower’s income, and outstanding balances, if any, are forgiven after 25 years in repayment. (In the first 3 years, an interest subsidy is available for Stafford loans and for the Stafford Loan portion of Consolidation Loans.) To ensure that student debts are manageable, SAFRA adopted most of the Administration’s 2011 budget policy—reducing monthly payments in IBR from 15 percent of a borrower’s prior-year discretionary income to 10 percent, and reducing the maximum length of time a borrower is in the IBR program from 25 years to 20 years, after which any remaining balance is forgiven. New loans beginning July 1, 2014 are eligible for this treatment.
Borrowers under Direct Loans may choose from the same payment plans as in FFEL, except that instead of the FFEL income-sensitive repayment plan, an income-contingent repayment (ICR) plan is available in Direct Loans (with terms similar to the newer income-based repayment plan). Direct Loan borrowers may switch between repayment plans at any time.
In FY 2011, the first year in which Direct Loans will account for all new student loans, net commitment loan volume is estimated at $135.6 billion, which includes almost $20 billion in Consolidation loans. Approximately $221 billion in total Direct Loans was outstanding at the end
STUDENT LOANS OVERVIEW
of FY 2010. Across the FFEL guaranteed program—including the Liquidating account composed of loans issued before 1992—there were approximately $424 billion in FFEL loans and $100 billion in ECASLA program loans outstanding at the end of FY 2010.
Funding
Both FFEL and Direct Loans are mandatory programs whose costs are largely driven by Federal borrowing costs, prevailing interest rates, defaults, and loan volume. The programs are funded by indefinite budget authority and do not require annual congressional appropriations. A loan subsidy—the portion of cost paid by the Federal Government—is calculated for each loan cohort based on the Federal Credit Reform Act of 1990, and reflects the net present value of future cash flows associated with the Direct Loan or loan guarantee.
Both the FFEL and Direct Loan programs incur various administrative expenses, some of which are funded through subsidy while most are funded through administrative funds. In FY 2012, the Administration requests $1.1 billion in discretionary funding to administer the Federal student aid programs in the Student Aid Administration (SAA) account. This includes $725 million for student aid administration, and $370 million for loan servicing activities. In addition, $247 million in mandatory funds will be used for student loan servicing. This request is discussed in detail in the justification for Student Aid Administration, beginning on page AA-1.
Credit Reform Estimates
Student loan program costs are estimated consistent with the terms of the Federal Credit Reform Act of 1990. Under the Act, future costs and revenues associated with a loan are estimated for the life of the loan and discounted back to the date of disbursement using Treasury interest rates. Costs related to pre-1992 loans in the FFEL Liquidating account and most Federal administrative costs are statutorily excluded from credit reform calculations. For FFEL, credit reform costs include reimbursements to lenders for in-school interest benefits, special allowance payments to lenders, and default reinsurance payments. These costs are partially or, in 2010, more than completely offset by student and lender origination fees, negative special allowance payments—referred to as rebates—and collections on defaulted loans.
In the Direct Loan program, cash transactions consist of Federal Government loan disbursements to students, payments of student loan fees, and borrower loan repayments. Defaults and loan discharges reduce future student loan repayments. In FY 2011 and FY 2012, the Direct Loan program reflects a net total negative subsidy due in part to reduced discount rates that lower the Federal Government’s borrowing costs, while borrower repayments and origination fees contribute to increased cash flows as collections to the Federal Government helping to offset Federal costs.
Federal loan programs are often compared using subsidy rates, which represent the Federal cost (the appropriation) as a percentage of loan originations. For FFEL guaranteed loans in 2010, the Budget estimates the overall weighted average subsidy rate was -0.22 percent: that is, for this 2010 cohort, Government revenues from fees and, in particular, negative special allowance, exceed the cost of loan guarantees. (This is largely driven by historically low commercial paper rates, which result in unusually high negative special allowance payments.) For Direct Loans, the overall weighted average subsidy rate was estimated to be -7.82 percent in FY 2010; that is, the program is projected to earn about $7.82 on every $100 of loans originated.
STUDENT LOANS OVERVIEW
In an effort to better reflect interest rate variability of future estimates, the Administration in 2006 implemented probabilistic scoring for the FFEL and Direct Loan programs similar to the Congressional Budget Office methodology. Previously, estimates for both the FFEL and Direct Loan programs were developed using point estimates of future interest rates. The updated method factors in the probability that a range of interest rate scenarios may differ from current economic projections.
Estimated Program Subsidy Costs
The largest loan subsidy costs involve in-school interest subsidies for borrowers and costs associated with borrowers who default on their loans. In FY 2012, the FFEL program will not originate any new loans or result in any new subsidy costs because the Direct Loan program assumed all new lending beginning July 1, 2010. Based on proposed policies, the Direct Loan subsidy costs in fiscal year 2012 are estimated at -$27.2 billion, supporting over $162 billion in estimated total Direct Loan gross commitments, which equates to $147 billion in net loan volume commitments—after loan cancellations.
Generally, subsidy costs may reflect a combination of positive and negative subsidy by loan type with the relative weightings by loan type and other accounting rules determining the overall net positive or negative subsidy. A negative subsidy occurs when the present value of cash inflows to the Government is estimated to exceed the present value of cash outflows. In that case, the Federal Government is earning more than it is spending.
Subsidy rates represent the Federal portion of non-administrative costs—principally interest subsidies and defaults—associated with each borrowed dollar over the life of the loan. Under Federal Credit Reform Act rules, subsidy costs such as default costs and in-school interest benefits are embedded within the program subsidy, whereas
Federal administration costs are treated as annual cash amounts and are not included within the subsidy rate.
The subsidy rate reflects the estimated unit cost per loan, over the life of the loan, to the Federal Government. For example, a $1,000 loan with Federal subsidy costs of $100 would have a subsidy rate of 10 percent. If loan subsidy costs were negative, such as -$100, the loan would have a negative subsidy rate of -10 percent, indicating that the Federal Government was earning 10 percent on each loan instead of incurring a cost. Program changes, economic conditions, as well as borrower repayment patterns can affect subsidy estimates and reestimates.
For FY 2012, the Direct Loan program weighted average subsidy rate is estimated to be -16.77 percent. Annual variations in the subsidy rate are largely due to the relationship between the OMB-provided discount rate that drives the Government’s borrowing rate and the interest rate at which borrowers repay their loans. Technical assumptions regarding defaults, repayment patterns, and other borrower characteristics would also apply. The loan subsidy estimates are particularly sensitive to fluctuations in the discount rate. Even small shifts in economic projections may produce substantial movement, up or down, in the subsidy rate.
Reestimates
Under credit reform, the Department annually reestimates the cost of all outstanding loans by cohort to reflect updated modeling assumptions, the President’s Budget economic assumptions,
STUDENT LOANS OVERVIEW
and actual experience. In essence, the reestimating process allows for a “reality check” each year whereby the most recent economic and technical assumptions get applied to prior cohorts.
For the approximately $221 billion in Direct Loans outstanding at the end of 2010, the Budget projects net future Federal costs will be lower in FY 2011 than estimated in last year’s President’s Budget. The total change in costs for all outstanding Direct Loan program account loans at the end of FY 2010 is depicted as the 2011 reestimate. The 2011 total net downward reestimate of approximately -$5.7 billion reflects an upward component of about +$2.8 billion and a downward component of -$8.5 billion. The upward reestimate requires a current-year (i.e., FY 2011) mandatory appropriation.
The total change in costs for all outstanding FFEL guaranteed program account loans at the end of 2010 is reflected as the 2011 reestimate. The 2011 FFEL guaranteed loan reestimate reflects an upward component of +$146 million and a downward component of -$18.8 billion for a total net downward reestimate of approximately -$18.6 billion.
Thus, the estimated Federal cost of prior FFEL guaranteed loan cohorts (1992-2010) is now lower by $18.6 billion as reflected in the net downward reestimate.
The four ECASLA programs, discussed on page S-3, show a net downward reestimate of -$5.9 billion which when combined with the FFEL guaranteed portion produces an overall net downward FFEL reestimate of about -$24.5 billion. This large net downward FFEL reestimate is due primarily to decreases in the OMB-provided interest rates released under the 2012 President’s Budget economic assumptions.
Loan Terms
Generally, the Federal Government provides four types of student loans:
Subsidized Stafford Loans are subsidized, low-interest, fixed rate loans based on financial need. The Federal Government pays the interest while the student is in school and during grace and deferment periods. For loans made on or after July 1, 2006, interest rates are fixed at 6.8 percent. The CCRAA authorized a phased reduction to the interest rate for undergraduates borrowing Stafford Loans so that by July 1, 2011, the rate would be cut in half to 3.4 percent for loans originated for a period of 1 year. The scheduled reduction follows: 6.0 percent starting July 1, 2008; 5.6 percent starting July 1, 2009; 4.5 percent starting July 1, 2010; 3.4 percent starting July 1, 2011. The interest rate reverts to 6.8 percent for loans originated as of July 1, 2012.
Unsubsidized Stafford Loans are low-interest, fixed rate loans that are available to student borrowers, regardless of financial need. The Federal Government does not pay accrued interest. Borrowers may defer payment of interest while in school and have it capitalized until entering repayment. For loans made on or after July 1, 2006, the interest rate is fixed at 6.8 percent.
PLUS Loans are available to parents of dependent undergraduate students and to graduate and professional students. The Federal Government does not pay interest accruing on PLUS Loans. The PLUS interest rate is fixed at 7.9 percent.
Consolidation Loans allow borrowers with existing student loans to combine their obligations and possibly extend their repayment schedules based on their total student loan debt outstanding. The interest rate for Consolidation Loans is based on the weighted average of the underlying loans being consolidated rounded up to the nearest 1/8 of 1 percent.
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