Costs and Policy Options for Federal Student Loan Programs

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March 25, 2010

The federal government helps students finance higher education through two major loan programs—one that guarantees loans made by private lenders, and one that makes loans directly to borrowers. Between 2000 and 2009, the volume of outstanding federal student loans more than quadrupled, from about $149 billion to about $630 billion.

Although both programs offer similar types of loans on similar terms to borrowers, they differ significantly in how they are funded and administered. In the guaranteed loan program, loans are made and administered by financial institutions—such as Sallie Mae, commercial banks, and nonprofit agencies. The government bears almost all of the risk of borrowers defaulting and makes certain payments to the lenders. Those lenders usually raise the money to make loans in the private capital markets. By contrast, in the direct loan program, the Department of Education and its contractors bear all of the risks and manage most administrative functions; those loans are funded through the Treasury. Those differences cause the guaranteed loan program to be more costly to the federal government per dollar of lending than the direct loan program.

Today CBO released a study—prepared at the request of the Ranking Member of the Senate Budget Committee—examining the costs of the federal student loan programs, calculated two different ways. One estimate follows the methodology delineated by the Federal Credit Reform Act of 1990, which governs the treatment of credit programs (including student loans) in the federal budget. The other estimate was done on a so-called “fair-value basis,” which provides a more comprehensive measure of cost by including administrative costs and the cost of market risk (the risk that losses from defaults will be higher during periods of market stress, when resources are scarce and hence most valuable). A fair-value estimate represents what a private entity would need to be paid to assume the costs and risks to the government of providing the loans or guarantees.

CBO’s calculations indicate that:

  • For both programs, subsidies calculated on a fair-value basis show substantially higher costs than those based on the standard budgetary treatment.
  • Regardless of which methodology is used, for a given set of borrowers and loan types, the guaranteed loans cost the government more than those it makes directly.

For example, on a fair-value basis, a mix of representative guaranteed loans would typically cost the government about 20 percent of the principal amount of the loans. Those same loans, made directly by the government to the same people, would typically cost about 12 percent of the principal amount.

The study also looks at several proposals for modifying the student loan programs. For example, the President’s 2011 budget calls for ending the guarantee program’s authority to make new loans on July 1, 2010, and switching entirely to the direct lending program to realize the savings from that program’s lower costs. (CBO recently provided a cost estimate for that particular proposal in a letter to Senator Gregg on March 15 and in our Analysis of the President’s Budget released yesterday.) The House of Representatives and the Senate have both passed legislation (H.R. 4872, the Health Care and Education Affordability Reconciliation Act of 2010) to carry out a similar change.

Other policy options, some of which would reduce costs to the government and others that would increase those costs, include:

  • Reducing the cost of the guarantee program by cutting government payments to lenders, reducing the guarantee percentage on loans, or auctioning off the right to lend under the program;
  • Indexing interest rates to market rates, allowing federal costs to be more predictable;
  • Improving the affordability of student loans by lowering interest rates; and
  • Lessening the hardships that borrowers face in repaying loans by making repayment of loans contingent on income, for example.

This study was prepared by Deborah Lucas, CBO’s Associate Director for Financial Analysis, and Damien Moore of CBO’s Macroeconomic Analysis Division.