Putting Students First

An Analysis of the Potential for Cost Savings and Increased Aid to Students through Greater Participation in the Direct Loan Program

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Putting Students First
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In this new century, access to college is more important than ever. More than 80 percent of the 23 million jobs that will be created over the next 10 years will require at least some postsecondary education. Over the last 30 years, the proportion of factory jobs held by individuals who attended college has tripled. The rewards of advanced education – to students and to the economy as a whole – continue to grow. College graduates earn 80 percent more than high school graduates – an average of approximately $1 million in a lifetime. 

The Congressional Advisory Committee on Student Financial Assistance (ACSFA) estimates that over the next decade more than 4 million college-qualified high school graduates will not attend a four-year college and 2 million of those graduates will attend no college at all due to financial barriers. Recent trends in college costs and the failure of student aid to keep pace create obstacles for poor and middle class families. Tuition and fees at colleges have risen by as much as 40 percent in some states, while the 2002-03 maximum Pell Grant or federal scholarship was worth $500 less than the maximum Pell Grant in 1975-76 when adjusted for inflation. Despite growing debt levels (an average of $17,000 per undergraduate), many students can not make ends meet. According to a report by ACSFA, after taking into account family contributions, student loans, grants and work, the average low-income student needs $3,800 more to meet college costs and the average middle-income student needs $2,250 more.

The current federal student aid programs are scheduled to be reauthorized this year. Within Congress there appears to be a consensus that increased assistance is needed – whether by raising loan limits or increasing grants. But how such increases are to be financed is the subject of much debate.

One possibility under consideration is to eliminate a student borrower’s ability to consolidate  student loans. Currently, student borrowers are given the option to consolidate their loans after graduation, allowing them to lock in a low fixed interest rate rather than pay the variable rate on each loan. According to a recent analysis by the Congressional Research Service, eliminating this benefit will cost the average student borrower $5500.

An alternative is to eliminate excessive subsidies paid to banks and other private lenders under the existing student loan program. This report illustrates the magnitude of the savings that would result if Congress were to choose this alternative. The data contained in this report represent the savings by school and by state that could be realized if the government were to encourage or require that student loans that are currently administered through the Federal Family Education Loan (FFEL) Program be administered instead through the William D. Ford Direct Loan (Direct Loan) program.

According to 2001-2002 loan volume data, adoption of such a policy with respect to new and consolidated loans would save over $4.5 billion per year. When the current savings stemming from schools already participating in the Direct Loan program is considered (an appropriate exercise since schools can drop out of the program), the total estimated savings is over $6.6 billion per year. Indeed, given that loan volume has grown since 2001-2002 and is projected to grow substantially in the future, the potential savings are even greater than these numbers reflects.

Direct vs. FFEL Loans

Currently, schools may choose to offer their students one of two types of federally guaranteed loans – those administered through the Direct Loan program or those administered through the FFEL program. Under the Direct Loan program, the government is the lender, getting its capital wholesale through Treasury bonds. Under  the FFEL program, the government guarantees the returns to private lenders – such as Sallie Mae and Citibank – who provide the capital.

FFEL is a no-lose proposition for private lenders. The government guarantees repayment in the case of default and a predetermined profit margin, paying a subsidy if the student interest rate falls below a set level. Therefore, it is not surprising that the largest private lender in FFEL – Sallie Mae – is also one of the most profitable companies in the country. In fact, Sallie Mae was recently identified as the second most profitable company in the United States with over 36 percent return on revenues – compared to a median return of 4.6 percent for the nation’s 500 biggest companies.

Direct Loans are a better deal for the taxpayers. First, they ensure that the interest is returned to the Treasury, rather than subsidizing banks working as middlemen. Second, they provide the necessary capital at a lower cost. When a bank makes a student loan, it borrows money on the open market and then lends it out to the customer. The federal government does the same thing. But the government’s cost of borrowing is much lower than a bank’s, because the government borrows against U.S. Treasury bills backed by the “full faith and credit” of the United States. Former Bush Council of Economic Advisors Chief Lawrence Lindsey made this point in 1995, stating that “taxpayer cost is less for direct lending largely because the government can obtain capital less expensively through the sale of government securities than the market rates it must pay to support a system of loan guarantees.”

The FFEL and Direct Loan systems deliver the same loans at the same interest rates to students, and colleges choose in which program to participate. But every time a school opts for FFEL, the taxpayer loses because the costs to the government far exceed the costs of Direct Loans.

If schools were encouraged or required to switch from FFEL to Direct Loans, the government savings could be used to expand grants and other student aid to students at the federal or institutional levels. To illustrate the potential impact of such a policy, this report estimates the savings that would be generated if every institution of higher learning that now participates in the FFEL program were to switch to the Direct Loan program based on the volume of student loans during the 2001-2002 academic year. The report also provides an estimate for the potential savings that could be generated if existing consolidated loan were administered through the Direct Loan program. 


Based on data provided in a 1999 U.S. Department of Education report on the administrative costs of each student loan program and the “subsidy” costs associated with each loan program contained in the Administration’s budget for fiscal year 2005, we can estimate that direct loans cost the government approximately 69 cents per every $100 loaned or less than one penny per dollar loaned. In contrast, FFEL loans cost the government $10.51 for every $100 borrowed or a little more than 10 cents on the dollar. So the savings affiliated with opting for a Direct Loan rather than a FFEL loan are approximately $9.82 ($10.51 – $0.69) per $100 borrowed, or more than 9 cents on the dollar.

We multiplied the student loan volume at each institution during the 2001-2002 academic year (the most recent available from the Department of Education) by institution with the estimated savings of $9.82 per $100 borrowed. Using the same methodology, we estimated that the savings from  switching from FFEL consolidated loans to Direct consolidated loans – considering the consolidated loan volume for the 2001-2002 academic year – would be an additional $1.6 billion. These numbers underestimate the impact of a switch to Direct Loans as student loan volume has increased substantially since 2001-2002. Nevertheless, these estimates are useful illustrations of the impact of encouraging or requiring schools to offer their students Direct Loans rather than FFEL.

Institutions currently using Direct Loans are in bold. Schools using FFEL are in regular type. We have provided subtotals by state and nationally to show current savings (from those schools currently participating in Direct Loans) vs. potential savings (from those switching to Direct Loans).

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