Issue Brief
With the costs of higher education rising every year, it is not surprising that taxpayers are increasingly being asked to help pay the bills. But widening streams of federal tax dollars can make matters worse if they are applied to supporting flawed programs. Unless current trends are reversed, a number of new Congressional proposals would produce the unwanted effect of raising default rates on student loans, leaving taxpayers holding the bag.
Federally-insured student loans now provide 30 percent of all payments for college tuition costs. That loan market has more then doubled in the past 10 years, and economists have argued that the result has actually put upward pressure on college costs.
The federal Department of Education operates two competing loan programs, and taxpayers carry the credit risk for both of them. Under the William D. Ford Direct Loan Program, the Department makes and administers loans directly to borrowers. Under the Federal Family Education Loan (FFEL) program, private companies provide the capital and administer the loans, which are largely federally insured.
Recent plans proposed by Republicans and Democrats alike would expand the Direct Loan program while tightening market conditions for FFEL in various ways. But data from the Department of Education show that default rates are significantly higher for loans made under the Direct Loan program than under FFEL.
The chart below shows student loan default rates by program and category of loan. The Office of Management and Budget has predicted that the Direct Loan program will experience a weighted average default rate 5 percentage points higher than the FFEL program for FY 2008. With over 3.1 million Direct Loans expected, taxpayers can expect an increased burden should the program be expanded.
Student loan debt is unique in that it cannot be erased when an individual declares bankruptcy. When a loan defaults, it is frequently because a lender loses track of the loan recipient. Private companies are often better equipped than government agencies for keeping track of their customers. They have a greater incentive to be innovative and respond faster, and often employ more state-of-the-art technology — a critical edge in fast-changing financial markets.
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