The federal government makes loans to students through private- and public-sector lenders in the FFELP or directly to students through FDLP. These two programs are among the largest of the federal government’s credit programs. At the end of 2004, there were about $245 billion in outstanding FFELP loans, about 20 percent of total federal guaranteed loans outstanding, and $107 billion in outstanding FDLP loans, about 43 percent of total federal direct loans outstanding. Students and parents are able to borrow the same types of loans through FFELP and FDLP, which include: Subsidized and Unsubsidized Stafford Loans—variable rate loans available to students. The federal government pays the interest on behalf of subsidized loan borrowers while the student is in school and during a brief grace period when the student first leaves school. PLUS Loans—variable rate loans made to parents, on behalf of students. The borrower pays all interest costs. Consolidation Loans—borrowers may combine multiple federal student loans into a single loan. The interest rate is fixed based on the weighted average of the interest rates in effect on the loans being consolidated. Under either loan program borrowers are able to repay loans earlier than required, with no penalty. The programs have several repayment options available to borrowers. For Stafford and PLUS loans, the standard repayment in both loan programs is a fixed amount per month for up to 10 years. Borrowers have other repayment options that allow them to extend repayment for up to 30 years, gradually increase the monthly payment, or base monthly payments on their adjusted gross income. The criteria for some of the alternative repayment options are different in FFELP and FDLP. For consolidation loans, the repayment terms depend on the loan amount. Moreover, borrowers that graduate, leave school, or become a less than half-time student are given a 6-month grace period before they must begin to repay their Stafford or consolidation loans. All borrowers may postpone repayment through deferment or forbearance if they meet certain criteria and the loan is not in default. Deferment is allowed for borrowers who remain in a postsecondary school at least half- time, a graduate program, or have experienced economic hardship. For borrowers who are temporarily unable to meet repayment obligations but are not eligible for deferment, lenders may grant a temporary and limited time period in which these borrowers do not need to repay their student loans, called forbearance. The FCRA guidance issued by OMB and accounting standards provide the framework for the process Education uses to calculate subsidy costs for student loans. Subsidy costs are calculated by estimating the federal government’s future cash flows for loans made or guaranteed in a particular fiscal year, called a loan cohort. In estimating cash flows for a loan cohort, Education must make assumptions about loan characteristics and future borrower behavior, such as: type and dollar amount of loans obligated or guaranteed, and how many borrowers will pay early, pay late, or default on their loans and at what point in time. Moreover, the model used to estimate future cash flows includes assumptions about future interest rates. OMB provides Education with interest rate assumptions that are used for the discount rate, borrower interest rate, and lender yields. Education aggregates cash flows by loan cohort, loan type, and risk category, which reflects the differences in the likelihood of default. Education has five risk categories, which include, in order of higher to lower risk of default: (1) students at proprietary schools, (2) students at 2-year colleges, (3) freshman and sophomores at 4-year colleges, (4) juniors and seniors at 4-year colleges, and (5) students at graduate schools. Although the method for calculating the subsidy cost is the same for both FFELP and FDLP, the federal government’s role in each loan program differs significantly, which, in turn, affects the type and timing of cash flows in each program. In FFELP, private lenders, such as banks, fund the loans, and the federal government guarantees lenders a statutorily specified minimum yield that is tied to, and varies with, market financial instruments. When the interest rate paid by borrowers is below that yield, the federal government gives lenders subsidy payments, called SAP. Moreover, the federal government, through state-designated guaranty agencies, guarantees repayment of loans if borrowers default. Guaranty agencies provide insurance to lenders for 98 percent of the unpaid principal of defaulted loans. The federal government, in turn, pays guaranty agencies 95 percent of their default claims. Guaranty agencies also perform various administrative functions in the FFELP. As shown in figure 1, under FFELP cash inflows to the federal government include fees and other payments from lenders and outflows from the federal government include SAP and default payments. FFELP cash flows are spread out over the life of the loan. fees) Under FDLP, the U.S. Treasury funds the loans, which are originated through participating schools and contractors. Education’s Office of Federal Student Aid is responsible for delivering funds to schools participating in FDLP, monitoring its contracts, and providing technical assistance to schools. Education contracts with private-sector companies to perform various administrative activities in FDLP, such as originating and servicing loans, and collecting defaulted loans. As shown in figure 2, FDLP cash inflows to the federal government are repayments of principal and interest payments and outflows include loan disbursements to borrowers. Because the federal government funds the loans, cash outflows occur in the early years as loan disbursements are made. Cash inflows, in the form of principal repayment and interest payments, occur in later years as borrowers enter repayment. Principal repayments may be less than disbursements, reflecting defaults, loan discharges, and loan forgiveness. Annually, agencies are generally required to update or “reestimate” loan costs for differences in estimated loan performance, such as differences between assumed and actual default rates, the actual program costs recorded in the accounting records, and new forecasts of future economic conditions, such as interest rates. Reestimates include all aspects of the original cost estimate, including prepayments, defaults, delinquencies, recoveries, and interest. Reestimates of the credit subsidy allow agency management to compare the original budget estimates with actual program results to identify variances from the original estimate, assess the quality of the original estimate, and adjust future program estimates as appropriate. Both FFELP and FDLP reestimated subsidy costs have differed from original estimates for loans made in fiscal years 1994 through 2004, highlighting the challenges in estimating the costs of federal student loans. FFELP reestimated subsidy costs were similar to or lower than original estimates for loans made in fiscal years 1994 to 2002, but higher than originally estimated for loans made in fiscal years 2003 and 2004. In comparison, FDLP reestimated subsidy costs were generally similar to or higher than original estimates for loans made in fiscal years 1994 through 2004. Across all types of loans, FDLP subsidy costs per $100 of loans disbursed were, for almost all loan cohorts, lower than those of FFELP. Reestimated subsidy costs for FFELP loans disbursed between fiscal years 1994 and 2002 were, in general, close to or lower than original estimates, while reestimated subsidy costs for loans disbursed in 2003 and 2004 were higher than originally expected, as shown in figure 3. From fiscal years 1994 to 1999, reestimated subsidy costs for FFELP were typically close to original estimates, while loans disbursed from fiscal year 2000 to fiscal year 2002 had reestimated subsidy costs that were lower than original estimates, ranging from $1.5 to $2.2 billion lower. Reestimated subsidy costs for loans disbursed in fiscal years 2003 and 2004 were $2.7 and $3.6 billion higher than original estimates. Differences between reestimated and original subsidy costs estimates for the 2003 and 2004 loan cohorts were in part due to significant differences between expected and actual loan volume. For example, Education originally estimated about $40 billion in FFELP loans would be disbursed in 2003 when actually $69 billion was disbursed that year. The large difference was primarily due to a significantly higher volume of FFELP consolidation loans than originally estimated and the relatively high subsidy costs per $100 of these loans compared to consolidation loans made in previous years. After controlling for loan volume, FFELP reestimated subsidy costs per $100 disbursed were generally close to or lower than original subsidy cost estimates across loan types. As shown in table 1, for FFELP Stafford unsubsidized and PLUS loans, reestimated subsidy costs per $100 disbursed were lower for all loan cohorts than what was originally estimated—except fiscal year 1999. For subsidized Stafford loans, about two-thirds of the loan cohorts had lower reestimated subsidy costs per $100 disbursed. Slightly over half of all consolidation loan cohorts had lower reestimated subsidy costs per $100 disbursed than originally estimated. Reestimated subsidy costs for FDLP loans were in general similar to or higher than original estimates for loans disbursed between fiscal years 1994 and 2004. For FDLP loans disbursed between fiscal years 1994 and 1999, total reestimated subsidy costs were in general close to original estimates, but there was one loan cohort that had higher reestimated subsidy costs and another with much lower reestimated subsidy costs than originally expected, as shown in figure 4.