College tuition continues to skyrocket. Grants and scholarships have not kept pace. Higher education is increasingly being financed by debt. It is no surprise, as families struggle to afford higher education, politicians are proposing major structural changes to the federal student loan program.
Among the most drastic measures – with unanimous support among the Democratic Presidential hopefuls – is a proposal to eliminate the role for private banks in the Federal Family Education Loan (FFEL) program and mandate that all federal student loans be administered directly by the government through the Federal Direct Lending Program (FDLP).
It is common sense, proponents of the plan argue, that eliminating private banks as the middle-man in student loan delivery will achieve cost savings.
Presumably, if the government (instead of private banks) collects the interest paid on student loans, it could use that money to finance the student loan program – making it less expensive to taxpayers. And because the government is not profit-seeking, the loans, in theory, would be less expensive to student borrowers. A seeming win for both taxpayers and students.
But there are three ways in which these assumptions oversimplify direct lending and likely overstate its benefits.
ONE. The federal government does not have any money to lend. In order to lend money to students, the US Treasury itself has to borrow money (adding to the national debt) and pay interest on it. The relevant question is whether the US Treasury can borrow money at a rate lower than the Department of Education (DOE) is charging students.
Changes made last year lowered interest rates over time to 3.4% for subsidized Stafford loans. In 2007, 42% of money lent to undergraduates fell into this category. New rules regarding consolidation and repayment terms mean that such a low interest rate can be fixed for decades into the future. Other federal loans enjoy low fixed rates also.
TWO. In order to achieve the savings proponents claim, the difference between interest rates must be sufficient to cover the cost of students who default on their loans. According to the DOE, approximately 5% of students default on their loans within 2 years, the vast majority of whom never make a single payment. A look at default rates for the full life of a loan shows they are closer to 12%.
The total amount of money loaned through the federal student loan program during the 2006-07 school year alone was $60 billion. When borrowers default on federal student loans, it is taxpayers who are left holding the bag. And policies aimed at lowering default rates benefit both students and taxpayers.
THREE. Administrative costs. The task of delivering $60 billion, in $2,000 increments, multiple times a year, to nearly 14 million people is expensive. This week, the Office of Management and Budget (OMB) released new data showing that the federal government’s own Ford Direct Loan Program costs more than the FFEL program administered by private banks. For 2009, the total subsidy rate is projected to be $2.58 for each $100 lent by FFEL, and $2.64 for each $100 lent directly by the federal Department of Education.
Fortunately, the US House of Representatives has called for a comprehensive independent audit of the FDLP as part of the Higher Education Reauthorization Act scheduled to come to the Floor this week. The audit provision creates a valuable level of transparency never before revealed.
Before we subject more students to the highly habit-forming practice of turning to federal programs for assistance, we should understand all of the costs associated with direct lending.
In the FFEL program, through partial interest rate reimbursements and partial guarantees in the event of default, taxpayers bear a portion of the cost and banks bear a portion of the cost, of the below-market interest rates for students. In Direct Lending, taxpayers bear 100% of those costs.
The popularity of federally-subsidized student loan programs all but ensures that they will be with us for a long time. That is all the more reason why policymakers should ensure that they serve not only students and their families well, but taxpayers too.
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