CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

PAPER

NOVEMBER 2005

Subsidy Estimates 

for Guaranteed 

and Direct

Student Loans

CBO

The Congress of the United States O Congressional Budget Office

CBO

Subsidy Estimates for Guaranteed and 

Direct Student Loans

November 2005

A

PAPER
Notes

Unless otherwise indicated, all years referred to in this paper are fiscal years.

Numbers in the text and tables may not add up to totals because of rounding.
Preface

The federal government assists students and their parents in meeting the costs of postsecondary education through two student loan programs, the Federal Family Education Loan 

Program and the William D. Ford Direct Loan Program. Although the two programs provide 

similar benefits to borrowers, their structures and operations differ greatly. As a result, the federal government’s cash flows for the two programs differ, as do its net budgetary costs when 

calculated as specified in the Federal Credit Reform Act.

This Congressional Budget Office (CBO) paper—prepared at the request of the Senate Budget Committee—describes how the agency estimates the budgetary costs of the two student 

loan programs and what factors account for the differences in those costs. In accordance with 

CBO's mandate to provide impartial analysis, the paper makes no recommendations. 

Justin Humphrey of the Budget Analysis Division wrote the paper under the supervision of 

Paul Cullinan, Peter Fontaine, and Robert Sunshine. Nabeel Alsalam, Chad Chirico, Robert 

Dennis, Douglas Hamilton, Arlene Holen, Deborah Kalcevic, Marvin Phaup, and Dennis 

Zimmerman provided valuable comments. 

Christine Bogusz, John Skeen, and Christian Spoor edited the paper, with assistance from 

Janey Cohen. Darren Young assisted with production, and Maureen Costantino designed the 

cover and prepared the paper for publication. Lenny Skutnik produced the printed copies, 

and Simone Thomas and Annette Kalicki produced the electronic version for CBO’s Web site 

(www.cbo.gov).

Douglas Holtz-Eakin

Director

November 2005

Summary ix

The Student Loan Programs 1

The Federal Family Education Loan Program 1

The William D. Ford Direct Loan Program 1

The FFEL and Direct Loan Programs Today 1

Stafford Loans 1

Cash Flows in the FFEL and Direct Loan Programs 2

Cash Flows for a Subsidized Loan Repaid in Full

Under a Standard Repayment Plan 4

The Impact of Loan Defaults and Consolidations on

Cash Flows 6

Other Costs Incurred by the Federal Government in

Both Programs 9

Examples of Subsidy Rate Calculations 9

Subsidy Costs of Loans Under the FFEL and Direct Loan

Programs 9

Impact of the Length of Enrollment on Subsidy Costs 13

Sources of Difference in Subsidy Rate Calculations 13

Special Allowance Payments to Lenders 14

Discounting and Interest Rates 14

Net Collections on Defaulted Loans 14

Administrative Costs 15

Appendix A: Sample Subsidy Rates When a Borrower Defaults

or Consolidates Loans 17

Appendix B: Examples of Subsidy Rates Calculated Using the

Fixed Interest Rates That Take Effect in 2006 23

Appendix C: CBO’s Estimates of Subsidy Rates for Various

Types of Guaranteed and Direct Student Loans Made in 2006 31

Appendix D: Recent Legislative and Administrative Actions

Affecting the Student Loan Programs 33

CONTENTS
vi SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

Tables

1. The Federal Government’s Cash Flows for Student Loans,

by Type of Loan 4

2. The Federal Government’s Cash Flows for Collections on

Defaulted Student Loans, by Type of Loan 6

3. The Federal Government’s Cash Flows for the Consolidation

Repayment Option, by Type of Loan 8

4. Comparison of Subsidy Costs for a Hypothetical $3,000

Loan Under the FFEL and Direct Loan Programs 11

5. Examples of the Impact on Subsidy Rates of the Length of a

Borrower’s Enrollment Period, by Type of Loan 13

A-1. Comparison of Subsidy Costs for a Hypothetical $3,000

Variable-Rate Loan Under the FFEL and Direct Loan

Programs When the Borrower Defaults and Some

Funds Are Recovered 18

A-2. Comparison of Subsidy Costs for a Hypothetical $3,000

Variable-Rate Loan Under the FFEL and Direct Loan

Programs with Loan Consolidation After the Grace Period 20

B-1. Comparison of Subsidy Costs for a Hypothetical $3,000

Fixed-Rate Loan Under the FFEL and Direct Loan

Programs 24

B-2. Comparison of Subsidy Costs for a Hypothetical $3,000

Fixed-Rate Loan Under the FFEL and Direct Loan

Programs When the Borrower Defaults and Some Funds

Are Recovered 26

B-3. Comparison of Subsidy Costs for a Hypothetical $3,000

Fixed-Rate Loan Under the FFEL and Direct Loan

Programs with Loan Consolidation After the Grace Period 28

C-1. CBO’s Estimates of Federal Subsidy Rates for Variable-Rate and 

Fixed-Rate Student Loans in 2006 32

Boxes

1. Guaranty Agencies and the Federal Government 7

2. Credit Reform 10
Summary

Through two major loan programs, the federal government assists students and their parents in meeting the 

costs of postsecondary education. Under the Federal 

Family Education Loan (FFEL) Program, private lenders 

make loans to students or parents and the federal government pays a portion of the interest received by those 

lenders and guarantees the loans to protect lenders 

against significant losses resulting from borrowers’ defaults, deaths, or disabilities. The William D. Ford Direct 

Loan Program offers the same types of loans, but in that 

program, the federal government makes the loans directly 

to the students.

The student loan programs convey substantial financial 

benefits to borrowers because of their favorable terms, including interest rates that are below those on purely private loans, deferment of debt service, and the option to 

consolidate one or more variable-rate loans into a single 

fixed-rate loan with an extended maturity. Although both 

programs are designed to provide the same kinds of loans, 

and the borrowers and their behavior are similar, the programs differ in their basic structure and operation, resulting in cash flows and net budgetary costs to the federal 

government that are very different. 

Using the procedures specified in the Federal Credit Reform Act, the Congressional Budget Office (CBO) estimates that loans made under the FFEL program have 

higher budgetary costs to the government than direct 

loans do.1

 According to CBO’s estimates, the overall subsidy rate (that is, the net budgetary costs measured as a 

percentage of the amount lent) for loans originated in 

2006 in the FFEL program is about 15 percent, whereas 

the rate for the direct loan program is about -2 percent—

meaning that for every $1 in loans, the federal government incurs budgetary costs of $0.15 in the FFEL program and realizes budgetary savings of $0.02 in the direct 

loan program.2

The government does not really “make money” providing 

student loans—the subsidy calculations under the Credit 

Reform Act are not designed to fully capture the economic costs to the government of the assistance that the 

student loan programs provide, nor do they capture all of 

the effects of the programs on federal spending and revenues. This paper deals only with the subsidy estimates as 

currently calculated under the credit reform framework, 

which are the present values of estimated cash flows for 

the two types of loans. 

Several factors account for the different subsidy rates for 

the two programs. The two biggest factors are the government’s payments to lenders in the FFEL program and the 

government’s collection of interest in the direct loan program at a rate that is higher than the discount rate used in 

the subsidy calculation, which is the interest rate on Treasury securities. A third, lesser factor is the difference in 

how much of the recoveries on defaulted loans the government retains in the two programs. Finally, a small portion can be ascribed to the fact that the subsidy calculations for the two programs treat administrative costs 

differently.

First, under the FFEL program, the government makes 

payments to private lenders, which are designed to encourage them to participate in the program by offering 

them interest rates that are often higher than those paid 

by the borrowers. For example, while a borrower is enrolled in school, the borrower’s interest rate on a Stafford 

loan is the 91-day Treasury bill rate plus 1.70 percentage 

points (currently about 4.7 percent).3 The federal government pays the lender either that rate or a rate equal to 

1. Credit reform was enacted as part of Public Law 101-508, and its 

provisions became title V of the Congressional Budget and 

Impoundment Control Act.

2. Like CBO, the Office of Management and Budget also projects 

that the subsidy rate for the FFEL program is higher than that for 

the direct loan program. See Budget of the United States Government, Fiscal Year 2006, Appendix, p. 371. 
viii SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

the rate on commercial paper (promissory notes usually 

issued by corporations) plus 1.74 percentage points 

(about 5.5 percent for the quarter ending September 30, 

2005), whichever rate is higher. Later, when the borrower 

begins repaying the loan, the government pays the difference between the borrower’s rate and the lender’s yield 

(both of which are set 0.60 percentage points higher than 

the rates that applied when the borrower was in school). 

Paying the higher interest rate to lenders creates a budgetary cost that does not exist in the direct loan program. 

That cost accounts for about 7 percentage points of the 

difference in subsidy rates between the FFEL and direct 

loan programs for loans made in 2006.

The second major source of the spread between subsidy 

rates for the two programs is the difference between the 

borrower’s interest rate and the discount rate. In both 

programs, borrowers pay the same rate of interest, and 

cash flows are discounted at the same rate. However, in 

the direct loan program, the government is the recipient 

of those payments, and the calculation of the subsidy 

rates generally shows a net gain to the government because the principal and interest payments it receives are 

discounted at a different, and generally lower, rate than 

borrowers pay.4

 That factor also accounts for about 7 percentage points of the difference in subsidy rates for loans 

originated in 2006.

A third factor, accounting for about 1.5 percentage points 

in the spread in subsidy rates between the two programs, 

is the different procedures for collecting amounts owed 

on defaulted loans. When a borrower in the FFEL program defaults, the federal government reimburses the 

lender for much of its loss and assumes responsibility for 

the loan. If a guaranty agency recovers some or all of the 

amount owed on the defaulted loan, it incurs the cost of 

collections and retains a portion of those collections. 

When a borrower in the direct loan program defaults, 

however, the federal government alone retains all of the 

recovered funds. Although the federal government incurs 

costs for the collections, those costs are not included in 

the subsidy rate.

Finally, that difference in treatment of administrative 

costs also accounts for some of the spread in subsidy rates. 

Under credit reform, the subsidy cost calculations for 

loans and loan guarantees exclude most of the administrative costs that the federal government incurs to operate 

the programs; those costs are funded separately. But most 

of the administrative costs of the FFEL program are 

borne by the private-sector lenders—paid for out of the 

payments they receive from borrowers and the government.5

 Thus, those costs are incorporated in the subsidy 

costs of the guarantees. As a result, the exclusion of the 

government’s administrative costs has a somewhat larger 

effect on the subsidy rate for direct loans than on those 

for guaranteed loans. 

CBO estimates that including the federal government’s 

administrative costs in the subsidy rate for the direct loan 

program would raise that rate by approximately 1.5 percentage points; including all federal administrative costs 

of the FFEL program would raise its subsidy rate by approximately 0.8 percentage points. As a result, the treatment of administrative costs accounts for less than 1 percentage point of the difference in the subsidy rates 

between the two programs.

3. Stafford loans are low-interest loans available to both undergraduate and graduate students who generally must be enrolled at least 

half time at the postsecondary level.

4. For example, CBO’s March 2005 baseline projects the borrower’s 

rate for 2006 (based on the 91-day Treasury bill plus 2.30 percentage points) to be 6.2 percent for borrowers during repayment. 

(The interest-rate formula is scheduled to switch to a fixed rate of 

6.8 percent in July 2006.) In contrast, CBO’s projections for rates 

used to discount future cash flows are much lower. The March 

2005 baseline forecast for 2006 is 4.0 percent for the 364-day bill 

and 5.3 percent for the 10-year bond.

5. Some administrative costs related to collections are included in the 

subsidy rate for the FFEL program.
Subsidy Estimates for Guaranteed

and Direct Student Loans

The Student Loan Programs

The Federal Family Education Loan (FFEL) Program and 

the William D. Ford Direct Loan Program provide loans 

to assist undergraduate and graduate students and the 

parents of undergraduate students in meeting the costs of 

postsecondary education. Institutions of higher education 

(or in some cases, academic units within an institution) 

choose to participate in either the FFEL program or the 

direct loan program; all of their students who seek loans 

must participate in the chosen loan program. While the 

overall goals of the two programs are the same, their operations are quite different.1

The Federal Family Education Loan Program

Under the FFEL program, created in 1965 and formerly 

known as the Guaranteed Student Loan Program, private 

lenders (such as banks and credit unions as well as some 

institutions of higher education) make the loans. The 

federal government pays a portion of the interest received 

by those lenders; guarantees them against significant 

losses resulting from borrowers’ defaults, deaths, or disabilities; and provides funds to the guaranty agencies that 

administer certain aspects of the program for the federal 

government.

The William D. Ford Direct Loan Program

Created by the Omnibus Budget Reconciliation Act of 

1993 and implemented in 1994, the direct loan program 

offers the same types of loans as the FFEL program does, 

but in the direct loan program, the federal government 

serves as the lender.2 The direct loan program was 

required by statute to attain at least a 60 percent share of 

the total volume of student loans by 1998, but the highest loan volume achieved by the program was 34 percent, 

which occurred during the 1997-1998 academic year.

The FFEL and Direct Loan Programs Today

Today, FFEL loans account for about three-quarters of all 

new student loans and direct loans account for the remaining quarter. The Congressional Budget Office 

(CBO) estimates that in 2005, the FFEL program made 

more than 10 million loans to students and parents totaling about $44 billion, and the direct loan program made 

nearly 3.2 million loans totaling about $15 billion.

The FFEL and direct loan programs offer two main types 

of loans: Stafford loans and parent loans to undergraduate students, termed PLUS loans. Most borrowers also 

have the option to consolidate multiple Stafford or PLUS 

loans into one consolidation loan. Stafford loans constitute the bulk of all loans (and are therefore the focus of 

this paper). CBO estimates that Stafford loans accounted 

for about 93 percent of loans made in 2005.

Stafford Loans

Stafford loans are low-interest loans available to both undergraduate and graduate students who generally must be 

enrolled at least half time at the postsecondary level. For 

Stafford loans disbursed before July 1, 2006, while bor1. For more details on the programs, see Congressional Research Service, Federal Student Loans: Terms and Conditions for Borrowers, 

CRS Report RL30655 (June 29, 2005); and The Administration of 

Federal Student Loan Programs: Background and Provisions, CRS 

Report RL30656 (June 29, 2005). For a broader analysis, see 

Congressional Budget Office, Private and Public Contributions to 

Financing College Education (January 2004). 

2. The direct loan program was initially established as a pilot program in the 1992 reauthorization of the Higher Education Act 

but was not implemented before the 1993 reconciliation legislation authorized the full program. Earlier, the federal government 

provided loans directly to college students under the National 

Defense Act of 1958, which created the National Defense Loan 

Program. That program was later renamed the National Direct 

Loan Program and then the Federal Perkins Loan Program. The 

Perkins program, which did not receive new appropriations in 

2005, is a smaller, campus-based loan program in which institutions received matching funds from the federal government.
2 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

rowers are in school, in a grace period following school, 

or in another authorized period of deferment, the interest 

rate charged is the 91-day Treasury bill rate (converted to 

an equivalent full-year interest rate) plus 1.70 percentage 

points, adjusted annually, up to a cap of 8.25 percent.3

When borrowers begin to repay the loans, the rate 

changes to the 91-day Treasury bill rate plus 2.30 percentage points (again capped at 8.25 percent). Those 

rates are currently 4.7 percent and 5.3 percent, respectively. Based on the last auction of Treasury bills in May, 

the rates are determined once each year and apply for 

most variable-rate loans during the upcoming 12-month 

period beginning in July.4

 A set of amendments to the 

Higher Education Act in 2002 changed the rates that 

borrowers pay on most future loans from variable to 

fixed. Consequently, under current law, all Stafford loans 

disbursed after June 30, 2006, will have a fixed rate of 6.8 

percent.

For loans made by private institutions, the interest received by the lenders is generally different from that paid 

by the borrowers; the government makes up the difference. For Stafford loans, lenders receive interest at the 

commercial paper rate plus 1.74 percentage points when 

borrowers are in school and at the commercial paper rate 

plus 2.34 percentage points during repayment, except 

when the rate paid by borrowers is higher, in which case 

the lenders receive just the borrowers’ payments. (The 

rates paid to lenders were 5.5 percent and 6.1 percent, 

respectively, for the quarter ending September 30, 2005.) 

Those yields, which are calculated quarterly, will continue to be at variable rates after June 30, 2006. When 

the lender-yield formula provides a rate above that paid 

by borrowers, the government pays the difference to lenders in the form of special allowance payments (SAPs).

There are two types of Stafford loans:

B Subsidized loans—Borrowers pay no interest on subsidized loans while they are enrolled in school, during 

the six-month grace period after leaving school, and 

during other deferment periods. Students must show 

financial need to qualify for subsidized loans. CBO 

estimates that subsidized loans accounted for about 57 

percent of all Stafford loans made in 2005.

B Unsubsidized loans—Borrowers are responsible for the 

interest on unsubsidized loans at all times, and all students qualify, regardless of need. Borrowers may pay 

the interest on these loans while they are in school, or 

the interest can be capitalized in the principal when 

borrowers begin repayment. Unsubsidized loans still 

cost borrowers less than private loans because the 

interest rates set by the federal government are lower. 

CBO estimates that unsubsidized loans accounted for 

about 43 percent of all Stafford loans made in 2005.

Undergraduate students may borrow between $2,625 and 

$10,500 per year (up to a maximum of $46,000 for all 

undergraduate years for dependent students) in subsidized and unsubsidized loans, depending on their year in 

school and dependency status. Most graduate students 

may borrow up to $18,500 per year (with no more than 

$8,500 in subsidized loans), up to a maximum of 

$138,500 in total undergraduate and graduate loans.5

The standard repayment period for Stafford loans is 10 

years.

Cash Flows in the FFEL and 

Direct Loan Programs

The cash flows associated with each loan portfolio are the 

basis for calculating the subsidy rate. Because a loan can 

be outstanding in excess of 30 years from disbursement, 

not only do the payments and receipts have to be estimated, but the timing of those payments over the entire 

life of the loan must also be projected. Such timing is 

important because a subsidy estimate is calculated by discounting the cash flows back to the year of the loan’s disbursement to reflect the time value of money (the value 

today of $100 to be received in a future year is less than 

the value of $100 received now).

The repayment plan selected by a borrower has a large 

impact on the length and timing of the cash flows. Borrowers in the FFEL and direct loan programs can choose 

3. The grace period is the six-month period beginning when borrowers cease to be enrolled in an institution of higher education 

(because of either graduation or withdrawal), during which time 

they do not pay interest on the loans. Borrowers may be granted a 

deferment if they enroll in additional postsecondary coursework 

or encounter a period of unemployment or economic hardship.

4. From July 1994 to June 1998, rates were based on the 91-day 

Treasury bill rate plus 3.1 percentage points when the loan was in 

repayment and 2.5 percentage points otherwise.

5. Students in certain medical degree programs have higher loan limits. For example, medical, dental, and veterinary students may 

borrow up to $38,500 per year, up to a total of $189,125.
SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS 3

from among several repayment plans, but even within a 

single plan, repayment options may vary slightly between 

the programs. The most common repayment options 

include the following:

B Standard repayment plan—Under this plan, borrowers 

make fixed monthly payments of at least $50 for up to 

10 years. This is the default repayment plan for both 

programs.

B Consolidation—Under this repayment option, borrowers consolidate all of their loans into a single loan with 

a fixed interest rate. That rate is based on the weighted 

average of the rates on those loans that are consolidated, rounded up to the nearest one-eighth of one 

percent.6

B Graduated repayment plan—Borrowers in this plan 

make smaller payments early in the repayment period 

and larger payments in the later years; payments are 

tailored for those borrowers whose income will increase over time.

B Extended repayment plan—The extended repayment 

plan may allow borrowers a longer repayment period 

than the 10-year window in the standard repayment 

plan.7

Borrowers in the FFEL program who are enrolled in the 

graduated or extended repayment plans are still limited to 

a 10-year repayment period unless they have received 

their loans since 1998 and have outstanding loans in 

excess of $30,000. Those borrowers who want to extend 

their repayment period beyond 10 years and do not meet 

those criteria must consolidate their loans.

CBO uses data from the National Student Loan Data 

System (NSLDS) to project the timing of loan disbursements, the length of time borrowers are enrolled in 

school, borrowers’ behavior (such as patterns of default 

and consolidation), and other factors (such as tax refund 

offsets).8,9 Using those data, CBO’s economic forecasts, 

and information from the Department of Education and 

other sources, CBO estimates the timing of aggregate 

cash flows for different types of loans and borrowers’ 

characteristics in both of the loan programs.

The government’s cash flows for guaranteed and direct 

loans include various components (see Table 1). The importance of the components varies significantly between 

the programs, depending on how long the borrower remains in school, how long and what type of repayment 

options the borrower exercises (including the option to 

consolidate multiple loans), whether the borrower defaults or the loan is discharged, and other factors. This 

paper highlights the most common and significant characteristics of the cash flows but does not address all of the 

nuances that are incorporated in the calculations of the 

subsidy rates.10 The examples that follow illustrate common repayment patterns and are designed to illustrate 

how the government’s cash flows differ under the two 

6. CBO and the Department of Education treat consolidation loans programs.

differently in computing subsidy rates. On the basis of section 

502(5)(c) of the Federal Credit Reform Act of 1990, CBO considers a consolidated loan to be a part of an original loan. The 

department treats it as a new loan and therefore calculates the subsidy rates separately for the original loan and the consolidated 

loan.

7. In addition to the four plans listed here, the FFEL program also 

offers an income-sensitive repayment plan, and the direct loan 

program offers an income-contingent repayment plan. In the 

income-sensitive plan, borrowers’ monthly payments are based on 

their loan amount and annual income, and payments rise or fall 

with income. Under that plan, borrowers have 10 years to repay 

the loan and five years of eligibility for forbearance. In the 

income-contingent plan, monthly payments are based on the loan 

amount, interest rates, family size, and annual income, and payments rise and fall with income. After 25 years, the remaining 

loan balance is forgiven in the income-contingent plan.

8. The NSLDS is the Department of Education’s centralized database for tracking student aid, by borrower, through its entire life 

cycle, from approval to repayment. The database receives information directly from institutions of higher education, guaranty agencies, lenders in the direct loan program, and other Department of 

Education programs.

9. The Internal Revenue Service may withhold a federal tax refund as 

repayment on a defaulted student loan.

10. The discussion and examples do not include the specific effects of 

some factors that influence CBO’s estimates, such as the timing of 

disbursements, the impact of students who leave school early or 

attend schools that close, borrowers’ participation in loan forgiveness programs for teachers, or the differences in the timing and 

amounts of collections of defaulted loans resulting from varying 

collection methods.
4 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

Table 1.

The Federal Government’s Cash Flows 

for Student Loans, by Type of Loan

Source: Congressional Budget Office.

Note: X = applicable to that type of loan.

Cash Flows for a Subsidized Loan Repaid in Full

Under a Standard Repayment Plan

This section describes the cash flows for a subsidized loan 

in the FFEL and direct loan programs when a student 

repays the principal and interest under one of the standard repayment plans.11 The next section discusses how 

the cash flows differ if a borrower defaults on or consolidates an original loan.

The FFEL Program. The cash flows for a subsidized loan 

in the FFEL program can be divided into three main categories: payments and receipts that occur at the time of 

the loan’s disbursement; payments made to the lender 

while the borrower is enrolled in school; and payments 

made to the lender while the loan is in repayment. When 

calculating the net present value of those cash flows, the 

timing is important. A federal payment or receipt at the 

time of a loan’s disbursement will have a higher net 

present value than a payment or receipt during the loan’s 

repayment because the former happens earlier in the life 

of the loan.

Cash Flows at the Loan’s Disbursement. Two types of federal receipts and a federal disbursement occur when a 

lender makes a loan through the FFEL program. 

First, the Department of Education charges the lender an 

origination fee of 0.5 percent of the principal on all loans. 

Second, the department charges the lender a borrower’s 

origination fee of 3 percent of the principal. The lender 

pays that fee directly to the federal government and then 

has the choice of whether or not to pass some or all of the 

cost on to the borrower. Both of those fees are designed to 

help offset some of the federal government’s costs of insuring and subsidizing student loans.12 Third, the federal 

government pays the guaranty agency a onetime loanprocessing and issuance fee of 0.40 percent of the loan’s 

principal to cover the administrative costs associated with 

the disbursement.13

Thus, for a $3,000 guaranteed loan, the government 

would collect a lender’s origination fee of $15 and a borrower’s origination fee of $90 and would pay the guaranty 

agency a loan-processing and issuance fee of $12.

Federal Payments While the Borrower Is in School. The federal government makes two types of payments to lenders 

in the FFEL program while student borrowers are enrolled in postsecondary education. Both of those payments represent budgetary costs in the calculation of the 

subsidy rate. The first is termed the in-school interest 

payment, which is made on behalf of the borrower. Stu11. Cash flows for an unsubsidized loan are very similar to those for a 

subsidized loan. In the FFEL program, the only difference for an 

unsubsidized loan is that the federal government does not pay the 

lender the in-school interest subsidy. In the direct loan program, 

the only difference for an unsubsidized loan is that the student 

must either pay the accrued interest while he or she is in school or 

have the interest capitalized into the principal of the loan.

Guaranteed Direct

Loans Loans

X

X X

X

X

X

X

X

X X

Component of Cash Flow

Principal Disbursement

Fees Collected or Paid at 

Interest Paid to Lenders While 

Special Allowance Payments

Principal Repayment

Interest Paid While Loans Are in 

Defaults and Subsequent 

Interest Not Collected from 

Origination

Borrowers Are in School

Borrowers While They Are in

School

Repayment

Collections

12. Guaranty agencies may charge borrowers an insurance premium 

of up to 1.0 percent. The receipt of that premium is recorded in 

the budget as income to the federal student loan reserve fund and 

is not part of the subsidy calculation. The reserve fund, which is 

the property of the federal government and is managed by guaranty agencies, is an account used to pay claims by lenders. Thus, 

to the extent that the premium is not charged to borrowers, federal receipts are diminished.

13. For loans originated after October 1, 1998, and prior to 

October 1, 2003, the loan-processing and issuance fee was 0.65 

percent of each guaranteed loan, paid on the gross loan amount 

disbursed.
SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS 5

dent borrowers are not responsible for interest payments 

on subsidized loans while they are enrolled in school or 

during their six-month grace period after leaving school 

(or other authorized periods of deferment).

The second is the special allowance payment, which is 

designed to encourage private lenders to participate in the 

FFEL program. SAPs are subsidy payments made to compensate lenders for the difference between the statutorily 

set interest rate charged to borrowers and the rate guaranteed to lenders.

For Stafford loans, lenders receive no less than the 

three-month commercial paper rate plus 1.74 percentage 

points while students are in school. The quarterly SAP 

(currently about 0.8 percent) is the difference, if positive, 

between that interest rate and the borrower’s rate, times 

the principal, divided by four. If the difference is negative, lenders do not receive a SAP. Unlike the borrower’s 

interest rate, which is adjusted annually, the SAP is 

adjusted and paid quarterly. 

For a $3,000 loan, the SAP (for the third quarter of calendar year 2005) while the borrower was in school would 

have amounted to about $6 (the total will change each 

quarter as the commercial paper rate changes). As recently as the second quarter of 2005, when interest rates 

were lower, the difference between the two interest rates 

and the resulting SAP was much greater; in that quarter, 

the SAPs on a $3,000 loan were about $14.

CBO estimates interest payments and SAPs on 

variable-rate loans and SAPs on direct loans using statistical techniques designed to capture the effects of volatility 

in interest rates. Specifically, such estimates are based on 

Monte Carlo simulations, a technique based on statistical 

inference regarding the uncertainty in estimates and projections of economic variables.14 In particular, the Monte 

Carlo simulations account for the likelihood that interest 

rates will differ from CBO’s baseline assumptions. 

The methodology enables CBO to estimate the costs (or 

savings) of different interest rate caps, for example. Although CBO’s assumptions for interest rates in its current 

baseline do not result in rates for borrowers as high as the 

8.25 percent caps, such rates are nevertheless possible. 

The simulations take into account the range of possible 

interest rates and indicate how often the caps may be constraining and by how much the caps can reduce the effective interest rates for borrowers.

Federal Payments on Loans During the Loan’s Repayment.

The government’s only cash flow associated with the 

FFEL program when the loan is in repayment is the 

quarterly SAP (except for deferment periods and for loan 

forgiveness). During that phase of the loan, the SAP calculation changes slightly (mirroring a change in the borrower’s interest rate). For Stafford loans, lenders receive 

the sum of the three-month commercial paper rate plus 

2.34 percentage points. When the borrower’s rate is 

higher than the target rate for lenders, the borrower’s rate 

acts as a floor on lenders’ income, and the SAP is zero.

For a $3,000 loan, the SAP during the first quarter of 

repayment would be about $6. In addition, the SAP will 

change each quarter as the borrower repays the principal 

and the lender’s yield changes.

The Direct Loan Program. The government’s cash flows 

for a typical direct loan are quite different from those for 

the typical guaranteed loan described above.

Cash Flows at the Loan’s Disbursement. Two kinds of cash 

flows occur at the time the federal government disburses a 

direct loan. The first is the disbursement of the loan to 

the individual borrower. The federal government provides 100 percent of the capital to fund the student loan 

and transmits it to the student.

The second cash flow is the origination fee, which is paid 

by the student borrower to the federal government (the 

fee is netted against the loan disbursement). As in the 

FFEL program, the federal government charges borrowers a 3.0 percent origination fee to help offset some of the 

costs of subsidizing student loans. Unlike borrowers in 

the FFEL program, however, borrowers in the direct loan 

program are charged an up-front origination fee of only 

1.5 percent when the loan is disbursed.15 Borrowers who 

make their first 12 monthly loan payments within six 

14. For further information, see Congressional Budget Office, A 

Framework for Projecting Interest Rate Spreads and Volatilities (January 2000); and How CBO Analyzes the Sources of Lenders’ Interest 

Income on Guaranteed Student Loans (June 2004).

15. Many lenders in the FFEL program pay some or all of the origination fee on behalf of borrowers. Because the federal government 

receives a full 3 percent fee up front regardless of who pays it, the 

arrangement between lenders and borrowers has no effect on the 

government’s cash flows in the FFEL program.
6 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

days of the due date are forgiven the additional 1.5 percent fee. CBO estimates that most borrowers, however, 

fail to make those payments and have the additional 1.5 

percent fee added to the original principal and amortized 

over the life of the loan.

For a $3,000 loan, the initial disbursement (net of the 1.5 

percent fee of $45) would be $2,955.

Cash Flows During Repayment. Because the federal government is the lender in the direct loan program, the borrower repays the federal government directly. The borrower is responsible for repaying both the principal and 

interest on the loan, and the borrower’s interest rate in the 

direct loan program is the same as in the FFEL program. 

On subsidized loans, the interest owed while the borrower is in school is forgiven, and the borrower makes no 

payment to the federal government. On unsubsidized 

loans, if the borrower does not pay the interest as it accrues while he or she is in school (and most do not), it is 

added to the principal of the loan when the borrower begins to repay the loan.

The Impact of Loan Defaults and 

Consolidations on Cash Flows

The federal payments and receipts described above assume the standard repayment of loans in both the FFEL 

and direct loan programs. Cash flows will differ, however, 

if the borrower defaults, consolidates his or her loans, 

defers payments, enters forbearance, has loans forgiven, 

dies, or is disabled.

Cash Flows for the Collections on a Defaulted Loan. 

A loan is considered to be in default if the borrower fails 

to make a payment for 270 days (330 days if payments 

are due less frequently than each month). In the past, 

defaults were a major concern, in part because of some 

schools whose students defaulted at particularly high 

rates. But changes made in the 1990s helped reduce those 

high default rates. Many of the changes had their greatest 

effects on proprietary schools (for-profit institutions run 

by individuals or corporations). For example, the cohort’s 

default rate at those schools dropped from a high of 

about 41 percent in 1990 to about 7 percent in 2003. 

The elimination of some schools has helped lower the 

2003 cohort’s default rate to 4.5 percent, the lowest level 

in the history of the program.16 Because of the low 

default rate and the implementation of new collection 

tools to recover the amounts owed on defaulted loans, 

Table 2.

The Federal Government’s Cash Flows 

for Collections on Defaulted Student 

Loans, by Type of Loan

Source: Congressional Budget Office.

Note: X = applicable to that type of loan.

net default rates have become a much smaller part of federal subsidy costs for loans than they were in the not-sodistant past.17

When a borrower defaults in the FFEL program, the federal government, in essence, assumes responsibility for 

the loan. There are significant differences in how 

amounts owed on defaulted loans are recovered in the 

FFEL and direct loan programs, however, which make 

the government’s cash flows different (see Table 2).

16. That rate is the percentage of borrowers who began repaying their 

loans between October 1, 2002, and September 30, 2003, and 

defaulted before September 30, 2004. Data for later periods are 

not yet available.

17. Both guaranty agencies and the Department of Education can 

obtain address and wage information for delinquent borrowers 

from the National Directory of New Hires, which provides information on all newly hired employees in the United States, and 

garnish wages to collect amounts owed on defaulted loans from 

delinquent borrowers. In addition, the Department of Education 

can use tax refund offsets to collect amounts owed. Historical 

default recovery ratios from the NSLDS indicate that for each dollar paid out for a federal default claim in the FFEL program, the 

government ultimately collected an average of $1.25 (undiscounted) through those various collection means.

Guaranteed Direct

Loans Loans

X

X

X

X

X X

Guaranty Agencies

Payments from Borrowers

on Defaults

on Defaults

Component of Cash Flow

Payments of Principal and Accrued 

Loss of Principal and Interest 

Partial Share of Collections 

100 Percent Share of Collections 

Default Penalty

Interest to Lenders Through 
SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS 7

Whether or not any recoveries are made and how long 

after default they are made also affect the budgetary cost 

of the loan to the federal government. If, for example, 

amounts owed on a loan are never recovered or only partially recovered, the subsidy cost of the loan will be higher 

than if all amounts owed are fully recovered or the borrower pays a default penalty.

Cash Flows for the Collections on a Defaulted Loan in the 

FFEL Program. When a borrower in the FFEL program 

defaults, the federal government ceases to pay the lender a 

special allowance payment. Instead, the federal government, acting through a guaranty agency, reimburses the 

lender for 98 percent of the defaulted principal and accrued interest (see Box 1 for more details on guaranty 

agencies).18 The federal government then has 45 days 

from the default date to make an intragovernmental 

transfer to reimburse the guaranty agency’s federal student loan reserve fund 95 percent of the reimbursement 

amount; that payment is reflected in the calculation of 

the subsidy rate.

The guaranty agency, often relying on a collection agency, 

attempts to recover the funds from the original borrower. 

For each dollar recovered by the guaranty agency, the first 

5 percent goes to the federal government (through the 

student loan reserve account); 23 percent of the remaining 95 percent is retained by the guaranty agency, with 

the rest also going to the federal government. The guaranty agency may also choose to charge the borrower a fee 

of up to 18.5 percent of the outstanding principal on a 

defaulted loan. When the penalty is applied, it is often 

subtracted from the borrower’s initial repayments once he 

or she begins repayment.

Box 1.

Guaranty Agencies and the Federal Government

Guaranty agencies play a critical role within the operations of the Federal Family Education Loan Program. Under contracts with the federal government, 

the agencies administer the federal guarantee program for lenders, attempt to recover amounts owed 

on defaulted loans, work with borrowers so that they 

resume payments on defaulted loans, and perform 

other activities. In turn, the federal government supplies the funding for the guarantees, shares in the recoveries, and provides some funding for the agencies’ 

administrative costs.

A guaranty agency’s finances are organized into a 

nonfederal account for its operating fund and a federal account for its student loan reserves. 

An agency’s operating fund pays for processing applications, disbursing loans, and activities aimed at 

averting defaults or collecting on defaulted loans. 

That fund’s income, primarily derived from federal 

payments, consists of loan-processing and issuance 

fees, an account-maintenance fee, fees dedicated to 

averting defaults, and retained default collections. 

Those disbursements and collections are part of a 

guaranty agency’s budget and do not appear in the 

federal budget.

The outlays from the federal fund consist of payments to lenders for the guarantees and to the guaranty agency’s operating fund for activities to avert 

defaults. Receipts for the account include reimbursements from the Department of Education for payments to lenders, a portion of default collections, 

borrowers’ insurance premiums, and other receipts. 

The net income of a guaranty agency’s federal fund 

appears on the outlay side of the federal budget; it 

does not affect the subsidy calculations.

Because the federal government owns the federal 

fund, payments to that fund from a government 

agency, such as payments from the Department of 

Education, have no effect on the total federal budget 

because they exactly offset the Treasury’s outlays for 

the payments (that is, they are intragovernmental 

transactions). In contrast, borrowers’ payments of 

premiums are governmental receipts and are reflected in the net income of the fund, thereby reducing net federal spending. 

18. Some lenders who meet certain criteria are reimbursed for 100 

percent of the defaulted principal and interest.
8 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

If the guaranty agency is unsuccessful in collecting the 

defaulted loan, it will be assigned to the Department of 

Education.19 If the department is successful, the federal 

government retains all of the recovered funds.

Cash Flows for the Collections on a Defaulted Loan in the 

Direct Loan Program. The Department of Education 

charges the 18.5 percent penalty for all borrowers who 

default in the direct loan program. Because the defaulted 

loans come directly from the federal government, the 

Department of Education is not responsible for reimbursing any other entities for the loans. In addition, in the 

direct loan program, the federal government, not the 

guaranty agency, initially works with the collection 

agency to get the defaulted borrower to resume payments. 

As a result, the department receives all of the recovered 

funds. The cost of recovering the amounts owed on the 

defaulted loan is not considered in the subsidy rate, as it 

is part of federal administrative costs.

Cash Flows for a Consolidated Repayment Option. Consolidation allows a borrower to combine his or her current loans into a single loan, in many cases extending the 

repayment period. The interest rate, which becomes fixed 

to the borrower after consolidation, is based on the 

weighted average of the rates on those loans that are consolidated, rounded up to the nearest one-eighth of one 

percent. Thus, different borrowers with variable-rate 

Stafford loans may end up paying different interest rates 

on their consolidated loans. Because all Stafford loans disbursed after June 30, 2006, will have fixed rates of 6.8 

percent, borrowers who consolidate those loans will have 

their interest rate rounded up to 6.875 percent. Cash 

flows for consolidated loans vary between the two programs (see Table 3). 

Cash Flows for a Consolidation Option Under the FFEL 

Program. When a borrower consolidates a guaranteed 

loan, the federal government charges the lender in the 

FFEL program an origination fee of 0.5 percent of the 

principal and pays a processing fee of 0.40 percent to the 

guaranty agency to cover administrative costs. In addition, the federal government charges the lender a loan

Table 3.

The Federal Government’s Cash Flows 

for the Consolidation Repayment 

Option, by Type of Loan

Source: Congressional Budget Office.

Note: X = applicable to that type of loan.

a. With variable-rate loans, some borrowers will actually pay less 

interest when they consolidate, if interest rates subsequently 

rise.

consolidation fee, equal to 1.05 percent of outstanding 

principal, each year the consolidation loan is in repayment. That fee is designed to offset the higher SAPs, 

which provide the lender with a minimum yield equal to 

the commercial paper rate plus 2.64 percentage points on 

all consolidated loans (as opposed to the commercial 

paper rate plus 2.34 percentage points for Stafford loans 

prior to consolidation) and to reflect the lender’s lower 

cost in servicing a single larger loan rather than several 

smaller ones. The lender pays the loan consolidation fee 

regardless of whether or not the federal government owes 

a SAP to the lender.

Cash Flows for a Consolidation Under the Direct Loan Program. Cash flows in the direct loan program for a consolidated loan are very similar to those for the original loan. 

When variable-rate loans are consolidated, the borrower 

pays a rate based on the weighted average of the rates on 

those loans, rounded up to the nearest one-eighth of one 

percent. When fixed-rate loans are consolidated, the borrower pays 6.875 percent interest. In either case, the 

amount of interest paid will be higher than before. Often, 

though, borrowers in the FFEL program consolidate their 

loans so they may take a longer period of time to repay 

them, although the degree to which they can extend payments depends in part on their overall indebtedness. Borrowers in the direct loan program can extend their repay19. A guaranty agency must assign to the Department of Education 

any student loan that meets all of the following criteria as of 

April 15 of each year: the unpaid principal balance is at least $100; 

the loan has been held by the guaranty agency for at least five 

years; a payment has not been received on the loan in the last year; 

and a judgment has not been made against the borrower.

Guaranteed Direct

Loans Loans

X

X

X

X

Government During Repayment X a

Component of Cash Flow

Loan Consolidation Fee

Lender's Origination Fee

Loan-Processing Fee

Higher Special Allowance Payments

Higher Interest Rate Paid to 
SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS 9

ment period beyond 10 years by participating in the 

extended repayment plan, so they are less likely to consolidate their loans to extend their repayment period.

Other Costs Incurred by the Federal 

Government in Both Programs 

Under several other scenarios, the federal government 

may bear some or all of the costs of student loans, either 

temporarily or permanently, in both the FFEL and direct 

loan programs. They include the following:

B Deferment—A borrower may receive a deferment if he 

or she enrolls in additional postsecondary coursework 

or encounters a period of unemployment or economic 

hardship. The federal government pays the interest on 

a subsidized loan while it is in deferment, but the borrower is still responsible for any interest that accrues 

(at the in-school rate) on an unsubsidized loan. For an 

unsubsidized loan in the direct loan program, deferment delays the repayment of principal and interest. A 

borrower may defer his or her payments for a total of 

up to 36 months.

B Forbearance—A borrower who is willing but unable to 

continue payments on student loans may be granted 

forbearance, which is temporary relief from the obligation for repayment. Unlike the case during deferment, 

however, interest will continue to accrue (at the repayment rate) on both subsidized and unsubsidized loans 

during this time. Generally, the goal of forbearance is 

to prevent the borrower from defaulting on a loan. In 

some cases, the lender (either a private lender or the 

Department of Education) and the borrower may 

agree to lower the borrower’s monthly payments; in 

other cases, the lender may allow the borrower to stop 

making payments for a period of time. A borrower 

may be granted forbearance for up to 36 months.

B Loan discharge—In certain extreme cases, a borrower 

may have his or her loan discharged and be completely 

freed from all obligation to repay the loan. In the case 

of the borrower’s death or total and permanent disability, the borrower is forgiven 100 percent of the loan, 

and, in the FFEL program, the government reimburses the lender for the principal and accrued interest 

on the loan.

B Loan forgiveness—In other situations, a portion of a 

borrower’s loan debt may be forgiven. For example, a 

student who becomes a full-time teacher for five consecutive years in a designated elementary or secondary 

school serving students from low-income families can 

receive up to $5,000 in loan forgiveness.20

Examples of Subsidy Rate Calculations

The cash flows just described are used to calculate the 

FFEL and direct loan programs’ subsidy rates. The examples in this section provide a sense of how cash flows and 

subsidy rates might vary under different circumstances 

but do not necessarily represent the typical timing or 

budgetary costs of events such as defaults or consolidations for either program. Under credit reform procedures, 

the subsidy rate for each program is the sum of the discounted cash flows for all loans associated with the program divided by total loan volume. (See Box 2 for a 

description of how credit subsidies are calculated.)

This paper deals only with the subsidy estimates in the 

credit reform framework, which is not intended to capture the programs’ full economic costs to the government. 

Beyond the costs reflected in the budget, economic costs 

incorporate valuations of risk, potential impacts on federal revenues, administrative costs, and other factors. In 

addition, the estimates are based on projections of key 

variables for many years into the future and therefore are 

quite uncertain. Participation rates, interest rates, default 

rates, prepayment patterns, and other aspects of the programs’ operations are very likely to differ from those 

assumed in the estimates. The history of credit reestimates in the student loan accounts of the federal budget 

offers ample evidence of that divergence. Between 1994 

and 2004, the Department of Education added about $6 

billion to the $33 billion that it had initially estimated for 

the subsidy costs.

Subsidy Costs of Loans Under the FFEL 

and Direct Loan Programs

As an illustration, consider a student who borrows 

$3,000, finishes school and completes the grace period in 

two years, and begins to repay the loan at the beginning 

of the third year under a standard 10-year repayment plan 

(see Table 4). To reflect current law, the example assumes 

a variable interest rate. Because different students are 

enrolled for various lengths of time and select different 

repayment options, the timing and amounts of the cash 

flows may look very different for any two borrowers, even 

if both repay their student loans in their entirety.

20. Under P.L. 108-409, borrowers who meet that criterion and teach 

math, science, or special education are eligible for up to $17,500.
10 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

Box 2.

Credit Reform

The Federal Credit Reform Act (FCRA) of 1990 and 

subsequent legislation changed the way the costs of 

federal loan programs are shown in the budget, shifting from a cash basis to a net-present-value basis beginning in 1992.1 Under credit reform, the estimated net cost to the federal government of a direct 

loan or loan guarantee over the entire life of that loan 

is recorded as an outlay in the budget when the loan 

is disbursed. The “subsidy” cost for a credit program 

for a particular year is the estimated net present value 

(NPV) of all future cash flows associated with loans 

made during the year. Present-value calculations are 

used to reflect the fact that the value today of $1 to 

be received in a future year is less than the value of 

$1 received now. Under that process, known as discounting, future cash flows are expressed in terms of 

today’s dollars. FCRA requires the calculation of 

present values by discounting expected cash flows at 

the interest rates on Treasury securities (the rates at 

which the government borrows money). The individual discounted cash flows, representing federal expenditures and receipts anticipated during each year 

of the expected life of the loans, are then summed to 

determine the total costs of the loans. The basic 

equation for NPV is expressed as follows:

NPV = cash flow year 1 + cash flow year 2 / (1 + discount rate) + cash flow year 3 / (1 + discount rate)2, 

and so on.

For example, assuming annual cash payments of 

$100 per year over five years with a discount rate of 5 

percent, the NPV calculation would be the 

following:

NPV= 100 + 100/(1 + .05) + 100/(1 + .05)2

 + 

100/(1 + .05)3 + 100/(1 + .05)4

From the perspective of the federal budget, that 

stream of payments is equivalent to a single payment 

of $447.41 in year 1. The Balanced Budget Act of 

1997 introduced a new method of discounting, 

commonly referred to as a basket-of-zeroes calculation. In that calculation, a different discount rate is 

applied to each year’s cash flow.2

 That rate is the interest rate that would be paid on a zero-coupon bond 

issued by the federal government and maturing in 

the same year as the cash expenditure or receipt. For 

example, an expenditure or receipt occurring three 

years after the year of disbursement would be discounted using the interest rate on a three-year zerocoupon bond, and one occurring after six years 

would be discounted using the interest rate on a sixyear zero-coupon bond.

Under FCRA, the cash flows for loans exclude most 

of the federal government’s administrative costs for 

operating both programs. That exclusion has a somewhat larger effect on the subsidy rates for direct 

loans. Under that statute, those expenditures are specifically designated to remain on a cash basis.

1. Credit reform was enacted as part of Public Law 101-508, 

and its provisions became title V of the Congressional Budget and Impoundment Control Act.

2. Prior to the enactment of the Balanced Budget Act, a single 

discount rate was used, assigned according to the typical 

maturity of the loans in a program.
SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS 11

Table 4.

Comparison of Subsidy Costs for a Hypothetical $3,000 Loan 

Under the FFEL and Direct Loan Programs

(Dollars)

Source: Congressional Budget Office.

Notes: These numbers assume that the loan is made in 2006 and that repayments follow a standard 10-year plan.

Interest and special allowance payments are estimated using a statistical technique designed to reflect the probability that interest 

rates will be higher or lower than CBO projects.

FFEL = Federal Family Education Loan; - = not applicable.

In the example at hand, the subsidy rate in the FFEL program is 15.0 percent ($450 in discounted cash flows 

divided by the $3,000 loan), meaning that for every $1 

loaned, the federal government incurs a net budgetary 

cost of $0.15. The subsidy rate for the loan under the 

direct loan program is -2.1 percent (-$63 in discounted 

cash flows divided by the $3,000 loan), meaning that the 

federal government records a budgetary savings of $0.02 

for every $1 loaned.

Components of the Subsidy Costs in the FFEL Program. 

The subsidy rate is derived by calculating the net present 

value of all the cash payments and receipts and dividing 

that total by the loan amount. The components and their 

impact on the FFEL subsidy are the following:

B In-school and grace period interest—In the example, the 

federal government makes interest payments to the 

lender of $137 for the first year and $171 for the second (for a total net present value of $301).

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

137 171 ---------- 301

-90 ----------- -90

-15 ----------- -15

grace period 44 38 ---------- 81

- - 33 32 30 27 25 21 17 13 8 3 161

12 ----------- 12 __ ___ __ __ __ __ __ __ __ _ __ _ ___

88 209 33 32 30 27 25 21 17 13 8 3 450

3,000 ----------- 3,000

-45 ----------- -45

- - -222 -238 -255 -272 -290 -310 -330 -352 -375 -400 -2,151

- - -195 -178 -160 -142 -124 -105 -84 -62 -39 -14 -866 _____ _ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ _____

Total Costs 2,955 0 -417 -416 -415 -415 -414 -414 -414 -414 -414 -414 -63

Principal

Interest

Repayment

Borrower's origination fee

Lender's origination fee

Principal disbursement

Borrower's origination fee

During repayment period

Total

(Discounted)

During school or 

Special Allowance Payments

Guaranteed Loan Under the FFEL Program

(Subsidy rate: 15.0 percent)

Interest Costs and 

Up-Front Fees

In-school interest

Direct Loan

(Subsidy rate: -2.1 percent)

Disbursement

Loan-Processing Fee

Total Costs

Nominal Cash Flows
12 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

B Borrower’s origination fee—This receipt totals $90 (3 

percent of the principal) and reduces the cost of the 

loan to the federal government. Because the fee occurs 

at the time that the loan is disbursed, the nominal and 

discounted values are the same.

B Lender’s origination fee—This receipt is $15 in this instance, slightly reducing the subsidy rate.

B Special allowance payments—To cover the SAPs, the 

federal government pays the lender a net-present-value 

amount of $81 while the borrower is enrolled in postsecondary education and $161 while the loan is in repayment. For this example, the SAPs constitute the 

largest component of the subsidy cost.

B Loan-processing fee—This fee, paid to the guaranty 

agency, increases the cost of the loan to the federal 

government by $12.

Components of the Subsidy Costs in the Direct Loan

Program. In the direct loan program, the federal government provides the loan directly to the borrower, and the 

borrower repays the federal government the principal and 

accrued interest, so the major components of the subsidy 

rate are quite different from those in the FFEL program:

B Loan disbursement—In this example, the federal government disburses the loan principal of $3,000.

B Borrower’s origination fee—The federal government’s 

receipts from the borrower’s origination fee total $45. 

The scenario assumes that, like the majority of student 

loan borrowers, the individual fails to make the first 

12 payments within six days of the due date (but does 

so within 15 days of the due date), so the second half 

of the origination fee is added to the outstanding principal after the borrower’s 12th payment.

B Loan repayment—The net present value of payments 

to the government of principal and interest, including 

the second half of the origination fee, totals $3,017. 

Because the discount rate used to determine the net 

present value of these cash flows is lower than the 

interest rate paid by the borrower, the government 

shows a budgetary gain on this loan under the procedures of credit reform.

Subsidy Costs When a Borrower Defaults. Not all borrowers repay their loans under the standard 10-year repayment plan. If the borrower defaults on his or her loan 

and some or all of the amount owed on the defaulted 

loan is collected, the cash flows and corresponding subsidy rates are different from what they are when the borrower adheres to the standard repayment plan. 

In its sample scenario, CBO assumes that a borrower 

defaults in the third year and that some of the amount 

owed is recovered, although neither the guaranty agency 

(in the example for the FFEL program) nor the federal 

government (in the example for the direct loan program) 

is able to collect all of the defaulted principal and interest 

(see Table A-1 in Appendix A). As discussed earlier, if, 

when, and how much of the defaulted loan is recovered 

all have an impact on the budgetary cost of the loan to 

the federal government.

The subsidy rate for this hypothetical defaulted loan 

(with variable interest rates) in the FFEL program is 30.5 

percent, 15.5 percentage points higher than the subsidy 

rate under the 10-year standard repayment plan. A substantial portion of the higher subsidy rate occurs in this 

example because, although the federal government pays 

no SAPs on the defaulted loan, the guaranty agency is 

able to recover only a portion of the defaulted principal 

and interest and then retains some of those funds to cover 

its administrative costs. 

For the comparable direct loan, the subsidy rate is 14.6 

percent. Because the federal government is unable to 

recover all of the defaulted principal and interest, the subsidy rate is 16.7 percentage points higher in this example 

than in the example with a standard repayment.

Subsidy Costs When a Borrower Consolidates Loans.

The cash flows and resultant subsidy rates also differ if 

the borrower consolidates his or her student loans. Again, 

many factors, including when the borrower consolidates 

and the interest rate at that time, will have a large impact 

on the budgetary cost of the consolidation to the government.

In a sample scenario, the subsidy rate is 14.7 percent for 

a $3,000 subsidized loan (with variable interest rates) 

made in the FFEL program when the borrower consolidates it with other student loans (see Table A-2 in 

Appendix A).21 That subsidy rate is slightly lower than

21. In accordance with the provisions of the Federal Credit Reform 

Act of 1990, CBO considers consolidation to be a repayment 

option and not a separate loan.
SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS 13

Table 5.

Examples of the Impact on Subsidy Rates of the Length of a Borrower’s

Enrollment Period, by Type of Loan

(Subsidy rate, in percent)

Source: Congressional Budget Office.

Note: The subsidy rates shown here are illustrative; they do not necessarily represent the actual experience of the student loan programs. 

The calculations assume variable interest rates for borrowers.

that for the loan that was repaid over 10 years because 

increased costs from the higher SAPs, which are paid over 

12 years instead of 10, are more than offset by the loan 

consolidation fee paid by the lender. The higher SAPs are 

the result of two changes that occur with consolidations. 

First, the borrower converts a variable-rate loan to a fixedrate one, which has the effect of increasing the likely gap 

between the borrower’s rate and the lender’s rate because 

the former no longer moves roughly in tandem with the 

latter. The gap widens further if interest rates are generally rising. Second, the lender formula provides an additional 0.3 percentage points above the commercial paper 

rate for consolidation loans.

For the comparable direct loan, the subsidy rate for the 

same consolidated loan is -4.3 percent. That morenegative subsidy rate results from the additional two years 

of interest paid by the borrower over the 12-year repayment period, rather than the 10-year period, and by the 

higher interest rate paid on the consolidation loan (because it is rounded up to the nearest one-eighth).22,23

Impact of the Length of Enrollment on

Subsidy Costs

Subsidy estimates vary considerably depending on the 

timing of events. For example, the length of time the borrower is enrolled in postsecondary education affects the 

subsidy rates significantly. A loan issued earlier during an 

individual’s postsecondary enrollment increases the period over which the government pays in-school interest 

and SAPs in the FFEL program, thus increasing the budgetary cost of the loan. Longer in-school periods also 

delay the repayment of principal and interest in the direct 

loan program, reducing the net present value of those 

payments. Thus, for the examples previously discussed, a 

shorter enrollment period results in a lower subsidy cost 

(see Table 5). 

Sources of Difference in 

Subsidy Rate Calculations

Although the FFEL and direct loan programs are designed to provide the same kinds of loans to individual 

borrowers, the cash flows of the two programs and their 

net budgetary costs to the government under credit reform differ substantially. In the direct loan program, the 

federal government makes a loan to the borrower and the 

borrower repays the principal and pays interest on that 

loan to the federal government. In the FFEL program, a 

transaction involves four parties: the borrower; the private lender; the guaranty agency; and the federal government, which subsidizes the lender if the borrower’s inter26.6 9.5 15.0 -2.1 7.4 -7.6

39.8 24.2 30.5 14.6 23.5 10.0

Grace Period 26.5 4.7 14.7 -4.3 6.6 -9.9

Loan Consolidation at End of 

Direct

Loans

Standard 10-Year Repayment

Immediate Default with Recovery

Direct

Loans

Plus Grace Period

Guaranteed

Loans

Direct

Loans

Guaranteed

Loans

Four Years in School Two Years in School 

Plus Grace Period

Guaranteed

Loans

One Year in School 

Plus Grace Period

22. As with other aspects of the loan programs, the credit reform calculations do not necessarily provide a good measure of the economic costs to the government of loan consolidations. A forthcoming CBO paper will describe and assess those costs.

23. CBO’s scenarios described in the text and presented in Tables 4, 

A-1, and A-2 assume variable interest rates. Appendix B includes 

corollary scenarios that assume fixed rates.
14 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

est rate drops below a certain point and reimburses the 

lender—through the guaranty agency—for most of its 

loss should the borrower default, die, or become disabled. 

Therefore, the budgetary gains or losses calculated under 

credit reform procedures are divided up differently for the 

two programs, with some of the gains in the FFEL program accruing to private-sector parties.

In CBO’s March 2005 baseline projections, the estimated 

subsidy rate for student loans issued in 2006 is about 15 

percent for the FFEL program and about -2 percent for 

the direct loan program, meaning that for every $1 in 

loans, the federal government incurs a budgetary cost of 

$0.15 in the FFEL program and records a budgetary saving of $0.02 in the direct loan program.24 Several factors 

account for that spread.

Special Allowance Payments to Lenders

One of the two biggest factors is the yield provided to 

lenders in the FFEL program. Borrowers pay interest at 

the 91-day Treasury bill rate plus 1.70 percentage points, 

while lenders receive either the borrower’s interest rate or 

the commercial paper rate plus 1.74 percentage points 

(whichever is higher). Because the commercial paper rate 

plus 1.74 percentage points is generally higher than the 

borrower’s rate, the government pays the difference to 

lenders in the form of special allowance payments, which 

is a cost that does not exist in the direct loan program. 

In CBO’s simple scenario in which a student borrows 

$3,000 and repays the loan under a standard 10-year 

repayment plan, for example, the SAPs account for more 

than half of the subsidy cost for the FFEL program (see 

Table 4 on page 11). Overall, CBO estimates that this 

factor accounts for roughly 7 percentage points of the difference in the subsidy rates between the FFEL and direct 

loan programs for loans in 2006.

Discounting and Interest Rates 

A second major factor results from the difference between 

the borrower’s interest rate and the discount rate used in 

the present-value calculation. In the calculation of the 

subsidy rate for the direct loan program, principal and interest payments are discounted at a different, and generally lower, rate than the borrower pays. The result is a net 

budgetary gain to the federal government that does not 

exist in the FFEL program. In general, as long as the borrower’s interest rate on a loan is higher than the rate at 

which the federal government discounts the loan, the federal budget will show that the government earns money 

on the loan (barring other factors such as default or consolidation).

For example, in CBO’s scenario based on standard repayment (presented in Table 4), the net present value of the 

principal and interest payments ($3,017) is greater than 

the government’s initial disbursement of $3,000 because 

the interest rate on the loan (which ranges from 5.1 percent to 6.6 percent) is greater than the discount rate 

(which ranges from 4.0 percent to 5.3 percent).25 Overall, CBO estimates that this factor accounts for approximately 7 percentage points of the difference in subsidy 

rates between the FFEL and direct loan programs for 

loans in 2006.

Net Collections on Defaulted Loans 

A third, much smaller factor in the spread between subsidy rates is the difference in procedures for collecting defaulted loans in the two programs. When a borrower in 

the FFEL program defaults, the federal government reimburses the lender for most of the defaulted funds, and a 

guaranty agency attempts to recover them. If the guaranty 

agency is able to collect the funds, it retains a portion of 

them, so the government does not receive all of the recovered funds. When a borrower in the direct loan program 

defaults, however, the federal government alone retains 

any recovered funds. (Although the Department of Education incurs collection costs that average about 16 percent of a defaulted loan, those administrative costs are not 

included in the subsidy calculation, as specified by the 

Credit Reform Act.) Because the default rate for student 

loans is relatively low, this factor has only a small effect, 

about 1.5 percentage points, on the difference in subsidy 

rates for the two programs. (The cohort’s default rate for 

loans originated in 2003 was 4.5 percent, the lowest level 

in the history of the programs.)

24. Appendix C shows the impact of different components in the 

FFEL and direct loan programs on CBO’s overall subsidy rates for 

loans originated in 2006 in its March 2005 baseline by each loan 

type—subsidized, unsubsidized, and PLUS. Appendix D 

describes how the programs functioned before the most recent 

reauthorization (in 1998) of the Higher Education Act and presents some of the major legislative and administrative changes that 

have affected the subsidy rates for both programs. 

25. Those interest rates are based on CBO’s economic forecast in its 

March 2005 baseline and do not necessarily reflect actual interest 

rates.
SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS 15

Administrative Costs

According to statute, most of the government’s costs to 

administer the loan programs are recorded on a cash basis 

and are not included in the subsidy rate calculation. According to CBO’s estimates, including the government’s 

administrative costs in the FFEL program would raise its 

subsidy rate by approximately 0.8 percentage points; including the administrative costs of the direct loan program would raise its subsidy rate by approximately 1.5 

percentage points.

A

Sample Subsidy Rates When a Borrower

Defaults or Consolidates Loans

To supplement its scenario in which a borrower repays his or her loan under a standard 10-year repayment 

schedule, the Congressional Budget Office created scenarios in which the borrower defaults or consolidates his 

or her loans. Table A-1 shows the details of the subsidy 

rate in a scenario in which a student borrows $3,000 for 

two years and defaults on that loan in the third year, and 

some of the defaulted funds are recovered. Table A-2 

shows the details of the rate in a scenario in which a student borrows $3,000 for two years and then consolidates 

that loan with other student loans in the third year.

APPENDIX
18 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

Table A-1.

Comparison of Subsidy Costs for a Hypothetical $3,000 Variable-Rate Loan 

Under the FFEL and Direct Loan Programs When the Borrower Defaults and 

Some Funds Are Recovered

(Dollars)

Source: Congressional Budget Office.

Notes: Interest and special allowance payments are estimated using a statistical technique designed to reflect the probability that interest 

rates will be higher or lower than CBO projects. Recovery rates for each program are based on historical patterns of collections on 

defaulted loans.

FFEL = Federal Family Education Loan; - = not applicable.

2006 2007 2008 2009 2010 2011 2012 2013 2014

In-school interest 137 171 -------

Borrower's origination fee -90 --------

Lender's origination fee -15 --------

During school or grace period 44 38 -------

During repayment period - - 24 ------

Federal payments - - 2,925 ------

Federal share of recoveries - - -231 -470 -445 -335 -278 -239 -201

12 -------- __ ___ _____ ____ ____ ____ ____ ____ ____

88 209 2,719 -470 -445 -335 -278 -239 -201

Principal disbursement 3,000 --------

Borrower's origination fee -45 --------

- - -307 -588 -537 -409 -332 -281 -230 _____ _ ____ ____ ____ ____ ____ ____ ____

2,955 0 -307 -588 -537 -409 -332 -281 -230

Interest Costs and Up-Front Fees

Nominal Cash Flows

Guaranteed Loan Under the FFEL Program

(Subsidy rate: 30.5 percent)

Total Costs

Direct Loan

(Subsidy rate: 14.6 percent)

Default Recoveries

Disbursement

Loan-Processing Fee

Total Costs

Special Allowance Payments

Net Claim Payments
APPENDIX A SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS 19

Table A-1.

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

----------- 301

----------- -90

----------- -15

----------- 81

----------- 22

----------- 2,682

-155 -110 -91 -91 -71 -18 -18 -13 -8 -4 -4 -2,079

----------- 12 ____ ____ ___ ___ ___ ___ ___ ___ __ __ __ _____

-155 -110 -91 -91 -71 -18 -18 -13 -8 -4 -4 914

----------- 3,000

----------- -45

-179 -128 -102 -102 -77 -20 -20 -15 -10 -5 -5 -2,518 ____ ____ ____ ____ ___ ___ ___ ___ ___ __ __ _____

-179 -128 -102 -102 -77 -20 -20 -15 -10 -5 -5 437

Nominal Cash Flows Total

Direct Loan

(Subsidy rate: 14.6 percent)

(Discounted)

Guaranteed Loan Under the FFEL Program

(Subsidy rate: 30.5 percent)
20 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

Table A-2.

Comparison of Subsidy Costs for a Hypothetical $3,000 Variable-Rate Loan 

Under the FFEL and Direct Loan Programs with Loan Consolidation 

After the Grace Period

(Dollars)

Source: Congressional Budget Office.

Notes: Interest and special allowance payments are estimated using a statistical technique designed to reflect the probability that interest 

rates will be higher or lower than CBO projects.

FFEL = Federal Family Education Loan; - = not applicable.

2006 2007 2008 2009 2010 2011

In-school interest 137 171 ----

Borrower's origination fee -90 -----

Lender's origination fee -15 - -15 ---

Loan consolidation fee - - -31 -29 -27 -25

During school or grace period 44 38 ----

During repayment period - - 56 54 52 48

12 - 12 --- __ ___ __ __ __ __

88 209 23 26 25 24

Principal disbursement 3,000 -----

Borrower's origination fee -45 -----

Principal - - -171 -182 -195 -209

Interest - - -200 -188 -176 -162 _____ _ ____ ____ ____ ____

Total Costs 2,955 0 -371 -371 -371 -371

Disbursement

Loan-Processing Fee

Total Costs

Repayment

(Subsidy rate: -4.3 percent)

Direct Loan

Special Allowance Payments

Interest Costs and Up-Front Fees

Guaranteed Loan Under the FFEL Program

(Subsidy rate: 14.7 percent)

Nominal Cash Flows
APPENDIX A SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS 21

Table A-2.

2012 2013 2014 2015 2016 2017 2018 2019

-------- 301

-------- -90

-------- -29

-23 -20 -18 -15 -12 -9 -5 -2 -162

-------- 80

45 41 36 30 24 18 11 4 316

-------- 23 __ __ __ __ __ __ __ _ ____

22 21 18 15 13 9 6 2 440

-------- 3,000

-------- -45

-223 -239 -255 -273 -292 -313 -334 -358 -2,021

-148 -132 -115 -98 -79 -58 -36 -13 -1,063 ____ ____ ____ ____ ____ ____ ____ ____ _____

-371 -371 -371 -371 -371 -371 -371 -371 -129

Direct Loan

(Subsidy rate: -4.3 percent)

Total

(Discounted)

Guaranteed Loan Under the FFEL Program

(Subsidy rate: 14.7 percent)

Nominal Cash Flows

B

Examples of Subsidy Rates Calculated Using the

Fixed Interest Rates That Take Effect in 2006

Under current law, on all new loans issued after 

June 30, 2006, borrowers will pay a fixed rate of 6.8 percent rather than the variable rate that is adjusted annually. 

Replacing the variable rate with the fixed rate changes the 

subsidy costs. This appendix displays the subsidy costs for 

the hypothetical loans discussed earlier (in Tables 4, A-1, 

and A-2), applying the new fixed rates rather than variable rates (used in the preceding tables).

Subsidy Costs Under a Standard 

10-Year Repayment Plan 

The estimated subsidy cost on a fixed-rate loan under the 

Federal Family Education Loan (FFEL) Program when 

the borrower adheres to a standard 10-year repayment 

plan is 17.9 percent, or 2.9 percentage points higher than 

that for a variable-rate loan (see Table B-1compared with 

Table 4). In this scenario, the borrower’s effective interest 

rate is higher because the 6.8 percent fixed rate is higher 

than CBO’s projection of the variable interest rate. As a 

result, the federal government makes larger in-school interest payments. Moreover, because the borrower’s interest rate no longer moves in tandem with the lender’s rate, 

when interest rates rise the federal government owes 

larger special allowance payments (SAPs) to the lender, 

raising the subsidy rate.

For the comparable loan in the William D. Ford Direct 

Loan Program, the subsidy rate is -3.4 percent, or 1.3 

percentage points lower than that for a variable-rate loan. 

Again, because the fixed interest rate for borrowers is 

higher than the effective variable interest rate, the federal 

government receives more in interest payments.

Subsidy Costs When a Borrower 

Defaults and Collections Ensue

In a scenario in which the borrower defaults in year 3 

and most, but not all, of the defaulted funds are recovered, the subsidy rate for a fixed-rate loan in the FFEL 

program is 32.5 percent and for such a loan in the direct 

loan program, 14.4 percent (see Table B-2 compared 

with Table A-1). As is the case with a variable-rate loan, 

the subsidy rate for a fixed-rate loan with a default and 

recovery is higher than the subsidy rate for a loan with the 

standard 10-year repayment because not all of the defaulted funds are recovered. And, as with the previous 

case, the subsidy costs are higher for the FFEL program 

(because of higher in-school interest payments) and lower 

for the direct loan program (because the government 

receives higher collections resulting from higher interest 

charged to the borrower).

Subsidy Costs When a Borrower

Consolidates Loans

In a scenario in which the borrower consolidates a fixedrate student loan in year 3, the subsidy rate in the FFEL 

program is 14.3 percent (see Table B-3 compared with 

Table A-2). The cost to the federal government is lower 

than that for a loan that is repaid over 10 years because 

the increased consolidation fee, paid over 12 years, more 

than covers the increased SAPs. In such a scenario for the 

direct loan program, the subsidy rate is -5.0 percent.

APPENDIX
24 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

Table B-1.

Comparison of Subsidy Costs for a Hypothetical $3,000 Fixed-Rate Loan 

Under the FFEL and Direct Loan Programs

(Dollars)

Source: Congressional Budget Office.

Notes: These numbers assume that the loan is made in 2006 and that repayments follow a standard 10-year plan.

Special allowance payments are estimated using a statistical technique designed to reflect the probability that interest rates will be 

higher or lower than CBO projects.

FFEL = Federal Family Education Loan; - = not applicable.

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 0

In-school interest 204 204 ---------- 400

Borrower's origination fee -90 ----------- -90

Lender's origination fee -15 ----------- -15

During school or grace period 12 26 ---------- 37

During repayment period - - 39 38 36 33 29 25 20 15 9 3 193

12 ----------- 12 ___ ___ __ __ __ __ __ __ __ __ __ _ ____

123 230 39 38 36 33 29 25 20 15 9 3 537

Principal disbursement 3,000 ----------- 3,000

Borrower's origination fee -45 ----------- -45

Principal - - -220 -236 -252 -270 -289 -309 -331 -354 -379 -405 -2,148

Interest - - -200 -185 -168 -151 -132 -111 -90 -67 -42 -15 -909 _____ _ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

2,955 0 -421 -421 -421 -421 -421 -421 -421 -421 -421 -421 -103

Total

(Discounted)

Disbursement

Loan-Processing Fee

Total Costs

Guaranteed Loan Under the FFEL Program

Nominal Cash Flows

Special Allowance Payments

(Subsidy rate: 17.9 percent)

Interest Costs and Up-Front Fees

Total Costs

Direct Loan

(Subsidy rate: -3.4 percent)

Repayment

26 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

Table B-2.

Comparison of Subsidy Costs for a Hypothetical $3,000 Fixed-Rate Loan 

Under the FFEL and Direct Loan Programs When the Borrower Defaults and

Some Funds Are Recovered

(Dollars)

Source: Congressional Budget Office.

Notes: Special allowance payments are estimated using a statistical technique designed to reflect the probability that interest rates will be 

higher or lower than CBO projects. Recovery rates for each program are based on historical patterns of collections on defaulted loans.

FFEL = Federal Family Education Loan; - = not applicable.

2006 2007 2008 2009 2010 2011 2012 2013 2014

In-school interest 204 204 -------

Borrower's origination fee -90 --------

Lender's origination fee -15 --------

During school or grace period 12 26 -------

During repayment period - - 29 ------

Federal payments - - 2,929 ------

Federal share of recoveries - - -231 -471 -446 -336 -278 -239 -201

12 -------- ___ ___ _____ ____ ____ ____ ____ ____ ____

123 230 2,727 -471 -446 -336 -278 -239 -201

Principal disbursement 3,000 --------

Borrower's origination fee -45 --------

- - -307 -589 -537 -409 -333 -281 -230 ___ _ ____ ____ ____ ____ ____ ____ ____

2,955 0 -307 -589 -537 -409 -333 -281 -230

(Subsidy rate: 14.4 percent)

Special Allowance Payments

Total Costs

Default Recoveries

Disbursement

Loan-Processing Fee

Total Costs

Net Claim Payments

Interest Costs and Up-Front Fees

(Subsidy rate: 32.5 percent)

Nominal Cash Flows

Guaranteed Loan Under the FFEL Program

Direct Loan
APPENDIX B SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS 27

Table B-2.

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

----------- 400

----------- -90

----------- -15

----------- 37

----------- 27

----------- 2,685

-155 -110 -91 -91 -71 -18 -18 -13 -8 -4 -4 -2,081

----------- 12 ____ ____ ____ ____ ___ ___ ___ ___ __ __ __ _____

-155 -110 -91 -91 -71 -18 -18 -13 -8 -4 -4 974

----------- 3,000

----------- -45

-179 -128 -102 -102 -77 -20 -20 -15 -10 -5 -5 -2,552 ____ ____ ____ ____ ___ ___ ___ ___ ___ __ __ _____

-179 -128 -102 -102 -77 -20 -20 -15 -10 -5 -5 433

(Subsidy rate: 32.5 percent)

Direct Loan

(Subsidy rate: 14.4 percent)

Total

(Discounted)

Nominal Cash Flows

Guaranteed Loan Under the FFEL Program
28 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

Table B-3.

Comparison of Subsidy Costs for a Hypothetical $3,000 Fixed-Rate Loan 

Under the FFEL and Direct Loan Programs with Loan Consolidation 

After the Grace Period

(Dollars)

Source: Congressional Budget Office.

Notes: Special allowance payments are estimated using a statistical technique designed to reflect the probability that interest rates will be 

higher or lower than CBO projects.

FFEL = Federal Family Education Loan; - = not applicable.

2006 2007 2008 2009 2010 2011 2012

In-school interest 204 204 - - - - -

Borrower's origination fee -15 - -15 - - - -

Lender's origination fee -90 - - - - - -

Loan consolidation fee - - -31 -29 -27 -25 -23

During school or grace period 12 26 - - - - -

During repayment period - - 43 41 41 39 36

12 - 12 - - - - ___ ___ __ __ __ __ __

123 230 9 12 14 14 13

Principal disbursement 3,000 - - - - - -

Borrower's origination fee -45 - - - - - -

Principal - - -169 -181 -194 -208 -223

Interest - - -204 -192 -179 -165 -151 _____ _ ____ ____ ____ ____ ____

2,955 0 -373 -373 -373 -373 -373

Loan-Processing Fee

Total Costs

Nominal Cash Flows

Guaranteed Loan Under the FFEL Program

(Subsidy rate: 14.3 percent)

Total Costs

Repayment

(Subsidy rate: -5.0 percent)

Special Allowance Payments

Interest Costs and Up-Front Fees

Disbursement

Direct Loan
APPENDIX B SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS 29

Table B-3.

2013 2014 2015 2016 2017 2018 2019

- - - - - - - 400

- - - - - - - -29

- - - - - - - -90

-20 -18 -15 -12 -9 -5 -2 -162

- - - - - - - 37

33 29 24 20 15 9 3 249

- - - - - - - 23 __ __ __ __ __ _ _ ___

13 11 10 8 6 4 1 428

- - - - - - - 3,000

- - - - - - - -45

-238 -255 -274 -293 -314 -336 -360 -2,019

-135 -118 -100 -80 -60 -37 -14 -1,085 ____ ____ ____ ____ ____ ____ ____ _____

-373 -373 -373 -373 -373 -373 -373 -149

(Subsidy rate: 14.3 percent)

Direct Loan

(Subsidy rate: -5.0 percent)

Total

(Discounted)

Nominal Cash Flows

Guaranteed Loan Under the FFEL Program

C

CBO’s Estimates of Subsidy Rates for

Various Types of Guaranteed and Direct

Student Loans Made in 2006

According to the Congressional Budget Office’s 

March 2005 estimates, the overall subsidy rates for loans 

originated in 2006 in the Federal Family Education Loan 

(FFEL) Program were about 15 percent and in the William D. Ford Direct Loan Program, about -2 percent. The 

subsidy rates for the various types of guaranteed and 

direct student loans vary widely, however, by loan type—

subsidized and unsubsidized loans to students and loans 

to parents. The major elements of the subsidy rates for 

student loans disbursed in 2006 are displayed in 

Table C-1. Under current law, loans originated before 

July 1, 2006, will be variable-rate loans, and those originated after that will be different types of fixed-rate loans. 

The major effects of the change are the following:

B The gap between the subsidy rates for guaranteed 

loans and direct loans is larger—by 5 to 6 percentage 

points—for fixed-rate loans than it is for variable-rate 

loans.

B The switch from variable interest rates to fixed rates 

raises the budgetary cost for guaranteed loans and 

decreases it for direct loans.

B The component of the subsidy rates showing the largest change in the guaranteed loan program is the payment for in-school interest on subsidized loans; the 

largest difference in the direct loan program is in the 

receipt of interest payments from borrowers.

B In-school interest costs paid by the government (for 

guaranteed loans) and not collected by the government (in the case of direct loans) account for much of 

the budgetary cost of subsidized student loans.

APPENDIX
32 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

Table C-1.

CBO’s Estimates of Federal Subsidy Rates for Variable-Rate and Fixed-Rate

Student Loans in 2006

(Percent)

Source: Congressional Budget Office.

Note: Subsidy rates are shown as a percentage of each dollar loaned.

a. The loan consolidation fee is included with special allowance payments because it offsets interest paid to lenders.

b. Net federal claim payments include the costs of default reimbursements, death and disability payments, and receipts from collections.

-3.5 -3.5

14.3 16.9

6.3 6.5

2.5 2.5

2.8 3.5 ____ ____

Total Subsidy Rate 22.3 25.9

-3.6 -3.6

0 0

7.3 7.8

2.6 2.7

2.5 3.4 ___ ___

Total Subsidy Rate 8.9 10.3

-3.7 -3.7

0 0

2.4 3.9

3.1 3.1

0.9 1.3 ___ ___

Total Subsidy Rate 2.7 4.6

Guaranteed Loans

Subsidized Loans

Net federal claim paymentsb

In-school interest costs

Special allowance paymentsa

Net federal claim paymentsb

Special allowance paymentsa

Other

Unsubsidized Loans

Fees

Variable

Interest Rates

Fixed

Interest Rates

In-school interest costs

Fees

Other

Loans to Parents

Fees

In-school interest costs

Special allowance paymentsa

Net federal claim paymentsb

Other

-1.8 -1.8

98.8 98.8

-59.6 -58.7

-25.6 -28.1

-3.0 -2.9 ____ ____

Total Subsidy Rate 9.0 7.4

-1.8 -1.8

98.8 98.8

-68.5 -69.0

-30.7 -34.5

-3.7 -3.7 ____ ____

Total Subsidy Rate -5.8 -10.1

-1.9 -1.9

99.9 99.9

-70.0 -70.1

-34.0 -37.1

-6.2 -6.0 ____ ____

Total Subsidy Rate -12.2 -15.2

Variable Fixed

Interest Rates Interest Rates

Principal repaid

Interest paid

Other

Other

Loans to Parents

Fees

Disbursement

Fees

Principal repaid

Interest paid

Principal repaid

Interest paid

Other

Unsubsidized Loans

Subsidized Loans

Fees

Disbursement

Disbursement

Direct Loans
D

Recent Legislative and Administrative Actions 

Affecting the Student Loan Programs

Both the Federal Family Education Loan (FFEL) 

Program and the William D. Ford Direct Loan Program 

have undergone a host of legislative and administrative 

changes over the past decade. Since their reauthorization 

in 1998, some major changes have had a direct impact on 

the subsidy rates.

The Borrower’s Interest Rate and the 

Lender’s Yield Before the 1998

Reauthorization

From July 1994 to June 1998, both the borrower’s interest rate and the lender’s yield in the FFEL and direct loan 

programs were set at the 91-day Treasury bill rate plus 2.5 

percentage points while borrowers were in school, within 

a grace period, or in a period of deferment, and at the 

Treasury bill rate plus 3.1 percentage points while the 

loan was in repayment. The borrower’s rate was capped at 

8.25 percent. In July 1998, a new formula for calculating 

the variable interest rate on FFEL and direct loans, enacted as part of the Omnibus Budget Reconciliation Act 

of 1993, was scheduled to take effect. The interest rate 

paid by borrowers would have been the interest rate on 

bonds of comparable maturity, plus 1 percentage point, 

capped at 8.25 percent. Lenders would have received the 

same rate, without the cap, and the federal government 

would have covered the difference if the yield to lenders 

exceeded 8.25 percent.

Impact of the 1998 Reauthorization

of the Higher Education Act 

Legislation enacted in 1998 that reauthorized the Higher 

Education Act lowered both the borrower’s interest rate 

and the lender’s yield from their levels between 1994 and 

1998, but the reduction for borrowers was greater. Public 

Law 105-178 established the formula to determine the 

borrower’s interest rate at a level 50 basis points lower 

than the yield for lenders.1

 That new payment structure 

substantially widened the gap between the federal subsidy 

rate for loans in the FFEL program and that for the direct 

loan program. The borrower’s interest rate and the 

lender’s yield were calculated as follows:

B Borrower’s rate—Beginning in October 1998, P.L. 

105-178 set the interest rate paid by students for 

Stafford loans at the 91-day Treasury bill rate plus 

1.70 percentage points while borrowers are in school, 

within the grace period, or in a period of deferment, 

and at the 91-day Treasury bill rate plus 2.3 percentage points when loans are in repayment (capped at 

8.25 percent). The rate is set once a year, using the interest rate on Treasury bills set during the last auction 

in May, and applies to loans beginning in June.

B Lender’s yield—The lender’s yield on loans in the 

FFEL program changed to the 91-day Treasury bill 

rate plus 2.2 percentage points while borrowers are in 

school, within the grace period, or in a period of deferment, and to the Treasury bill rate plus 2.80 percentage points while loans are in repayment. Unlike the 

borrower’s interest rate, the lender’s yield is calculated 

quarterly.

The 1998 reauthorization also affected the provisions 

that apply to the guaranty agencies. First, it clarified that 

the student loan reserve accounts of guaranty agencies are 

federal rather than state (or in some cases, nonprofit) accounts. Second, it established a new federal fee to guaranty agencies equal to 0.65 percent of the volume of new 

loans made in the FFEL program from 1999 through 

2003 and 0.40 percent after that time (replacing a 1.0 

APPENDIX

1. A basis point is one-hundredth of a percentage point.
34 SUBSIDY ESTIMATES FOR GUARANTEED AND DIRECT STUDENT LOANS

percent administrative cost allowance). It also lowered the 

federal reinsurance rate to guaranty agencies from 98 percent to 95 percent. Finally, it lowered guaranty agencies’ 

retention rate on the recovery of defaults from 27 percent 

to 24 percent through 2004 and to 23 percent after that 

time.

Impact of Additional

Legislative Changes

Several other laws passed since the 1998 reauthorization 

of the Higher Education Act have affected the subsidy 

rates for the FFEL and direct loan programs. They include the Consolidated Appropriations Act for Fiscal Year 

2000 (P.L. 106-113), the Ticket to Work and Incentives 

Improvement Act (P.L. 106-170), and amendments to 

the Higher Education Act in 2002 (P.L. 107-139).

The Consolidated Appropriations Act for

Fiscal Year 2000

P.L. 106-113, signed into law on November 29, 1999, 

allowed the Department of Education access to the National Directory of New Hires (NDNH) to assist in 

tracking down borrowers with defaulted student loans. 

The NDNH, which was originally designed to help locate individuals who were delinquent on child support 

payments, provides information on all newly hired employees in the United States. The department matches its 

records on delinquent borrowers with the NDNH to obtain their address and wage information. That practice 

has helped both guaranty agencies and the department 

track down delinquent borrowers and increase recoveries.

The Ticket to Work and Incentives Improvement Act

P.L. 106-170, enacted on December 17, 1999, changed 

the benchmark for the lender’s yield on student loans 

from the 91-day Treasury bill rate to the commercial paper rate with a three-month maturity. The change affected the lender’s yield only on loans disbursed between 

January 1, 2000, and July 1, 2003, and did not have any 

impact on the borrower’s rate.

Amendments to the Higher Education Act in 2002

P.L. 107-139, which was enacted on January 24, 2002, 

extended the provision applying commercial rates to the 

lender’s yield to loans disbursed after July 1, 2003. In addition, it extended the structural difference between the 

borrower’s rate and the lender’s yield first introduced in 

the 1998 reauthorization and extended, until July 2006, 

the variable interest rates for borrowers. Finally, it replaced the variable rates with a fixed rate beginning in 

July 2006 and, with one exception, permanently extended the lender yield rates set by the 1999 legislation.

Administrative Changes

In addition to the legislative changes, the Department of 

Education instituted several administrative changes that, 

to varying degrees, increased the subsidy costs of the direct loan program.

Reduction in Origination Fees 

In June 1999, the Department of Education lowered the 

origination fee on direct student loans from 4 percent to 

3 percent. That lower fee became effective on July 16, 

1999, for the processing of all new direct loans with a 

first disbursement date on or after August 15, 1999.2

Direct Withdrawal of Funds 

Using the authority provided under subsection 444(b)(7) 

of the Higher Education Act, the department published a 

notice of rulemaking that provided a repayment incentive 

to borrowers participating in the direct loan program. 

The change, effective on November 1, 1999, reduced interest rates for borrowers by 25 basis points when they repaid their loans through automatic electronic withdrawals from their bank accounts.

On-Time Payments 

In August 2000, the department established a 1.5 percent 

up-front interest rebate for on-time payment of loans in 

the direct loan program.3

 Beginning in the 2000-2001 

academic year, the federal government provided a rebate 

to borrowers who made their first 12 loan payments 

within six days of the due date. The rebate was changed 

to be disbursed to borrowers up front (by reducing the 

origination fee from 3 percent to 1.5 percent) and rescinded if they failed to make their first 12 payments on 

time.

2. See the direct loan bulletin by the U.S. Department of Education, 

DLB-99-39, June 1, 1999. At the time, the change was controversial. For background, see the memorandum from Robert P. Murphy, General Counsel, General Accounting Office, to the 

Honorable Bill Goodling, House of Representatives, “Direct Student Loans: Legality of Regulations Authorizing Origination Fee 

Reduction,” September 29, 1999, available at www.gao.gov/

decisions/archive/283717.pdf.

3. See the direct loan bulletin by the U.S. Department of Education, 

DLB-00-42, August 1, 2000.