Student Loan Issues and the Reauthorization of the Higher Education Act

CRS Report for Congress
Student Loan Issues and the Reauthorization
of the Higher Education Act
November 22, 2004
Adam Stoll
Specialist in Social Legislation
Domestic Social Policy Division

Congressional Research Service ˜ The Library of Congress

Student Loan Issues and the Reauthorization of the
Higher Education Act
Summary
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 programs
provide more direct aid to support students’ postsecondary educational pursuits than
any other source. In FY2003, they provided $45.8 billion in new loans to students
and their parents.
The HEA is being considered for reauthorization. This report discusses issues
concerning the FFEL and DL student loan programs that are likely to be considered
during reauthorization.
Issues that are expected to receive attention include borrower interest rates, loan
fees, refinance opportunities, and annual and aggregate loan limits. Additionally, it
is likely that considerable attention will be devoted to promoting greater
comparability between the loan terms and conditions made available to borrowers in
the FFEL and DL programs.
In general, helping students by enhancing their benefits is a goal upon which
many can agree, but finding offsetting revenues is often a challenge. It is therefore
likely that some effort will be made to identify savings in the loan programs’
mandatory spending that could be used to offset costs associated with enhancements
in borrower benefits, or that could be used to finance other student aid expenditures.
This report will be updated as events warrant.

Contents
In troduction ......................................................1
Introduction to the Federal Student Loan Programs...................1
Underlying Tensions...........................................3
Reauthorization Issues..............................................3
Loan Terms and Conditions......................................3
Interest Rates on Stafford and PLUS Loans.....................3
Borrower Fees............................................5
Loan Limits..............................................5
Repayment Plans..........................................6
Loan Consolidation............................................7
Consolidation Loan Interest Rates.............................7
Reconsolidation ...........................................8
Borrowers’ Ability to Choose Among Consolidators..............8
Comparable Consolidation Loan Benefits Across the FFEL
and DL Programs......................................9
Joint Consolidation.......................................10
FFEL Financing and Structure...................................10
Guaranty Agencies........................................10
Excess Interest Provisions..................................11
9.5% Floor Loans.........................................11
List of Tables
Table 1. Annual and Aggregate Stafford Loan Limits.....................5

Student Loan Issues and the
Reauthorization of the Higher Education Act
Introduction
The Higher Education Act of 1965 (HEA) is being considered for
reauthorization. The HEA was last reauthorized by the Higher Education
Amendments of 1998 (P.L. 105-244). Title IV of the act authorizes the major federal
student aid programs, including the federal student loan programs, which provide
more direct aid to support students’ postsecondary educational pursuits than any
other source. In FY2003, the federal student loan programs provided $45.8 billion
in new loans to students and their parents. This report discusses issues concerning
the student loan programs that are likely to be considered during reauthorization.
The report is organized in the following manner. First it provides background
information on the student loan programs and their loans. Then it provides an
overview of many of the issues likely to receive attention in the reauthorization.¹
Introduction to the Federal Student Loan Programs
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
HEA, and the William D. Ford Direct Loan (DL) program, authorized by Part D²
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.
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. Under the DL program,
operated through the U.S. Department of Education (ED), the federal government
provides the loans to students and their families, using federal capital (i.e., funds

¹ Issues pertaining to loan forgiveness are not discussed here. A separate CRS Report
RL32516, Student Loan Forgiveness Programs, by Gail McCallion, addresses loan
forgiveness.
² There is a smaller, separate, campus-based student loan program (the Federal Perkins Loan
Program) that is also authorized by the HEA which will not be discussed here. For
information on Perkins loan reauthorization issues see CRS Report RL31618 Campus-Based
Student Financial Aid Programs Under the Higher Education Act, by David Smole.

from the U.S. Treasury). The two programs rely on different sources of capital and
different administrative structures, but essentially disburse the same set of loans.³
The DL program, established in 1993, was intended to streamline the student
loan delivery system and achieve cost savings. While the DL program was originally
introduced to gradually expand and replace the long-standing FFEL program, the
1998 HEA amendments removed the provisions of the law that referred to a “phase
in” of the DL program. Currently both programs are authorized and the two
programs compete for student loan business. In FY2003, these programs provided
$45.8 billion in new loans to students and their parents. In that year the FFEL
program provided 8,429,000 new loans averaging approximately $4,009 each and the
DL program provided 2,937,000 new loans averaging approximately $4,075 each.
The FFEL and DL programs provide the following types of loans to students and
their parents:
Stafford loans (subsidized and unsubsidized): Low interest, variable rate
loans available to undergraduate and graduate students. The interest rates on
subsidized and unsubsidized Stafford loans adjust annually, based on a statutorily
established, market-indexed, rate setting formula, and may not exceed 8.25%.
To qualify for a subsidized Stafford loan, a student must establish financial
need. The federal government pays the interest on the borrower’s behalf on the
subsidized Stafford loans while the borrower is in school (on at least a half-time
basis) and during grace periods and deferment periods.
PLUS loans: Variable rate loans available to parents of dependent
undergraduate students. The interest rates on these loans adjust annually, based
on a statutorily established, market-indexed, rate-setting formula, and may not
exceed 9%.
Consolidation loans: Loans that provide borrowers refinancing options. A
consolidation loan may be comprised of one underlying loan or multiple
underlying loans. Consolidation provides borrowers with multiple loans the
opportunity to simplify the repayment of loans by combining multiple loans into
one. Consolidation loans also enable borrowers to lower monthly payments by
extending the repayment period. Additionally, consolidation loans afford
borrowers the opportunity to pursue a more favorable long term interest rate
through locking in a fixed interest rate on their student loans, based on the
weighted average of the interest rates in effect on the loans being consolidated⁴

rounded up to the nearest one-eighth of 1%, capped at 8.25%.
³ For detailed information on the array of FFEL and DL program loans, see CRS Report
RL30655, Federal Student Loans: Terms and Conditions for Borrowers, by Adam Stoll.
For a thorough discussion of how the loan programs operate, see CRS Report RL30656, The
Administration of Federal Student Loan Programs: Background and Provisions, by Adam
Stoll.
⁴ For a comprehensive description of consolidation loans’ terms and conditions see CRS
Report RL31575, Consolidation Loan Provisions in the Federal Family Education Loan and
Direct Loan Programs, by Adam Stoll.

Underlying Tensions
Prior to discussing individual reauthorization issues, it may be helpful to note
that there are certain underlying tensions inherent in the current design of the loan
programs that affect many of the reauthorization issues considered in this report.
One pertains to program cost. It is generally the case that enhancements to borrower
benefits increase federal subsidy costs. For instance, in the FFEL program, where the
government insures and subsidizes loans made by private lenders, federal subsidy
costs increase when less revenue is derived from borrower fees and when interest
subsidy payments to lenders are increased (lenders receive a subsidy payment that
ensures they receive the difference between the statutorily set borrower rate and a fair
market rate). In the DL program, where the government acts as lender, federal
subsidy costs are increased when borrower fees or repayment revenues paid to the
government are reduced.
Another tension stems from dissimilarities in FFEL and DL program loan terms
and conditions. The two programs disburse the same set of loans, but loan terms and
conditions are not perfectly parallel across the two programs. Each program has its
supporters. Some favor promoting more parallel terms and conditions, others do not
if parallel terms and conditions are achieved by reducing a benefit currently available
in only one of the two programs.⁵
Reauthorization Issues
Loan Terms and Conditions
Interest Rates on Stafford and PLUS Loans. The Stafford and PLUS
loans currently being disbursed are variable rate loans. As of July 2006, under
current law, new Stafford and PLUS loans will carry fixed interest rates. The
desirability of this planned switch has been the subject of considerable debate.
Student loan interest rates were a focal issue in the 1998 reauthorization. The
statutory rate setting formulas, which are used to establish rates for loans disbursed
from July 1, 1998 through June 30, 2006, were initially enacted in June 1998 and
extended in the HEA amendments of 1998.
The formula for calculating interest rates on Stafford loans is based on the 91-
day Treasury bill rate plus 1.7% while the borrower is in school, and plus 2.3% when
the borrower is in repayment. Stafford rates are capped at 8.25%. The formula in
effect for calculating interest rates on PLUS loans is based on the 91-day Treasury⁶

bill rate plus 3.1%, and the PLUS rates are capped at 9%.
⁵ In instances where the terms and conditions differ across programs it will be noted.
Otherwise the reader should assume terms and conditions being discussed apply in both
programs.
⁶ Variable rates for Stafford and PLUS loans adjust annually. For Stafford and PLUS loans,
(continued...)

The current rate setting formulas were adopted as a result of deliberations that
centered on how to replace so called “comparable maturity rates” that were set to take
effect July 1, 1998. The comparable maturity rate-setting formula was initially
enacted in the Student Loan Reform Act (SLRA) of 1993, the legislation that created
the DL program. The formula afforded the Secretary of Education a great deal of
latitude in establishing borrower rates.⁷
The decision to move toward a comparable maturity rate was made in 1993
within the context of the assumption that the DL program would be phased in over
a series of years and ultimately replace the guaranteed loan system. In years
following the enactment of the SLRA, Congressional support emerged for sustaining
both loan programs and, within this context, considerable attention was devoted to
replacing the comparable maturity rate structure before it took effect. This led to the
adoption of the rate setting formulas currently in effect. However, due to cost
considerations under prevailing budget scoring rules, the HEA amendments of 1998
were only able to install the current formula until June 30, 2003, after which the
comparable maturity rates were once again set to take effect.
The interest rate issue was revisited in 2002 with the passage of P.L. 107-139.
This measure extended the existing variable rate setting formulas through June 30,
2006. Additionally, it installed fixed interest rates of 6.8% for Stafford loans and

7.9% for PLUS loans disbursed thereafter.

In the upcoming reauthorization of the HEA it is likely that borrower interest
rates will once again receive consideration. Some feel that the 6.8% fixed rate set to
take effect for new loans made on or after July 1, 2006 is a good rate in comparison
to historical borrower rates in the program, and that a fixed rate provides the
borrower with a set of predictable monthly payments which many borrowers desire.
Others feel that a borrower is better served under a variable rate formula where the
borrower is able to take advantage of low market rates when available (such as the
3.37% repayment rate being charged this year) but still receive protection against
high rates thanks to the 8.25% interest cap.
It is likely that student loan interest rates will be hotly debated. Part of the
debate is likely to focus on enhancing or preserving borrower benefits. There will
also likely be concerns about the federal subsidy cost. This is because, in the FFEL
program, lenders are provided a federal interest subsidy payment (discussed later)
when the statutorily set borrower rate fails to provide lenders a market rate of return.
In the DL program, where the federal government acts as lender, federal subsidy
costs increase when repayment revenues are reduced. Across both programs, more
generous borrower benefits generally increase federal costs.

⁶ (...continued)
the T-bill rates used in establishing the annual borrower rate are the bond equivalent rates
from the last auction prior to June 1. Rates take effect from July 1 through the following
June 30.
⁷ The statute states that the borrower rate would adjust annually, but does not specify the
index upon which the variable rate will be established. The selection of the security to serve
as the index would be left to the Secretary.

Borrower Fees. Several proposals have been forwarded recently that call for
reductions in borrower fees. Currently, Stafford borrowers in the DL program pay
a 3% origination fee that goes to the federal government to help offset program costs.
Statutory provisions call for DL borrowers to pay a 4% origination fee, but ED
reduced the fee for Stafford DL borrowers effective August 15, 1999. DL PLUS
borrowers pay a 4% origination fee.
In the FFEL program, the origination fee for PLUS and Stafford borrowers is
3% which goes to the federal government. Lenders may opt to pay the fee or a
portion of the fee on the borrower’s behalf in order to secure loan business.
Additionally, FFEL borrowers may be required to pay a 1% insurance premium. This
fee goes to guaranty agencies to help offset loan insurance costs. Guarantors may
wave the fee, and if the fee is assessed lenders may opt to pay the fee or a portion of
the fee on the borrower’s behalf.
It is likely that a reduction in borrower origination fees (particularly for student
borrowers) will be considered in reauthorization. Helping students by reducing
charges is a goal upon which many can agree, but finding offsetting revenues from
other sources is often a challenge. In FY2003, borrower origination fees generated
approximately $1.3 billion in revenue across the two programs. Additionally,
attention may be devoted to examining the comparability of borrower fees charged
across and within the two loan programs.
Loan Limits. To limit the federal government’s subsidy costs, and to limit the
amount of debt incurred by borrowers, annual and aggregate Stafford borrowing caps
have been established. Considerable interest has surfaced in the adequacy of the
existing loan limits. The current caps for undergraduate students, which were
enacted in the Higher Education Amendments of 1992 (P.L. 102-325), are as follows.
Table 1. Annual and Aggregate Stafford Loan Limits
Dependent undergraduate studentsIndependent undergraduate students
Annual limits:Annual limits:
1^st year$2,6251^st year $6,625
2^nd year$3,5002^nd year$7,500
3^rd year and beyond$5,5003^rd year and beyond$10,500
Aggregate limit$23,000Aggregate limit$46,000
^Source:^H^E^A^,^S^ectⁱ^oⁿ^{428 (20 U}^.^S^.^C^.^1078).

As Table 1 shows, dependency status is a key determinant of a student’s
personal borrowing limits.⁸ It is assumed that dependent students and the parents of
dependent students will co-finance the postsecondary education of the dependent
students. Dependent students are therefore afforded lower personal borrowing limits
than independent students. At the same time, parents of dependent students are
afforded the opportunity to take out federal PLUS loans to support dependent⁹
students. Some have questioned, however, whether dependent students in particular
are being provided adequate borrowing opportunities if they have to self finance their
studies.
In general, those in favor of expanding loan limits suggest loan limits have not
kept pace with tuition increases and thus constrain students’ ability to finance their
education, adversely affecting student access, choice, and persistence. Those
opposed suggest it is undesirable for students to incur more debt, and question
whether the expansion of borrowing opportunities will have any positive effect on
access, choice or persistence — particularly for lower income students. Also at issue
are federal subsidy costs, because as borrowing opportunities are expanded so are
federal subsidy costs.
Repayment Plans. Issues concerning repayment plans that surface with some
regularity relate to differences between options made available to borrowers in the
DL program and those made available to borrowers in the FFEL program. A brief
summary of the repayment options available in each program is offered below.
All FFEL borrowers are allowed to choose among standard, graduated, and
income sensitive repayment plans. For new borrowers on or after October 7, 1998,
who accumulate (after such date) outstanding loans totaling more than $30,000, a
fourth repayment option is available — an extended repayment plan.
Like FFEL borrowers, all DL borrowers are allowed to choose among standard
and graduated repayment plans. In addition, all DL borrowers are allowed to choose
extended repayment (there are no restrictions similar to those in FFEL). Income
contingent repayment (as opposed to income sensitive repayment) is available to all¹⁰

DL unsubsidized and subsidized Stafford borrowers.
⁸ For federal student aid, a student is considered independent of his or her parents if the
student is at least 24 years old by December 31 of the award year, is an orphan or ward of
the state (or was until age18), is a veteran of the armed forces, is a graduate or professional
student, is married, has dependents other than a spouse, or is deemed independent by a
financial aid officer for “other unusual circumstances.”
⁹ Parents are actually provided quite flexible borrowing limits through PLUS loans. PLUS
borrowers may borrow any amount up to the dependent student’s cost of attendance minus
certain other types of aid (i.e., grants, scholarships, Federal Work Study, and Perkins loans).
¹⁰ PLUS borrowers are not eligible for income contingent repayment. The main difference
between income sensitive and income contingent repayment plans are the 10-year repayment
term and prohibition on negative amortization in income sensitive repayment. Negative
amortization refers to a situation where the borrower’s required monthly payment does not
cover the interest due on the loan.

One of the things likely to garner some attention is the difference in the
repayment terms available in each program. In FFEL, all repayment plans offer a 10-
year repayment term with the exception of extended repayment under which
repayment must occur within a time period not to exceed 25 years. In DL, standard
repayment offers a 10-year term. Under the income contingent repayment plan,
repayment must occur over a period not to exceed 25 years. Repayment periods for
DL extended and graduated repayment plans vary with the size of the loan.
It is likely that some attention may be devoted to adopting more comparable
repayment options across the two programs. Additionally, some interest exists in
adding a new “interest only” repayment option. Under such an option, a borrower
would have low “interest-only” payments in their initial years after graduation, but
would also delay the point at which they begin paying down loan principal.
Loan Consolidation
Consolidation Loan Interest Rates. In recent years, several congressional
hearings have focused on the fixed rate benefit on consolidation loans. In general,
the debate pertaining to the fixed rate benefit centers on its cost.
Consolidation loans were originally introduced in the HEA Amendments of
1986 (P.L. 99-498). They were initially intended to simplify repayment for
borrowers, simplify loan repayment servicing for lenders, and offer relief in the form
of extended repayment to those borrowers seeking lower monthly payments. As the
consolidation loan interest rate formula has been modified by Congress,
consolidation loans have evolved into a refinance benefit as well (i.e., a benefit that
enables a borrower to pursue a better interest rate).
The current consolidation loan interest rate formula affords borrowers the
opportunity to secure a fixed rate equal to the weighted average of the rates in effect
on underlying (variable rate) loans being consolidated rounded up to the nearest one
eighth of 1%. In the recent low interest rate environment consolidation volume has
grown dramatically as borrowers have sought to lock in as permanent the favorable
rates currently in effect on their variable rate loans. This has enabled a large number
of borrowers to secure a valuable refinance benefit. Currently, a borrower who
consolidates while in the grace period can secure a 2.88% interest rate. Over the last
two years, in which very low rates have been available, an estimated $63 billion in
loan volume has been consolidated. When borrowers exercise their option to lock
in low rates permanently the federal government is potentially exposed to high
subsidy costs. In the FFEL program, this is so because the government has
guaranteed the lenders a market rate of return, and must make up the difference
between the rate the borrower is paying and the rate the lender is guaranteed. In the
DL program, subsidy costs increase when repayment revenue is reduced.
Those in favor of the existing fixed rate setting formula assert that in the current
low interest rate environment the fixed rate amounts to a valuable benefit to
borrowers. At a time of escalating student loan debt it provides important repayment
relief and sends a signal to students and potential students that repayment will be
manageable. Further, proponents of the existing rate setting formula suggest that
eliminating the opportunity to lock in a fixed rate would be tantamount to taking

away a benefit that was available when borrowers received their Stafford loans and
that they are counting on utilizing once they enter repayment. The removal of this
benefit in a low interest environment would amount to dropping a large share of the
interest subsidy currently available to borrowers.
Those opposed to sustaining the existing rate setting formula suggest it offers
an overly generous borrower benefit that is costly to the point of placing future aid
in jeopardy. They also question whether it is necessary to offer a refinance benefit
when the rate is already subsidized on Stafford loans. Further they question whether
a benefit received in the years after postsecondary schooling contributes in any way
to students’ postsecondary access, persistence, or choice. They note the repayment
period subsidy is provided without regard to need, over a lengthy period potentially
extending up to 30 years beyond schooling, and disproportionately benefits students
who attended four-year private institutions and/or graduate programs.
Reconsolidation. In many ways the debate on “reconsolidation” is an
extension of the debate on the fixed rate benefit. Borrowers who have locked in
fixed rates through consolidation in high interest periods sometimes miss out on
more advantageous variable rates that they would have had on underlying loans. This
introduces a facet of the fixed rate benefit some find troubling — some borrowers
fare worse under the high fixed rates they lock in. This raises concern, particularly
with regard to those using consolidation for repayment relief (i.e., extended
repayment), because these borrowers may have to consolidate in years in which the
fixed rate is disadvantageous.
One way to address this situation is through offering borrowers multiple
refinance opportunities (i.e., offering borrowers with relatively high fixed rates the
prospect of securing a better rate). Any added interest benefit for a borrower,
however, would likely expand federal subsidy costs. Another way to address this is
to eliminate consolidation loans’ fixed rate benefit. This would prevent borrowers
from locking in disadvantageous rates in the future, but would not offer assistance
to those having already done so.
Borrowers’ Ability to Choose Among Consolidators. A complex set
of provisions has been enacted to regulate competition for consolidation loan
refinance business among loan holders within the FFEL program and across the DL
and FFEL programs and to protect borrowers — ensuring they are afforded equitable
refinancing options. In effect, some of these provisions constrain borrowers’ ability
to choose among consolidators.
FFEL borrowers whose loans are held by one holder must first attempt to
consolidate their loans with that holder.¹¹ If a consolidation loan is unavailable from

¹¹ If a FFEL lender secures an insurance agreement to make consolidation loans, the lender
may offer consolidation loans (upon request) to all borrowers for whom the lender is the
sole loan holder. Also, if FFEL lenders opt to make consolidation loans, the lenders may
not discriminate against borrowers seeking a consolidation loan, based upon: a) the number
and type of eligible student loans the borrower seeks to consolidate; b) the type of institution
(continued...)

that lender or the lender does not provide the borrower with an income sensitive
repayment plan acceptable to the borrower, then the borrower may pursue other
FFEL consolidation loans. Other FFEL borrowers, with loans from more than one
FFEL lender, may seek a consolidation loan through any FFEL lender. If FFEL
borrowers certify that they are unable to secure a consolidation loan through FFEL
lenders, or that they are unable to secure a FFEL consolidation loan with income
sensitive repayment terms (deemed to be acceptable by the borrower),¹² the borrower
may pursue a DL consolidation loan.¹³
DL borrowers may pursue consolidation loans within the DL program. DL
borrowers are also able to consolidate their loans through FFEL lenders.
It is likely that proposals calling for the elimination of provisions that constrain
borrowers’ choice among consolidators will receive consideration during
reauthorization. Those in favor of such changes suggest it is important to afford all
borrowers, not just some, the opportunity to shop among consolidators. Some FFEL
lenders object to making a change in this area, asserting they offer some up front
discounts on Stafford and PLUS loans based on the assumption they will be able to
hold the loan over its life, and their anticipated level of income from the loan will be
jeopardized if the borrower can consolidate elsewhere.
Comparable Consolidation Loan Benefits Across the FFEL and DL
Programs. Interest is often expressed in promoting greater comparability among
FFEL and DL consolidation benefits. There are several ways in which consolidation
loan benefits differ across the FFEL and DL programs. One of the primary ways
(discussed above) pertains to constraints placed on a borrower’s ability to choose
among consolidators. Some of the other principal differences are as follows.
In School consolidation: Borrowers seeking a FFEL consolidation loan are
eligible to pursue consolidation when the borrowers have entered the repayment or
grace period on each loan they are seeking to consolidate. In contrast, borrowers
seeking a DL consolidation loan may consolidate any eligible loans that have been
fully disbursed even if the borrowers have not yet entered a repayment or grace
period (i.e., the borrower may still be in their in-school period when consolidating).
In practical terms this affords DL consolidation borrowers a broader time period in
which they can lock in as permanent an in-school rate which is lower than the
repayment rate (T-bill + 1.7% as opposed to T-bill +2.3%). This affords borrowers

¹¹ (...continued)
the borrower attended; c) the interest rate to be charged to the borrower (which varies in
accordance with when the loans being consolidated were initially disbursed). Additionally,
FFEL lenders may not discriminate with regard to the types of repayment schedules they
make available to borrowers.
¹² For all FFEL consolidation loans made on or after July 1, 1994, lenders have been
required to offer borrowers income sensitive repayment plans, established by the lender, in
accordance with regulations promulgated by the Secretary.
¹³ For FFEL borrowers who also have outstanding DL program loans, this certification is not
required. Such borrowers are free to pursue consolidation in the DL program.

greater opportunity to lock in as permanent favorable variable rates in effect in years
when the borrowers are still in school.
Repayment term: Borrowers with less than $7,500 in outstanding loans seeking
to consolidate in FFEL may receive a maximum repayment term of 10 years. A 12-
year repayment term is available to borrowers with that level of debt in DL.
Joint Consolidation. Married persons, each of whom has eligible loans, are
eligible for a joint consolidation loan. Only one of the borrowers must meet the full
set of individual eligibility requirements for a new consolidation loan. However,
each agrees to become jointly and severally liable for repayment of the note
regardless of any changes in marital status. It is likely that proposals to eliminate
joint consolidations will receive consideration in the reauthorization.
While joint consolidation can simplify repayment for a married couple, concerns
have been raised in recent years about disadvantages that may be associated with
joint consolidation for some borrowers. For instance, borrowers with a joint
consolidation loan must both meet the requirements for a deferment or forbearance
in order to receive those benefits. Had the loans not been joined, each borrower
could qualify for these benefits based upon their own status. Additionally, concerns
have been raised about complications that may ensue for unsuccessful marriages
given that both parties agree to be liable for the total repayment of the joint
consolidation loan. Also, in instances involving a spouse who becomes permanently
disabled, a disability discharge is provided for that spouse (covering the proportion
of the loan attributable to their underlying debt), but each spouse remains liable for
repayment of the remaining loan amount.
FFEL Financing and Structure
Guaranty Agencies. Guaranty agencies administer the federal government’s
loan guarantee. The role guarantors play within the FFEL program has evolved a
good deal since the program’s inception. Initially, the federal government intended
to encourage the growth of state loan insurance programs. Over time the federal
government assumed the role of providing the insurance and now guaranty agencies
service the federal guarantee and perform various program administrative tasks. In
the 1998 reauthorization of the HEA considerable attention was devoted to more
clearly defining the role guaranty agencies play within the FFEL program and
insuring clear linkages exist between financing streams and tasks performed.
Changes adopted during the 1998 reauthorization focused on strengthening the
relationship between revenues and activities, and improving efficiency.
The 1998 amendments adopted a “risk sharing” approach. Under this approach,
uses of reserves are restricted, and guarantors are afforded flexibility in the use of
their operating funds. There is a clearer distinction between reserves and operating
funds, and clearer direction about where various revenue streams are to be deposited
— and ultimately about how these sources of revenue are to be used. Under this
arrangement reserves are held in a guarantor’s Federal Fund which is the property of
the federal government, and other funds are held in a guaranty agency’s Operating
Fund which is the property of the guarantor.

It is likely that some attention will be devoted to the solvency of Federal Funds
(i.e., locally held federal reserve funds) and the size of Operating Funds — which can
be used to support agency operations and also for discretionary student financial aid
expenditures. An overarching issue here pertains to the adequacy of revenues
flowing into each fund. Some concerns have been raised about shrinking reserves
and robust Operating Funds. Some proposals have already called for mandating
insurance premiums to strengthen reserves. Some observers have suggested
guarantor fees for loan collections and defaulted loan rehabilitation work may be too
high thus inflating Operating Funds.
Excess Interest Provisions. As has been noted, the federal government
provides lenders with a loan subsidy known as a special allowance payment (SAP).
The SAP amount is determined on a quarterly basis by a statutory formula which is
tied to a financial index and ensures lenders receive, at a minimum, a specified level
of interest income on loans. The SAP is designed to compensate lenders for the
difference between the below-market, statutorily set interest rate charged to
borrowers and a market set interest rate that is intended as fair market compensation
on the loan asset.¹⁴
In some instances lenders receive interest income from borrowers exceeding the
amount called for by the SAP calculation. The amount of income lenders receive
above the government SAP rate is often called “floor income.”
The SAP affords lenders necessary protection in high interest environments
during which the statutorily established borrower rate may provide lenders
insufficient below-market rate returns. However, in low interest environments, the
statutorily established borrower rate has the potential of providing lenders with
above-market rate returns (i.e., returns above the market-indexed SAP rate). Some
argue that since the SAP is designed to approximate fair market compensation it is
unnecessary to compensate lenders at levels that exceed the SAP rate. It is often
noted that in an earlier period, “excess interest provisions” were adopted that
essentially installed the SAP rate as the sole lender reimbursement rate for loans.
Several recent proposals have called for reducing federal subsidy costs by
establishing the SAP rate as the sole lender reimbursement rate and having lenders’
floor income refunded to the federal government.
9.5% Floor Loans. Some FFEL program loans which are made or purchased
with tax exempt funds provide lenders a guaranteed interest rate of at least 9.5%
(hereafter, these loans are referred to as 9.5% floor loans). This guarantee is
provided in the SAP formula applied to these loans, which requires the federal
government to supplement borrower interest payments so as to insure a minimum

9.5% rate for lenders. There seems to be broad Congressional support for curbing

¹⁴ The “lender rate” in SAP calculations, which serves as a proxy for fair market
compensation to lenders, is based on the average of daily quotes of the three-month
commercial paper rates plus 2.34% for Stafford loans in repayment. The lender rate is
intended to be sensitive to lender borrowing and servicing costs and the need for a profit
margin.

this rate guarantee for future loans. The legislative developments that led to the
enactment of the guarantee are briefly described below.
As part of an effort to ensure the FFEL program would be fully capitalized in
the program’s early years, provisions that served to encourage the issuance of tax-
exempt student loan bonds were included in the Tax Reform Act of 1976. Such
bonds are exempt from federal taxation, and are used by states to finance below
market interest rate loans for students.¹⁵ In essence, through the issuance of bonds
with low tax-exempt interest rates, state authorities are able to raise “low cost” funds,
and then re-lend the funds at higher rates.
Soon after these provisions were passed, student bond volume began to grow
rapidly, and concerns about the profitability of tax exempt student loans surfaced.
The 1980 HEA amendments took steps to curb the profitability of tax-exempt loans
by reducing by half the SAP rate on loans originating from the proceeds of tax-
exempt bonds. However, to ensure that student loan authorities were always able to
cover their operating costs, the amendments also established minimum SAPs, for
loans disbursed on or after October 1, 1980, which ensure a minimum return of 9.5%
on these loans.¹⁶
The discourse on the profitability of tax-exempt student loans continued through
the 1980s on into the early 1990s. The Omnibus Budget Reconciliation Act of 1993
(P.L. 103-66) contained a provision eliminating the floor on tax-exempt loans
supported through tax-exempt financing for issuances on or after October 1, 1993.
These loans were afforded the same SAP rates as were available for taxable loans.
However, different provisions were retained with regard to loans made or purchased
with tax-exempt funds obtained by holders from obligations originally issued on or
after October 1, 1980 and prior to October 1, 1993. These loans retained the 9.5%
floor reimbursement structure.
The statutory provisions adopted in P.L. 103-66 and ensuing regulatory
guidance from ED have served to establish funds (derived from debt originally issued
in the aforementioned period) that can be used by holders to finance 9.5% floor loans
on an ongoing basis. In recent years lenders have been using a variety of refinancing
techniques, and also invested earnings from existing 9.5% floor loans to make or
purchase new ones.
While 9.5% floor loans comprise a relatively small percentage of all outstanding
loans, in recent years they have accounted for a very large proportion of federal SAP
subsidies. There appears to be a general consensus that no federal policy objective
is served now by continually guaranteeing lenders a minimum return of 9.5%.
However, there is some debate about how best to phase out the guarantee for

¹⁵ Investors in tax-exempt bonds do not pay taxes on the interest they earn, and are thus
willing to accept a lower interest rate on their investment.
¹⁶ It should be noted that this decision was made within the context of a high interest rate
environment. In 1979, SAPs averaged 6.5% meaning a 13.5% return (6.5% SAP plus 7%
interest rate) constituted “fair market compensation in the prevailing interest rate
envi ronment.”

nonprofit lenders. The Taxpayer-Teacher Protection Act of 2004 (P.L. 108-409);
signed October 30, 2004, curbs growth in 9.5% loans, for one year, by eliminating
the 9.5% guarantee on new loans stemming from any new refinancing of obligations
originally issued on or after October 1, 1980 and prior to October 1, 1993. However,
it does not curtail the 9.5% guarantee on new loans stemming from “recycling”of
proceeds from outstanding 9.5% loans. These proceeds can be used to finance new

9.5% loans.

A phase out of the 9.5% guarantee would produce savings in mandatory
spending. These savings could be used to offset new expenditures.