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. 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  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. Borrowers’ Rates Have Dropped, and Loan Volume Has Risen

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. 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  borrowers to consolidate their variable rate student loans at a low, fixed  rate. 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. 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 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. 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. Education’s current cost accounting system does not specifically track  administration costs incurred by each of the student loan programs. 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.
Why GAO Did This Study

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.

What GAO Found

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. 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.