The Administration of the Federal Family Education Loan and William D. Ford Direct Loan Programs: Background and Provisions
CRS Report for Congress
The Administration of the Federal Family
Education Loan and William D. Ford Direct Loan
Programs: Background and Provisions
September 29, 2006
Specialist in Social Legislation
Domestic Social Policy Division
Congressional Research Service ˜ The Library of Congress
The Administration of
the Federal Family Education Loan and William D. Ford
Direct Loan Programs: Background and Provisions
The federal government operates two major student loan programs: the Federal
Family Education Loan (FFEL) program, authorized by Part B of Title IV of the
Higher Education Act (HEA) and the William D. Ford Direct Loan (DL) program,
authorized by Part D of Title IV of the HEA. These programs provide loans to
undergraduate and graduate students and the parents of undergraduate students to
help them meet the costs of postsecondary education.
Together, these federal student loan programs provide more direct aid to support
students’ postsecondary educational pursuits than any other source. In FY2005, these
programs provided $56.2 billion in new loans to students and their parents.
Under the FFEL program, loan capital is provided by private lenders, and the
federal government guarantees lenders against loss through borrower default, death,
permanent disability, or in limited instances, bankruptcy. FFEL program loans are
originated by private lenders. That is, private lenders work directly with students and
families to initiate the loan. Private lenders also are responsible for billing borrowers
and collecting loan payments. State and nonprofit guaranty agencies receive federal
funds to play the lead role in administering many aspects of the FFEL program. In
particular, the guaranty agencies provide many of the administrative services related
to the loan guarantee, including providing technical assistance and training to schools
on loan certification and to lenders on loan procedures, providing credit and loan
rehabilitation counseling to borrowers, reimbursing lenders when loans are placed in
default, and initiating collections work.
Under the DL program, the federal government provides the loans to students
and their families, using federal capital (i.e., funds from the U.S. Treasury), and owns
the loans. Under the DL program, schools may serve as loan originators, or the loans
may be originated by contractors working for the U.S. Department of Education
(ED). ED hires contractors to service the loans: i.e., to monitor student enrollment
and loan repayment status, process loan payments, and initiate collections work for
delinquent and defaulted loans.
The DL program was initially introduced to gradually expand and replace the
FFEL program. However, the 1998 amendments of the HEA removed the provisions
of the law that referred to a “phase-in” of the DL program. Currently, both programs
are authorized. They draw on different sources of capital and utilize different
administrative structures, but essentially disburse the same set of loans: subsidized
and unsubsidized Stafford loans for undergraduate and graduate students; PLUS
loans for parents of undergraduate students and for graduate students; and
Consolidation loans that offer borrowers refinancing options. This report will be
updated as program changes occur.
In troduction ......................................................1
Institutional Eligibility and Default Rates.......................3
FFEL Program: Introduction to How the Program Is Administered...........4
Credit Checks and Endorsement..............................9
Lender of Last Resort......................................10
Payments to Lenders..........................................10
Special Allowance Payment.................................11
Quarterly Special Allowance Formulas............................12
Guaranty Agency Provisions........................................14
Guaranty Agency Responsibilities................................14
Default Aversion Assistance................................14
Assignment of Defaulted Loans
to the Federal Government (Subrogation)..................14
Payments to Guaranty Agencies.................................14
Default Aversion Payments.................................15
Reserves and Solvency Requirements.............................16
Voluntary Flexible Agreements..................................17
Direct Loan Program: Introduction to How the Program
Provisions Related to DL Program Administration...................19
Disbursement of Funds to Borrowers.........................20
Loan Servicing, Delinquency Processing and Default Collections...21
Payments for Administration....................................21
List of Figures
Figure 1. Basic Elements of the FFEL Program Model....................7
Figure 2. Basic Elements of the DL Program Model.....................19
The Administration of the Federal Family
Education Loan and William D. Ford Direct
Loan Programs: Background and Provisions
The federal government operates two major student loan programs: the Federal
Family Education Loan (FFEL) program and the William D. Ford Direct Loan
(DL) program. These programs can trace their roots to the Guaranteed Student Loan
(GSL) program, which was enacted as part of Title IV of the Higher Education Act
(HEA) of 1965, to promote access to postsecondary education by making low-interest
loans available to students from low- and middle-income families.
The FFEL program, formerly named the GSL program, is authorized by Part B
of Title IV of the HEA. Under the FFEL program, loan capital is provided by private
lenders, and the federal government guarantees lenders against loss through borrower
default. FFEL program loans are originated by private lenders, and state and
nonprofit guaranty agencies receive federal funds to play the lead role in
administering many aspects of the FFEL program.
The federal government provides lenders a variety of incentives to invest private
capital in FFEL student loans. For example, to ensure that private capital will be
consistently available to support FFEL loans, the program provides private lenders
with a loan subsidy known as a “special allowance payment.” This loan subsidy,
which is tied to a financial market index, ensures that private lenders receive a
specified level of return on student loan investments.
In addition, the federal government helped establish a secondary purchase
market for FFEL loans. To help ensure that the FFEL program would be fully
capitalized, the federal government created the Student Loan Marketing Association,1
also known as Sallie Mae. Sallie Mae was created to purchase loans from lenders
seeking to sell them, thereby providing liquidity to help ensure that the FFEL
program is fully capitalized.
The DL program, authorized under Part D of Title IV of the HEA, established
in 1993, was intended to streamline the student loan delivery system and achieve cost
savings. The DL program was originally intended to gradually expand and replace
1 Up until very recently, Sallie Mae was a government sponsored enterprise, a federally
chartered shareholder owned corporation established for the purpose of creating a secondary
purchase market for federally guaranteed student loans. Under the provisions of P.L. 104-
the FFEL program. The DL program provides the same set of loans as the FFEL
program, but uses a different administrative structure and draws on a different source
of capital. Under the DL program, the federal government essentially serves as the
banker — that is, the federal government provides the loans to students and their
families, using federal capital (i.e., funds from the U.S. Treasury), and owns the
loans. Under the DL program, schools may serve as direct loan originators, or the
loans may be originated by contractors working for the U.S. Department of Education
(ED). ED also hires contractors to service the loans.
While the DL program was originally introduced to replace the FFEL program,
the 1998 amendments of the HEA removed the provisions of the law that referred to
a “phase-in” of the DL program and those which specified the proportion of new
student loan volume to be made through the DL program in particular academic
years. Currently both programs are authorized. Postsecondary institutions apply to
participate in one program or both. Borrowers borrow annually under one program.
The program they borrow under is determined by the postsecondary institution they
Together, these federal student loan programs provide more direct aid to support
students’ postsecondary educational pursuits than any other source. In FY2005, these
programs provided $56.2 billion in new loans to students and their parents. In that
year, the FFEL program provided 10,323,000 new loans averaging approximately
$4,193 each and the DL program provided 2,971,000 new loans averaging
approximately $4,352 each.
The loans made through the FFEL and DL programs are low-interest fixed rate
loans. Interest rates are determined by statutory provisions. The loans disbursed
through these programs include subsidized and unsubsidized Stafford loans for
undergraduate and graduate students; PLUS loans for parents of undergraduate
students and for graduate students; and Consolidation loans that offer borrowers
This report discusses the major provisions of law pertaining to the
administration of the FFEL and DL programs. The primary emphasis is placed on
discussing the provisions of the law that outline the roles and responsibilities of
participating postsecondary institutions, guaranty agencies, private lenders, and ED
contractors. A companion report, titled RL33673, Federal Family Education Loan
Program and William D. Ford Direct Loan Program Student Loans: Terms and
Conditions for Borrowers, has been prepared to discuss provisions related to
borrower eligibility, loan terms and conditions, borrower repayment relief, and loan
default and its consequences for borrowers. Both reports provide background
information on the FFEL and DL programs. This report provides updated
information through August 2006, and includes information on the HEA amendments
enacted in P.L. 109-171, the Higher Education Reconciliation Act (HERA).
Postsecondary institutions play a central role in administering the federal student
loan programs. The role postsecondary institutions play and provisions of the law
relating to their role will be discussed within the context of the FFEL and DL
programs in subsequent sections of this report. The discussion that follows outlines
the provisions of the HEA relating to institutional eligibility to participate in the
student loan programs.
Students taking out subsidized or unsubsidized Stafford loans or PLUS loans,
must be enrolled in a postsecondary institution that is eligible to participate in the
federal student loan programs. Similarly, parents may only take out a PLUS loan to
support a dependent student who is enrolled in an eligible postsecondary institution.
Eligible institutions may include public and private, non-profit colleges and
universities, community colleges, and trade and technical schools. Most of the trade
and technical schools are proprietary (private, for profit) schools offering programs
of vocational or occupational training lasting less than two years. For an institution
to be eligible to participate in the FFEL or DL program, the institution has to meet
certain general Title IV eligibility requirements, i.e., the institution must:2
!Be accredited by an agency recognized for that purpose by the
Secretary of Education (Secretary);
!Be licensed or otherwise legally authorized to provide postsecondary
education in the state in which it is located; and
!Be deemed eligible and certified to participate in federal student aid
programs by ED.
While not eligible to participate in other Title IV programs, schools with 300
hour programs (minimum 10 weeks) that are not graduate or professional programs
or that do not require at least an associate’s degree for admission may be eligible to
participate in the student loan programs. To be eligible, these short-term programs
must satisfy regulatory criteria prescribed by the Secretary, including having verified
completion and employment placement rates of at least 70%.3
Institutional Eligibility and Default Rates. In an effort to reduce default
costs, Congress has enacted provisions linking institutional eligibility and default
rates. As a result, institutions with a pattern of high loan default rates become
ineligible to participate in the FFEL and DL programs.
2 Institutions outside of the United States that are approved by the Secretary of Education
are also eligible for FFEL program participation.
3 For more detailed information about institutional eligibility for Title IV assistance see CRS
Report RL31926, Institutional Eligibility for Participation in Title IV Student Aid Programs
Under the Higher Education Act: Background and Issues, by Rebecca R. Skinner.
To determine institutions’ rates of default, a cohort default rate is calculated.
An institution’s cohort default rate is the number of borrowers last attending that
institution entering repayment on a Stafford (subsidized or unsubsidized) loan, or the
portion of a consolidation loan that is used to repay such loans, in a given year who
default (defined as an insurance claim having been paid on their loan) by the end of
the succeeding fiscal year divided by the total number of those borrowers entering
repayment in the given year. The Secretary of ED is required to report annually on
cohort default rates by institutional sector. Schools with few borrowers as
determined by a statutory formula (participation rate index) are exempt from
Institutions with cohort default rates of 25% or higher for each of the most
recent three fiscal years are ineligible to participate in the FFEL and DL programs for
the remainder of the fiscal year through the two following fiscal years.
Postsecondary institutions have the right to appeal the loss of eligibility and ED may
waive the provision if there are statutorily defined exceptional mitigating
circumstances or other exceptional mitigating circumstances as defined by the
Secretary.4 Postsecondary institutions also have the right to appeal the loss of
eligibility if the institution demonstrates that the calculation of its default rate is
inaccurate. Institutions may include in their appeal a defense based on improper loan
FFEL Program: Introduction to
How the Program Is Administered
FFEL program loans are financed by commercial and nonprofit lenders.
Commercial lenders include banks, savings and loans, credit unions, and insurance
companies. Nonprofit lenders include postsecondary institutions or agencies
designated by states.6
4 The statutorily defined exceptional mitigating circumstances include cases in which at least
two thirds of an institution’s students who were enrolled at least half time were eligible to
receive at least one half of the maximum Pell Grant award or whose adjusted gross income
is less than the Health and Human Services poverty level. In such cases, for an institution
to qualify for an “exceptional mitigating circumstances” exemption, a degree granting
institution must have a completion rate of at least 70% among full time students scheduled
to complete their programs, and a nondegree granting institution must have an employment
placement rate of 44%. For the Secretary’s definition of these circumstances, see 34CFR,
5 In such cases, the Secretary is required to give institutions access to a representative
sample of relevant records for a reasonable time and if the evidence demonstrates
inaccuracies, the Secretary must recalculate a rate based on correct data. Also, guaranty
agencies must afford schools the opportunity to review and correct records before they are
submitted to the Secretary for calculation of the default rates.
6 Under provisions enacted in the Higher Education Reconciliation Act, only those
postsecondary institutions that have made FFEL program loans on or prior to Apr. 1, 2006
may operate as FFEL program lenders. For additional information on school as lender
Originating lenders — the lenders who make the loans — often sell their FFEL
loans on the secondary market in order to secure new capital to make more loans.
The largest of these secondary market purchasers, holding about one-third of
outstanding FFEL paper, is Sallie Mae,7 which up until recently was a federally
sponsored private for-profit corporation or government-sponsored enterprise (GSE).8
Other loan purchasers are banks, and nonprofit state-level agencies or institutions
dealing exclusively in student loans and which often buy loans from lenders in their
own state or region.
Originating lenders, or the secondary market loan purchasers who hold a loan,
work with postsecondary institutions to track students’ enrollment and loan eligibility
status. Once loans are in repayment, loan holders bill borrowers and collect loan
State or national nonprofit guaranty agencies administer the federal insurance
which protects lenders against loss stemming from borrower default, death or
disability. Guaranty agencies also provide other services to lenders such as assistance
in preventing delinquent borrowers from going into default. Guaranty agencies are
state agencies created by state governments, or private nonprofit agencies operating
only within a state or nationally. Each state has a guaranty agency selected to serve
as the “designated” guarantor of FFELs for students going to schools in the state or
state residents going to schools elsewhere. Other guarantors, however, may serve
state students and residents also.
The primary function of the guaranty agency is to service the federal loan
insurance that is provided to lenders in the FFEL program. Under agreements with
lenders holding the loans, guaranty agencies are responsible for paying the principal
and accrued interest on defaulted loans. Through a reinsurance agreement with the
federal government, the guaranty agency is reimbursed for direct insurance claims it
requirements see HEA Section 435(d)(2).
7 Sallie Mae holdings as of Sept. 30, 2005 were reported to be $102 billion, see Greentree
Gazette, May 2006, p.10. Total outstanding FFEL volume as of Sept. 30, 2005 was $307
billion, see U.S. Department of Education, FY2007 Justifications of Appropriations to the
Congress, vol. II, p.Q16.
8 Sallie Mae was established to help correct market failures that existed in the early years
of the GSL program during which participating lenders experienced difficulty in selling their
student loans. Sallie Mae was given certain tax exemptions and borrowing privileges (from
the U.S. Treasury) that enabled it to profitably purchase and market loans even during times
when secondary market demand for student loans may not have been high. This has helped
originating lenders who needed to be able to sell loans in order to raise capital to originate
new loans. P.L. 104-208, the Student Loan Marketing Association Privatization Act of
1996, authorized Sallie Mae to fully privatize. Under the act, the GSE could continue to
function as a subsidiary of a private holding company through Sept. 30, 2008, after which
the GSE would cease to exist. On Dec. 29, 2004 Sallie Mae completed the process of fully
pays to lenders for such losses.9 These agencies also administer the loan discharges
available for borrower death, disability, bankruptcy (in limited instances), and school
closures. Guaranty agencies also recruit lenders to participate in the FFEL programs
to assure the access of students in the state to the loans, provide assistance to lenders
in collecting loans before they enter default (preclaims assistance), may act as a
lender of last resort, and may provide technical assistance to lenders.
Figure 1, presented below, depicts the basic elements of the FFEL program
9 For much of its first two decades of existence, the federal Stafford Loan program (then the
Guaranteed Student Loan program) operated under both state agency guarantees and direct
federal guarantees through the Federally Insured Student Loan (FISL) program. At times,
fewer than half of the loans made each year in this program were directly guaranteed by
state guaranty agencies with federal reinsurance. Legislative changes in 1976 (Education
Amendments of 1976, P.L. 94-482) made it more attractive for states and others to establish
guaranty agencies. The last FISLs were made during FY1984.
Figure 1. Basic Elements of the FFEL Program Model
Loan disbursement, servicing
Loan applicantsSupply of loan capital& program administrationa
Schools:Assess students’levels ofOriginating Lenders:Students and
financial need and certify borrowerOriginate loans,Parents:
eligibility for loans; disburse fundssupplying private loanComplete
(received from ED) to student andcapital to students andnecessary
parent borrowers and notify ED oftheir parents.forms to apply
those disbursements; providefor loans.
periodic reports to the NationalSecondary Market Loan
Student Loan Data SystemPurchasers:Purchase
Confirming students’loans from originating
enrollment/eligibility status; providelenders thereby
loan counseling to borrowers.providing an infusion of
Originating Lenders: Work withcapital which originatinglenders can use to make
borrowers and schools to obtainnew student loans.
completed loan applications and with
guaranty agencies to secure loan
guarantees; Obtain completed
promissory note from borrowers;
disburse loan funds to borrowers
Loan Holders (either the originating
lender or secondary market loan
enrollment/eligibility status; bill
borrowers; collect loan payments;
conduct initial collection services if
loans become delinquent.
Guaranty Agencies:Work with
borrowers to rehabilitate delinquent
and defaulted loans; reimburse
lenders for defaulted loans and
collect reinsurance payment from
ED; perform collections work;
provide summary information to ED
on loans guaranteed.
Source: Prepared by the Congressional Research Service.
a. Many of the administrative jobs performed in the FFEL program are handled via subcontracts. This
is particularly true with regard to loan servicing tasks (i.e., many of the administrative tasks identified
above as work originating lenders and loan holders and guaranty agencies are responsible for
completing). Several guaranty agencies and secondary market loan purchasers have developed large
servicing operations and typically secure many of the servicing contracts from loan holders.
The lender-related provisions of the law discussed below apply to any holder of
a FFEL loan, regardless of whether the loan holder originated the loan or bought it.
Loan Disbursement. Disbursement requirements are generally designed to
prevent fraud by assuring that the school has some control over the distribution of the
loan proceeds for student expenses. Lenders must send Stafford loan proceeds
directly to the institution of higher education. The check or other instrument used to
deliver the loan proceeds to the institution must require the endorsement of the
student and be payable directly to him or her, and may not be made co-payable to the
institution and borrower. If the student is studying abroad in a program approved for
credit by his or her home institution in the United States funds may be delivered
directly to the student upon request, and may be endorsed or a fund transfer
authorized through a power-of-attorney.
PLUS loans must be disbursed by means of an electronic funds transfer (EFT)
from the lender to the institution or in a check co-payable to the institution and
Multiple disbursement provisions are designed to lower defaults among students
who never attend the school in which they are enrolled or who drop out of
educational programs shortly after enrollment. The lender must disburse any Stafford
loan in two or more installments, none of which exceeds one-half the loan amount.
The interval between installments is required to be at least half the period of
enrollment unless this interferes with disbursement at the beginning of a semester,
quarter, or similar academic division. If a borrower ceases to be enrolled at the
institution prior to the second disbursement, the disbursement must be withheld and
credited to the borrower’s principal as a prepayment. Further, if a student receives
an over-award the institution must return the excess funds to the lender and the lender10
must credit the funds to the borrower’s principal as a prepayment. Lenders may not
sell loans to secondary markets or other entities before the final disbursement of loan
proceeds unless the sale of the loan does not change the identity of the party to whom
payments are made and the first disbursement has been made. The law authorizes
lenders other than the holder of the loan, as well as guaranty agencies, to act as
escrow agents for loan disbursements.
Also, as a default reduction measure, disbursement to first-time, first-year
Stafford borrowers must be delayed until 30 days after the borrower begins his or her
course of study. For other students, loans may not be disbursed prior to 30 days
before the beginning of the period of enrollment for which the loan is made.
Consolidation loans are not subject to many of these disbursement requirements,
including the multiple disbursement or the 30-day delayed disbursement
requirements. Postsecondary institutions with cohort default rates of less than 10%
10 An over-award is an award in excess of the amount for which the student is eligible.
for each of the past three fiscal years for which data are available, are also exempt
from many of these disbursement requirements.
Credit Checks and Endorsement. As a general rule lenders are neither
prohibited from evaluating nor required to evaluate a prospective Stafford borrower’s
financial condition through a credit check in order to make a decision regarding the
size of the loan based on such information. Lenders are required, however, to do
credit checks for prospective borrowers applying for PLUS loans, because program
eligibility is restricted to those borrowers with no adverse credit history.
Disclosures. The law requires lenders to make certain disclosures to
borrowers before disbursement of the loan proceeds and prior to the beginning of the
repayment period. Upon approval of a Stafford or PLUS loan, lenders must issue a
statement to the borrower on his or her rights and responsibilities with respect to the
loan and the consequences of defaulting on the loan, including that the defaulter will
be reported to credit bureaus. Before disbursement, the lender must disclose to the
borrower certain detailed information such as the principal owed, any additional
charges made, the interest rate, an explanation of the repayment requirements, the
total cumulative balance of the loans owed the lender by the borrower, and the
projected monthly balance (given the cumulative balance), prepayment rights, default
consequences, and any collection costs for which the borrower may become liable.
This disclosure, which must be in a written form, must contain a statement in bold
print that the borrower is receiving a loan that must be repaid.
The lender must provide other written information to the borrower not less than
30 days nor more than 240 days (these limits do not apply to PLUS and consolidation
loans) before the repayment period begins. This information generally relates to loan
repayment information such as who is to receive the payments, total interest charges,
what monthly payments will be, what repayment options may be available such as
consolidation or refinancing, prepayment rights, fees, etc. For PLUS and
unsubsidized Stafford loans, lenders may project monthly payments with or without
Notifications. Loan holders are required to notify Stafford borrowers no later
than 120 days after they leave school of the date their repayment period begins.
Upon the sale or transfer of any FFEL loan when the borrower is either in a grace
period or in repayment, the old and new holders, either jointly or separately, are
required to notify borrowers of the sale or transfer within 45 days from the date the
new holder will have an enforceable right of repayment from the borrower. The
notification must include such information as the identity of the new holder, the
address where payment must be sent and the telephone numbers of the original and
new holders. The new holder must also notify the guaranty agency and, if requested,
the institution the student attended, of the sale/transfer.
Lenders are required to report to national credit bureaus on the amount of a
FFEL loan made to an individual and the loan’s status.
Prohibitions. The law prohibits lenders from offering inducements for loan
applications, conducting unsolicited mailings for applications, using FFEL loans as
an inducement to a prospective borrower to buy life insurance, or engaging in
fraudulent or misleading advertising. Lenders are also prohibited from practicing
discrimination in their FFEL credit practices on the basis of race, national origin,
religion, sex, marital status, age, or disability status.
Collections. Under the insurance agreement, lenders are primarily responsible
for enforcing the repayment of loans they hold. If a borrower misses a payment and
a loan becomes delinquent, the lender must undertake certain federally prescribed
“due diligence” efforts to collect on the loan over a 270-day period.11 At the request
of a lender, guaranty agencies must assist the lender in pursuing borrowers with
delinquent FFEL accounts prior to the lender filing a default claim.
Lenders, loan servicers, and guaranty agencies are all required to pursue
delinquent or defaulted student loan accounts with “due diligence” as prescribed by
federal regulation. If irregularities are found in complying with these regulations, the
insurance payment on a default to a lender or a reinsurance payment to a guarantor
is jeopardized. Regular reviews associated with servicing and collection
requirements may be conducted on any loan. Once a loan being repaid in monthly
installments has been delinquent for 270 days, the lender files a default claim.12 If
the guarantor determines that the lender exercised the required diligence in
attempting to collect on the loan, the guaranty agency pays the claim. Once this
claim is paid, the lender ceases to have an interest in the loan.
Lender of Last Resort. Borrowers in certain geographic areas and borrowers
seeking loans that are less appealing to lenders (such as low-balance loans)
sometimes encounter difficulty securing loans. To ensure that qualified borrowers
will be able to secure FFEL loans, the law provides for “lenders of last resort” (LLR).
Guaranty agencies must act as a lender of last resort to serve otherwise eligible
applicants for subsidized Stafford loans who have been unable to secure a loan. The
Secretary is authorized to provide advances to guarantors to ensure they will make
Payments to Lenders
Interest Payments. Lenders receive interest income from FFEL loans.
Lender yields are determined through statutorily established rate-setting formulas.
For loans disbursed from April 1, 2006, onward, lender yields are determined by
lender rate formulas (described below). In practice, the lender receives monthly
interest payments on loan principal from borrowers (or from the federal government,
during in-school periods, grace periods, and deferment periods, in the case of
subsidized Stafford loans). Borrower interest rates are determined by statute.13 On
11 Due diligence is following procedures specified in 34 C.F.R. 682.411 in an attempt to
secure repayment of a loan.
12 For loans being repaid in less frequent than monthly installments, a default claim is filed
after 330 days of delinquency.
13 For additional information on the interest rates for various types of loans see CRS Report
RL33673, Federal Family Education Loan Program and William D. Ford Direct Loan
a quarterly basis, special allowance calculations are performed to determine the
amount a borrower rate is above or below the lender rate. When the borrower rate
is below the lender rate, the federal government pays a special allowance equal to the
difference. When the borrower rate is above the lender rate, the lender rebates the
excess interest amount to the federal government.14
Special Allowance Payment. A key component of the FFEL program for
lenders is the special allowance payment. It is a payment of additional interest on a
student loan that is made by the federal government when the borrower’s interest rate
does not meet a statutorily specified level of return to the lender. The provision dates
to the early days of the GSL program when the return on student loans was low
compared to what lenders could receive from other types of consumer credit, and
Congress wanted to provide an incentive for lenders to put their capital in GSLs. The
special allowance compensates the lender for the difference between the statutorily
set interest rate charged to borrowers and the market rate of return. In essence, the
Special Allowance Payment is in place to keep student loan investments appealing
to private lenders during periods when the statutorily capped interest rates for
borrowers would provide a lower rate of return than other investments. The special
allowance payment has been sustained to ensure that the program is consistently fully
The special allowance payment amount is determined quarterly under a statutory
formula. The special allowance paid for each loan is dependent on the formula in
effect when the loan was disbursed. The federal government pays any special
allowance due lenders from the time the loan is disbursed through the entire
Effective for Stafford, PLUS and Consolidation loans for which the first15
disbursement was on or after January 1, 2000, the special allowance payment
amount is determined through the use of a series of special allowance payment
formulas (displayed below). Each formula establishes a lender rate based on a
market index — three-month Commercial Paper (CP) rates16 — to keep lender yields
sensitive to market conditions. As is shown below, each of the formulas establish
Program Student Loans: Terms and Conditions for Borrowers, by Adam Stoll.
14 On loans made prior to Apr. 1, 2006, lenders are not required to rebate excess interest.
The excess interest provisions, which affect loans made on or after Apr. 1, 2006, were
enacted in the HERA.
15 The Ticket to Work and Work Incentives Improvement Act of 1999 (P.L. 106-170, Dec.
17, 1999) included an amendment to the HEA enacting these formulas for calculating the
special allowance for loans disbursed on or after Jan. 1, 2000 and before July 1, 2003. P.L.
107-139, adopted Feb. 8, 2002, included provisions that extend these formulas to loans
disbursed on or after July 1, 2003.
16 The “CP rate” used in the special allowance calculation is based on the average bond
equivalent rates of the daily quotes of the three-month commercial paper rates for each of
the days in a quarter.
a lender rate from which the borrower rate is subtracted;17 and then a quarterly
adjustment is made.
Quarterly Special Allowance Formulas
lender rate [3-month CP rate + a premium (1.74 or 2.34)] - borrower’s interest rate
PLUS and Consolidation loans
lender rate [3-month CP rate + a premium (2.64)] - borrower’s interest rate
In these formulas, the CP rate represents the cost of borrowing to banks (i.e.,
banks borrow the funds that are used to make loans at roughly this rate); the premium
reflects other costs associated with making and servicing loans as well as a return rate
subsidy (i.e., an agreed upon minimum profit margin deemed to be appropriate to
keep the loans appealing to lenders); the borrower’s interest rate reflects the interest
rate the borrower is paying the bank on the loan; and the denominator (4) reflects the
fact that the calculation is done to derive a quarterly payment.
If the result of this special allowance calculation is positive, the lender receives
a payment of this additional interest from the federal government, by multiplying the
result times the outstanding principal on the loan. If it is negative the lender receives
no quarterly special allowance payment, and for loans made on or after April 1, 2006,
the lender would rebate to the federal government the excess interest received. The
amount of excess interest that must be rebated is determined by subtracting the lender
rate from the borrower rate, multiplying the result by the average daily principal
balance during a quarter and dividing by four. For example, if the average daily
principal balance on a loan during a quarter was $1,000 and the borrower rate and
lender rate were 6.8% and 5.8% respectively, the amount of excess interest rebated
would be determined as follows: ($1,000 x 1%)/4 = $2.50.
For Stafford loans first disbursed on or after July 1, 1998 and before January 1,
2000, the special allowance rate is the sum of the average bond equivalent rates of
the 91-day T-bills auctioned during the quarter and 2.2% in school, and 2.8% in
repayment. The PLUS and Consolidation loan rate for loans disbursed during that
time period is based on the 91-day T-bills auctioned during the quarter plus 3.1%.
17 FFEL Stafford and PLUS loans disbursed on or after July 1, 2006, are fixed rate loans
with borrower rates of 6.8% and 8.5%, respectively. Consolidation loans have fixed rates
based upon the weighted average of the rates in effect on the underlying loans at the time
of consolidation. Stafford and PLUS loans disbursed in earlier periods (prior to July 1,
2006), have variable rates. For more complete information on borrower rates, see CRS
Report RL33673, Federal Family Education Loan Program and William D. Ford Direct
Loan Program Student Loans: Terms and Conditions for Borrowers, by Adam Stoll.
The special allowance is available for all types of FFEL loans. For the most
part, it is only paid on outstanding variable interest rate PLUS loans if the calculation
of borrower’s interest exceeds the interest cap (the cap is 9% for loans disbursed on
or after October 1, 1998 and before July 1, 2006).18 For Consolidation loans, the
borrower’s new interest rate on the consolidation loan is the basis for the special
allowance calculation, not the original interest rates of the individual loans that were
Default Claims. Lenders are insured against borrower default for 97% of the
outstanding loan principal. Lenders, loan servicers, and guaranty agencies who the
Secretary of Education finds have a 97% or greater compliance with due diligence
requirements may be designated as having “exceptional performance,” and relieved
from regular review for compliance with servicing and collection requirements. With
this designation, lenders and servicers also receive 99% reimbursement for their
default claims and guaranty agencies receive the appropriate level of reimbursement
from the federal government with no added review. The designation lasts for a
one-year period or until revoked by the Secretary, and annual audits of the lenders,
services and guarantors are required specific to the designation.
In recent years, numerous provisions designed to reduce federal costs in the
FFEL program have been enacted. These include fees charged to lenders and holders
of FFEL loans. In essence, these fees pass along some of the federal costs associated
with insuring and subsidizing student loans to lenders.
All lenders/loan holders are required to pay to the Secretary a loan fee
(subtracted by the Secretary from the quarterly interest and special allowance
payments due to lenders) equal to 0.5% of loan principal on all new FFEL loans for
which the first disbursement was on or after October 1, 1993. This fee is often
referred to as a “lender origination fee.” In addition, holders of consolidation loans
for which the first disbursement was made on or after October 1, 1993, must pay to
the Secretary, on a monthly basis, a rebate fee calculated on an annual basis, equal19
to 1.05% of the loan principal plus accrued interest.
18 The one exception to this is PLUS loans disbursed on or after July 1, 1994, and before
July 1, 1998 for which the rate cap restrictions do not apply.
19 The 1998 HEA amendments reduced the lender rebate fee on FFEL consolidation loans
based on applications received from Oct. 1, 1998 through Jan. 31, 1999 from 1.05% to
Guaranty Agency Provisions
Guaranty Agency Responsibilities
Loan Insurance. A central function of guaranty agencies is administering
federal loan guarantees. When loans are in default, and when loans are eligible for
a discharge (e.g., in instances of death or permanent disability), the guaranty agency
pays the lender’s insurance claim. The guaranty agency subsequently files a claim
with the federal government for a reinsurance payment.
Default Aversion Assistance. Upon receiving a request from a lender, notth
earlier than the 60 day after a loan has become delinquent, a guaranty agency is
required to provide the lender with default aversion assistance. This assistance is
aimed at preventing default by the borrower.
Collections. After the guaranty agency pays a lender’s insurance claim on a
defaulted loan, the note is assigned to it and the agency becomes responsible for
making efforts to collect on the loan. As part of its reinsurance agreement with the
federal government a guaranty agency is, like the lender, required to exercise
diligence in pursuing defaulters for repayment of principal and accrued interest due
on their loans under many of the same procedures required for lenders during loan20
delinquency. When a guarantor is assigned a loan, it can convert the loan from
defaulted status by rehabilitating it through loan rehabilitation or consolidation, or
the guarantor can collect on the loan.
Assignment of Defaulted Loans to the Federal Government
(Subrogation). At any time, the Secretary may require a guaranty agency to assign
the defaulted loan to the federal government for collection under the assumption that
the federal government will have more success in collection on a particular loan or
group of loans than the guaranty agency. Once a loan is assigned to the federal
government, the guaranty agency receives no further payment resulting from any
collections on that loan.
ED has established certain categories of loans for mandatory assignment such
as aged accounts and defaulted loans of federal employees. Also, loans that may be
collectable through the offset of the defaulter’s federal tax refund are temporarily
assigned to the federal government.
Payments to Guaranty Agencies
Administrative Payments. Guarantors receive payments as compensation
for the varied administrative tasks they perform as intermediaries within the FFEL
program. For loans originated on or after October 1, 1998 and before October 1,
2003, the Secretary paid guaranty agencies a loan processing fee equal to 0.65% of
the total amount of loan principal for the loans on which insurance was issued in each
fiscal year. The loan processing fee, which is paid quarterly, dropped to 0.40% for
20 34 CFR 682.410(b)(6).
insured loans originated on or after October 1, 2003. In addition, the 1998 HEA
amendments established an account maintenance fee that is paid quarterly by the
Secretary to guaranty agencies. For fiscal years 1999 and 2000, the payment equaled
0.12% of outstanding loan principal. For fiscal years thereafter through 2011, the
payment equals 0.10% of outstanding principal.
Default Aversion Payments. The 1998 HEA amendments established a
default aversion fee, that is intended to provide added incentive for guarantors to
work with borrowers to rehabilitate loans in danger of going into default. Under the
provisions, guaranty agencies are paid a default aversion fee equal to 1% of unpaid
principal and accrued interest on a loan for which a default claim is not paid within
300 days after the loan is 60 days delinquent — because the loan has been
successfully brought into “current status.” It should be noted that statutory and
regulatory provisions offer divergent guidance with regard to how default aversion21
fees are calculated and paid.
Default Fees. The HEA requires guaranty agencies to assess a federal default
fee equal to 1% of loan principal. This fee helps defray some of the federal cost of
insuring loans. The fee is a borrower fee that must be assessed. It can be either
deducted proportionally from the proceeds of the loan received by borrowers, or paid
on the borrower’s behalf from non-federal sources (e.g., the lender or guarantor may
pay the fee).
Reinsurance Payments. When a loan has gone into default, and a guaranty
agency has paid a lender’s insurance claim, the guaranty agency files a claim with the
federal government for a reinsurance payment. Reinsurance payments are deposited
in the guarantor’s Federal Fund — its locally held federal reserves. For loans
disbursed on or after October 1, 1998, reinsurance payments cover 95% of the cost
of the claim plus certain administrative costs, provided that overall reimbursements
don’t exceed 5% of the loans (in repayment) that are insured by the guaranty agency.
The reinsurance rate drops if the guarantor has default claims that are high compared
to the loans in repayment. If more than 5% of the guarantor’s loans (in repayment)
are in default in any fiscal year, the reimbursement rate drops to 85%; and if default
claims exceed 9% of loans in repayment status, the reimbursement rate drops to 75%.
For lender of last resort loans, the reinsurance rate is 100%.
Collection Payments. The guaranty agency is authorized to retain the
complement of the reinsurance percentage in effect when the reinsurance payment
was made plus a percentage of any collections it makes to pay for its costs associated
21 Regulatory provisions, developed in response to concerns raised at negotiated rule-
making, created a “netting out process” whereby guarantors may transfer default aversion
fees from their Federal Fund to their Operating Fund equal to 1% of principal and accrued
interest owed on all loans submitted by lenders to the guaranty agency for default aversion
assistance during a period (e.g., that quarter) minus 1% of unpaid principal and accrued
interest on loans for which default claims were paid during that time period (i.e., on those
loans for which default aversion fees have previously been paid). See HEA Section 428(l)
and 34 CFR 682.404(k).
with the collection.22 The reinsurance complement is deposited in the guarantor’s
Federal Fund. Prior to October 1, 2003, the percentage of collections the guaranty
agency was authorized to keep was 24%. On or after October 1, 2003, the guaranty
agency is authorized to keep 23%. For defaulted loans resold through rehabilitation,
the guaranty agency may retain 18.5% of the proceeds from the loan sale. The
guarantor may keep an additional amount equal to up to 18.5% of principal and
accrued interest from collection fees assessed to the borrower.23 For a loan that is
consolidated out of default, the guaranty agency may charge an amount equal to up
to 18.5% of principal and accrued interest in collection fees assessed to the borrower.
An amount equal to the lesser of 8.5% or the amount charged must be remitted to the
federal government and the remainder may be kept by the guaranty agency.24
Reserves and Solvency Requirements
In order to pay insurance claims on defaulted loans, guaranty agencies must
maintain a certain level of reserves in their Federal Fund. The HEA specifies:
!the level of reserves a guaranty agency must maintain;
!the actions that may be taken in the event of guaranty agency
!the mechanisms the federal government will use to oversee the
financial conditions of guaranty agencies;
!and the terms under which “excess reserves” may be recalled by the
Guaranty agencies are required to maintain reserve funds to protect against the
risk involved in administering the federal guaranty. An agency’s reserve level is its
cumulative revenues minus expenses. Its annual reserve ratio is calculated in
percentage terms as current reserves divided by the original principal of outstanding
loans guaranteed. Current law provides for a minimum ratio of 0.25%, and under
current law, reserves above 2.0% are considered “excess reserves” which are subject
to being recalled by the federal government.
In an effort to create clear separation between reserve funds and operating funds,
the 1998 HEA amendments required all guaranty agencies to establish two funds: a
Federal Fund; and an Operating Fund. The following payments are to be placed in
the Federal Fund: federal default fees, reinsurance payments from ED, and the
reinsurance complement from collections and rehabilitations.
22 For example, the complement of the reinsurance percentage in effect when the reinsurance
payment was paid would be 5%, if the reinsurance percentage in effect was 95%.
23 A borrower must make nine on-time repayments in a 10-month period to rehabilitate their
24 A borrower must make on-time repayments for three consecutive months for their loan to
be consolidated out of default.
25 In 1990, the largest student loan guarantor, the Higher Education Assistance Foundation
(HEAF) became insolvent because it did not have funds to meet its insurance obligations.
The law specifies that the Federal Fund, including its earnings, is the property
of the United States. The Federal Fund may be used to pay lender claims and to pay
default aversion fees into the guaranty agency’s Operating Fund.
The Operating Fund is to be used to support operating expenses and may also
be used by the guarantor to support discretionary student aid activities. The
Operating Fund, with the exception of funds temporarily transferred in from the
Federal Fund to support the fund’s establishment, is the property of the guaranty
agency. Guaranty agencies are authorized to deposit the following revenues into the
Operating Fund: loan processing and issuance fees, account maintenance fees, the
agency’s percentage of any collections on defaulted loans, compensation for
defaulted loan rehabilitations and consolidations, and default aversion fees
transferred from the Federal Fund.
In years leading up to the 1998 amendments, student loan defaults had declined,
and consequently guaranty agency reserves had grown. Hence there was increased
interest in recalling reserves. The Balanced Budget Act of 1997 required the return
of $1 billion from guaranty agency reserves by 2002. The 1998 HEA amendments
required the recall of an additional $250 million by FY2007. ED is required to report
annually to congressional authorizing committees on the fiscal soundness of the
guaranty agency system.
Voluntary Flexible Agreements
The 1998 HEA amendments included provisions that allow for up to six
guaranty agencies to enter into voluntary flexible agreements (VFAs) with the
Secretary in fiscal years 1999, 2000, 2001 to pilot new ways for guaranty agencies
to operate and receive fees for their services.26 As of FY2002 any guaranty agency
may enter into a VFA. Under the provisions of the HEA, the Secretary is afforded
considerable discretion in awarding statutory and regulatory waivers for VFAs and
establishing fees for services, except that the cost of the agreement “reasonably
projected” cannot exceed the cost as similarly projected in the absence of the
Direct Loan Program: Introduction to
How the Program Is Administered
Capital for the DL program is provided by the federal government and disbursed
to borrowers through schools. Schools seeking to participate in the DL program
apply to the Secretary. Participating schools originate loans for their students and
must be specifically approved by ED for this purpose. All participating schools must
certify borrower eligibility for the loans. Schools may choose whether to handle their
own paper promissory notes and whether they originate their own funding requests
26 The VFAs were introduced in an attempt to find new ways to tie guaranty agency
reimbursement to default prevention activities.
(i.e., “drawdown” their own money).27 For DL schools choosing not to handle these
tasks, or not approved for that purpose, these loan origination services are performed
by ED’s Common Origination and Disbursement (COD) system contractor. ED staff
play an important monitoring role in relation to the disbursement of funds to schools,
ensuring that schools drawdown appropriate sums.
ED has also hired a contractor to serve as the DL program’s loan servicer. It
performs all of the DL program’s servicing, accounting and delinquency processing
work. The Common Services for Borrowers (CSB) contract supports integrated
“back-end” operations. The contractor is responsible for DL loan servicing,
consolidation, and debt collection functions.
In general, schools participating in the DL program often assume more direct
administrative duties related to loan origination and servicing than they would have
as participants in the FFEL program. At the same time, they are freed of many tasks
associated with finding lenders for their students and working with an assortment of
lenders and guaranty agencies. Figure 2, presented below, depicts the basic elements
of the DL program model.
27 The DL program now uses a Master Promissory Note (MPN) which is available on ED’s
website. Many students use an e-MPN which can be used to make loans 10 years after it is
first disbursed against. When students complete their promissory notes on-line, the number
of promissory notes processed by schools goes down, thus lowering the schools’ burden.
Figure 2. Basic Elements of the DL Program Model
Loan disbursement, servicing
Loan applicantsSupply of loan capital& program administration
Schools:Assess students’levels ofThe Federal Government:ED Students and Parents:
financial need and certify borrowersecures funds from theComplete
eligibility for loans; disburse fundsU.S. Treasury andnecessary
(received from ED) to student andsupplies loan capitalforms to apply
parent borrowers and notify ED ofto students and theirfor loans.
those disbursements; provideparents.
periodic reports to the National
Student Loan Data System
enrollment/eligibility status; provide
loan counseling to borrowers.
Loan Originators (either the school
or the loan organization contractor):
Obtain completed promissory notes
from borrowers; request loan funds
from ED; perform fund management
task -including reconciling all
accounts on a monthly basis.
Loan Servicing Contractor:Monitors
student enrollment/eligibility status;
bill borrowers; collects loan
payments; conducts initial collection
services if loans become delinquent;
transfers defaulted loans to ED’s
debt collection system.
ED:Reviews requests for federal
loan capital and transfers funds;
monitors loan servicing and
collection activities; ensures
compliance with the law and
program regulations; monitors
institutional default rates.
Source: Prepared by the Congressional Research Service.
Provisions Related to DL Program Administration
Under the HEA, the Secretary is authorized to contract for origination, servicing,
default collections, data systems and sundry services connected with the operation
of the DL program. The contracts are briefly described below.
The COD origination services contract is a “share in savings” contract. The
contractor is paid a set fee for each DL loan they originate and a set fee for each
unique record processed on the database until a threshold is met after which the fee
paid is reduced substantially for additional records processed. There are no
performance incentives in the contract.
The CSB loan servicing contract has a tiered pricing structure so that as work
volume increases unit cost generally decreases. In addition, it features performance
incentives. The contractor receives a higher unit rate for borrowers maintained in a
current repayment status compared to borrowers in delinquent or default status. The
contract also provides disincentives for failing to meet performance standards related
to costumer service.
Loan Origination. To enhance financial controls and accountability, ED has
set up three levels of loan origination: standard origination, under which schools
have the least responsibility and control over funds; and two levels of school
origination. Schools must meet additional criteria beyond those for participating in
the DL program to have full authority to originate loans. Any school eligible to
participate in the Direct Loan program may operate under the standard origination
option, in which case the loan origination contractor, not the school, is responsible
for preparing the promissory note, obtaining the completed note from the borrower,
and initiating the drawdown of funds for the school to disburse to the student. To be
eligible for either of the two school origination options, which allows schools greater
control over funds, institutions must meet additional criteria that include participating
in the Pell Grant program; not being on the reimbursement system in the Pell Grant,
Work Study, or Perkins Loan programs; and demonstrating fiscal responsibility, as
determined by the Secretary. The Secretary has the authority under the final
regulations to require a change to standard origination based on evaluation of a
Under school origination option 1, the school would be responsible for the
promissory note, but the contractor would continue to be responsible for initiating
drawdown of funds. Under school origination option 2, the school would have full
responsibility for all aspects of the origination function, including determining
funding needs and initiating funds drawdown.
Federal funds for direct student loans are delivered to participating schools and28
students in essentially the same manner as Pell Grants, and other fiscal control and
record keeping practices by schools are the same for all HEA Title IV programs. ED
has developed loan origination software and training for schools, as well as entrance
and exit counseling materials.
Disbursement of Funds to Borrowers. Direct loans are disbursed to
students by first applying the loan to the student’s account with any remainder being
disbursed to the student. Parallel to a requirement in the FFEL program, a 30-day
delay in the distribution of loan proceeds to first-year, first-time borrowers also
applies to DL program loans.
28 For a description of the Pell Grant delivery system, see CRS Report RL31668, The
Federal Pell Grant Program of the Higher Education Act: Background and
Reauthorization, by Charmaine Mercer.
Loan Servicing, Delinquency Processing and Default Collections.
Under the DL program, loan servicing and delinquency processing are handled by
the DL program’s loan servicing contractor. The servicing contractor bills borrowers
whose loans are in repayment, processes loan payments, and processes deferments,
forbearances and discharges.
If a DL borrower fails to make any installment payments on a loan, the loan
becomes delinquent and the servicing contractor is responsible for exercising due
diligence in attempting to locate the borrower to initiate loan rehabilitation efforts.
Ultimately, if a DL loan becomes 270 days delinquent, the loan goes into default and
the ED’s Debt Collection Service (DCS) is responsible for conducting collections on
the defaulted loan. If the borrower chooses not to rehabilitate the loan, ED may take
any action authorized by law to collect a defaulted loan, including garnishing the
borrower’s wages; requesting the IRS to offset the borrower’s federal income tax
refund; or filing a lawsuit against the borrower. All defaulted loans are reported to
national credit bureaus.
Payments for Administration
Prior to FY2007, funds for federal administrative costs (program operations by
ED, servicing contracts and related costs) for Direct Loans are mandatory spending
with a permanent appropriation. In accordance with the provisions of the HERA, for
FY2007 through FY2011, such sums as may be necessary to cover DL administrative
costs may be provided through discretionary appropriations.