Crib Sheet: Direct Loans
How billions are being wasted that could go toward student aid.
Crib Sheet, Adam DeDent, Ohio State University, Mar. 2, 2006
Private Lenders are siphoning billions of taxpayer dollars from the federal government through the government-guaranteed student loan program – money that could be used in the form of Pell grants or other educational expenditures to assist millions more students in their goals of obtaining a college degree. What is more shocking, however, is that our colleges and universities have the power to make a change.
Adam DeDent, Ohio State University
Banks and Loan Organizations such as the Sallie Mae Foundation are making billions of dollars via a government-guaranteed student loan program called “FFELP”—or “Federal Family Education Loan Program.” A similar and competing government program, the The William D. Ford Federal Direct Loan Program (or simply, “Direct Loans”) serves exactly the same purpose as the FFELP system but costs the government substantially less. While the direct loan program does not change the amount paid by students on their loans, the savings could be reallocated to provide greater benefits to students. Currently colleges and universities have a choice between the two systems. With the clear advantages of the Direct Loan system, the choice should be obvious, but unfortunately many of our institutions of higher learning are making the wrong one.
What you Need to Know, Part One: How FFELP Works
Under the FFELP system of loans, a student borrows money from a private lender such as the Sallie Mae foundation, and then certain terms are set as to how and when that loan will be repaid. Normally, these payments are made after the student has finished school. The student repays the private lending organization the original amount plus accrued interest. It’s a pretty standard setup. What makes this program a great deal for the private lender is that through this system the government guarantees two major things to the private lenders:
- First, the government compensates the lender for loans that are defaulted (not paid) by a student borrower. So, if someone owes money to a private lender and does not or cannot pay, the burden is shifted to the government and, hence, the taxpayers.
- Two, as stated in the President’s 2007 budget proposal, page 365: “lenders may receive an interest subsidy, called a special allowance, from the Government to ensure a guaranteed rate of return on their loans.” What this means is that the government is paying money to lenders for each dollar that they lend to students – boosting their profits for an already safe loan.
The private lenders are placed in a no-lose situation – they are virtually assured a profit.
What You Need to Know, Part Two: Direct Loans
Perhaps the biggest difference between Direct Loans and the FFELP system is that the private lenders are cut out of the picture—the government directly oversees and allocates educational loans to students, thereby eliminating the middleman. The government and these private lenders have essentially the same system for loaning out money to those students who need it—when a student requests a loan, both the government and private lenders borrow money on the open market and subsequently loan that to the student. However, in the case of a direct loan, interest payments are paid back to the government, not to private lenders.
The government method is ultimately cheaper: According to a 2005 report by the Congressional Budget Office, close to half of the substantial difference in subsidy rates is due to the fact that under the government-guaranteed loan program, the government makes various payments to private lenders during the course of a loan – covering either the entire interest payment or making up the difference between the subsidized interest rate paid by the borrower and the guaranteed interest rate received by the lender. The source of the other half comes largely from the fact that the government can raise funds at a lower interest rate than can banks. In the direct loan program, the government receives the interest payments, and thus there is a net gain to the government for outstanding non-defaulted loans.
Just how much could we save?
According to a report released by The Center for American Progress the FFELP currently accounts for about 77 percent of student loans. The Ford Direct Loan Program comprises the remaining 23 percent. If these two programs cost taxpayers relatively the same amount, this disparity would be of little interest. Unfortunately, taxpayers pay approximately $7 more per every $100 lent on FFELP loans than they do on direct loans. Perhaps it does not look like much when presented this way, but with nearly $508 billion in FFELP loans from 1992 to 2005, that quickly adds up to billions in unnecessary spending.
The billions of taxpayer dollars saved from a shift from government-guaranteed loans to direct loans could be recycled back into the system to improve or expand other higher-education programs – such as the Pell Grant program (government aid to students that does not have to be repaid). According to the same report, “If 100 percent of loans were disbursed through the direct loan program, the savings could be redirected to the Pell Grant Program to provide up to 1.5 million new grants to students.” For those who are concerned about the overall cost of these two loan programs, take this bit of information: “From 1992 to 2005, $681 billion have been disbursed through both student loan programs ($508 billion through [FFELP], $173 billion through direct), with a total subsidy cost to the government of $62 billion. Had 100 percent of loans during that same time period been disbursed through the direct loan program, the total subsidy cost to the government would have been roughly $25 billion with a savings to taxpayers of $37 billion…” Despite the fact that direct loans are less expensive and represent a clear advantage for the taxpayers, the use of FFELP loans is nearly three times higher than that of direct loans. A system in which such large amounts of money are arbitrarily paid out to banks is fundamentally flawed and represents a failure of legislators to represent the people.
Dollars and Sense: Getting More of Both
The argument for direct loans as the sole source of federal student loans really comes down to the allocation of government funds and the right of every citizen to have their tax dollars spent in a responsible manner. In the early 90’s, when the Direct Loan system was first established, the government began pushing toward a phase-out of the FFELP system in favor of universal Direct Loans. However, after much heated debate, a “compromise” was reached—as the system stands right now, colleges and universities are presented with a choice of which federal student loan program they will adopt. Many colleges and universities have made the decision to only use the direct loan system, but there are many more who have either not made the switch or, perhaps, don’t intend to.
In Conclusion: You Gotta Fight For Your Right to Borrow
University attendance should not be something that is inaccessible to those who desire it, nor should it cripple a young person financially. The government, as well as the nation’s colleges, is responsible for ensuring that everyone has access to the best educational opportunities possible. That responsibility means not throwing away money to organizations and lenders such as Sallie Mae, and instead making Direct Loans the sole method of federal student loans. Unfortunately, it does not appear that our government plans to change course. The 2006/2007 CAP report states, “Figures from the President’s budget indicate that the administration anticipates that direct loans will remain far less expensive. Similarly, it anticipates little change in the allocation of loan funds to the two programs.” While our government should not maintain inefficient programs, we should also be asking our colleges and universities to help the shift along – as they can make the choice. If we do not fight for ourselves and ask that our colleges and universities make responsible choices, things will remain the same. Switching to direct loans is an essential change—it would free up billions of dollars a year that could be used for educational funding, paving the way for a more highly educated, effective workforce and a society with greater opportunity.
Take Action and Demand Accountability: The Center for American Progress has compiled a report detailing colleges and universities that either do or do not currently employ the direct loan system. Students should find out if their college is giving them, and the country, the best deal possible.