Harrison M. Wadsworth III, Special Counsel's Office Consumer Bankers Association Supporting Document - Student Loan Community HEA Reauthorization Recommendations
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Student Loan Community Higher Education Act
February 28, 2003
Since 1965, the Higher Education Act has done a remarkable job of fulfilling the public policy goals for which it was created: access to a quality postsecondary education and help in making that education affordable for lower- and middle-income Americans. The framework for its success has been a public-private partnership that has provided vital financial assistance to generations of postsecondary students. That assistance has taken the form of grants, work-study, and loans, with the latter taking on increasing importance as college costs have risen and grant funding has failed to keep pace.
The widespread availability of low-cost student loans has helped over 60 million students gain access to higher education. The benefits to these students, their families, and our society have been tremendous, while the costs to taxpayers have become increasingly modest.
In the 2001-2002 academic year, over $41 billion in federal loans were made to students, parents, and other borrowers, constituting just over 46 percent of the almost $90 billion in total aid provided for postsecondary education. Some 70 percent of these loans, or $30 billion, were made by loan providers in the Federal Family Education Loan Program (FFELP). The annual net cash cost of carrying these new loans and a portfolio of more than $150 billion in outstanding loans is less than $2 billion, the bulk of which represents the costs of borrower subsidies and defaults. In other words, the federal government pays about one cent per year for every dollar in outstanding FFELP loans. These figures highlight the substantial leverage that FFELP provides in raising private capital from around the globe to provide low-cost loans to America's students.
The FFELP community has made tremendous strides in driving down taxpayer and borrower costs, while greatly improving the quality of service to students and schools. Some of these strides have come as the result of legislative changes at the federal and state levels, some have sprung from the creativity of a competitive marketplace, others have been an outgrowth of broader technological change.
Over the past decade, the cost of FFELP has fallen by 58 percent in real terms, even though loan volume has tripled over the same period.
The reasons are several. First, default costs have been cut in half. Ten years ago defaulted loans amounted to 6 percent of the outstanding portfolio; today they are one fourth that amount. Second, the amount of defaulted loans that are recovered has increased dramatically. Collections have tripled since 1991, as more and more tools have been made available to recover dollars owed to the federal government. Finally, fees charged to lenders and holders have largely if not completely offset the cost of buying down borrower interest rates for loans in repayment.
Students and other borrowers have been the beneficiaries of dramatic improvements in both the servicing and costs of student loans. The cost of borrowing $18,000 today is the same as the cost of borrowing $8,000 fifteen years ago. Student loans remain the lowest cost loans in the country. An eighteen-year-old student, with no collateral or credit history, can often today find a loan with an after-tax cost as low as 2 percent.
Without a doubt, some of the achievements of FFELP stem from the economic expansion of the 1990's and the low interest rate environment of today. Default costs may increase somewhat due to the recent weakness of the economy, and borrower costs will certainly increase in tandem with interest rates as the economy strengthens.
But many of the improvements result from systemic reform rather than cyclical good fortune. The upcoming reauthorization provides an important opportunity to further the ongoing process of reform so that the program continues to deliver aid to students as efficiently as possible throughout the inevitable swings in the economy. Given the rising costs of higher education and the growing numbers of students, every effort must be made to make college affordable through a combination of grant aid and low-cost student loans.
The discussion below is divided into three parts. First, we will outline several general comments on student loan and related issues. Second, we will make a limited number of proposals on ways to improve FFELP for the years ahead. Finally, we will outline several smaller, more operational suggestions. These comments and proposals are, of course, apt to undergo revision and refinement as the discussions continue among the FFEL community and with other stakeholders. Some of the signatories will have additional proposals on issues such as consolidation loans and schools operating as lenders. But we hope the following discussion will be a helpful contribution as Congress begins its efforts to reauthorize the Higher Education Act of 1965.
Before tackling the questions of access and affordability, the first challenge to address is awareness of the opportunity that higher education affords. The lack of awareness of both post-secondary opportunities and the multitude of resources available to help pay for education are significant barriers to access, particularly for low-income families.
The FFELP community devotes substantial private resources to the development and delivery of effective and innovative college awareness and access programs. Many of our members offer services and programs such as college planning, early awareness, and financial literacy to schools, families and students at no cost to the taxpayer or to the recipients. Several of our members are also partners in federal early outreach and college support programs, such as GEAR UP, TRIO and LEAP. We urge increased support for these federal efforts, and will continue to devote private resources to advance the same goals.
While loans are relatively inexpensive, they should not form the principal source of aid for low-income students and their families. Over the past decade, while grant aid has doubled in real terms, its share of total aid has dropped from 50 percent to 39 percent.
A growing number of academically prepared and motivated students lack the financial wherewithal to cover the rising costs of a post-secondary education. While there is certainly debate as to the factors behind these cost increases, there can be no debate that low-income students face a daunting task in financing higher education, which increasingly will be a gateway to better opportunity. We urge that Congress provide maximum support to the Pell Grant and other campus-based programs in both the reauthorization and appropriations processes.
One of the major issues Congress must consider is an increase to loan limits. The amount students can borrow to pay for college has not increased since 1992 and has not kept pace with college costs. Along with the National Association of Student Financial Aid Administrators and others in the school community, we support a reasonable increase in loan limits provided that it is well targeted and can be supported within the overall context of the budget and other financial aid priorities.
Annual and aggregate loan limits in the Stafford program have not been raised since 1992, and freshman loan limits have increased only slightly on a nominal basis over the past 30 years. While we are mindful that increased loan limits may increase federal debt levels for borrowers, we believe doing so is preferable to many of the alternatives, such as financing higher education with private loans or credit cards for those who are creditworthy, or working a job for so many hours as to interfere with studies. In any case, the FFEL community will work closely with borrowers to ensure their access to the best debt management programs and repayment options.
We understand that there is reluctance in some quarters to increase loan limits for fear of aggravating tuition inflation, however, we believe the past decade or more of flat loan limits has demonstrated that tuition rates move independent of loan limits.
Office of Federal Student Aid Administration
We believe Congress correctly recognized the need to modernize the administration of the student financial assistance programs in 1998 and responded appropriately by creating the government's first performance-based organization, or PBO, within the Department of Education. The PBO has been successful in making improvements to the programs it administers and should be encouraged to continue these efforts.
We also support the continued use of negotiated rulemaking. Thanks to the leadership of Congressman McKeon and the late Congresswoman Mink, the broad participation in the FED UP project, and the efforts of the Department of Education, the most recent round of negotiated rulemaking was successful. With a few changes discussed below, we believe this model should be continued in the future.
Guaranty Agency Model 1
The guaranty agency administrative and funding model was changed in 1998 to better reflect the roles and functions of guaranty agencies. In addition, the 1998 amendments gave the Secretary the authority to enter into voluntary flexible agreements (VFAs) which, within certain limits, can contain modified requirements. Students, borrowers, schools, lenders and the government have all benefited from the services guaranty agencies provide. This overall structure, including authorizing the Secretary to enter into VFAs, should be maintained. In a later section we suggest that consideration may be given to making minor changes to some of the provisions on default prevention and recovery.
School as Lender
Current law permits limited participation by schools in the lender role. The past few years have seen a continued and growing increase in this activity. Because questions have been raised about some of the lending practices in the school as lender model, we believe Congress and the Administration should carefully review the school as lender model as part of reauthorization.
Our final comment goes to the structure of the student loan programs. We support Congress in its efforts to improve access and affordability within the financial aid programs of the Higher Education Act. As part of this effort Congress should give attention to whether some of the design elements of these programs, such as the ten-year loan term for Stafford loans, still make sense in today's world of higher education financing.
Congress also needs to confront whether terms in the Stafford loan program should be less favorable in many respects than those for consolidation loans. It may not make sense to provide substantial subsidies to borrowers well into their careers while continuing to tax college freshmen when they take out a student loan.
Regardless of the approach taken, the goals should be to drive the greatest amount of federal support to those who need it most, when they need it the most.
Despite their success by other measures, current higher education lending programs are beginning to fall short of these goals. In the fiscal year that ended in September, some $32 billion in consolidation loans were made within the FFELP and Direct Loan programs. That is only slightly less than the loan volume of the entire Stafford program the year before, and represents almost a tenfold increase since fiscal year 1995.
The borrowers who took out these consolidation loans -- some in-school, some just out, and some in mid-career -- for the most part made sound decisions to lock in an interest rate as low as 3.5 percent for as long as 30 years. But their collective decisions will result in substantial federal costs for an equally long period; costs that do nothing to improve access and that in some respects may be inversely related to need.
Consolidation loans have undergone a dramatic evolution over the past 15 years. Some of the results were intended, some not, but all of them bear examination as Congress reauthorizes the Higher Education Act. What began as a convenience for borrowers faced with writing checks to multiple servicers has become principally a means of refinancing student loans. While refinancing is common in the home mortgage industry, where borrower costs and rates are substantially higher and federal involvement is substantially lower, it is a relatively new phenomenon in the student loan sector. Indeed, consolidation loans cannot really be considered student loans, as by definition they are typically made to borrowers in repayment.
If substantial new mandatory spending can be budgeted for higher education purposes, then continuation of the current consolidation loan program and improvements to the student loan programs need not be in conflict. But if such new spending is not forthcoming, every dollar spent subsidizing consolidation loans is a dollar that cannot be spent improving access to and the affordability of higher education for students. In a tight fiscal environment, Congress should give strong consideration to promoting access to higher education by realigning federal policy and resources towards the next generation of needy students.
Proposal A: Repayment Terms
Statutory Reference: Section 428(b)(9)
General Summary: Ever since initial enactment of the Higher Education Act, most borrowers have been required to repay their student loans within the standard ten-year repayment period. While borrowers should be encouraged to repay their loans as quickly as possible, higher loan balances as well as other changes suggest that the length of the repayment term be reconsidered.
Issues/Objectives: As loan balances have, and may continue, to increase, the standard ten-year repayment period does not permit reasonable monthly payments in more and more cases. This can cause excessively large monthly payments. Many borrowers choose the loan consolidation program to extend their repayment, which may not be the best program for their needs and may extend repayment longer than is necessary, increasing total costs for the borrower. Repayment flexibility should be available, without needless complication of the terms or requiring borrowers to take out new loans. During the last reauthorization, extended repayment was made available for new borrowers with loan balances above $30,000. This concept should be expanded to all borrowers, with tiered repayment-term levels modeled on those contained in current law for consolidation loans. Regardless of the repayment term a borrower selects, the borrower should be encouraged to repay their loans early if at all possible.
- While retaining the standard 10 year repayment term, make a voluntary, tiered repayment term available to Stafford loan borrowers as an elective. This could be modeled after consolidation loan repayment terms, which allow for more reasonable monthly payments.
- Permit lenders to provide borrowers with more flexible graduated repayment schedules, including schedules where the smallest monthly payment may be less than one-third of the largest monthly payment.
Proposal B: Consolidation Loans
Statutory Reference: Sections 427A(k)(4); 427A(l)(3); 428C; 455(b)(6-7)
General Summary: The current structure of the Consolidation loan program has strayed from its original intent, with resulting adverse public policy outcomes. The program needs fundamental reform to once again serve its purposes as a part of the student financial assistance system: 1) providing those borrowers with multiple holders an opportunity to move their loans to one holder, and 2) allowing borrowers with financial duress the opportunity to extend their repayment terms and lower their monthly payments.
Issues/Objectives: The current-law mismatch between the interest rate basis for consolidation loans and Stafford or PLUS loans has created a situation where a program designed for convenience has turned into a huge refinancing tool that has major federal cost implications. This mismatch should be corrected, so that all three loan types are either variable or fixed. Changes to the consolidation loan program that rationalize the interest rates with the underlying loans further solidify the role of consolidation loans as a loan that borrowers truly need rather than one that is merely convenient while being costly to the federal government. Also, we believe there is a need to help borrowers better understand the pros and cons of loan consolidation. Finally, much was done in the 1998 reauthorization to remove differences between Direct and FFELP Consolidation Loans. A major difference remains: borrowers still in school can consolidate only into Direct Lending. In-school consolidation is a bad policy that does not make sense for guaranteed or direct loans. Borrowers in school do not know what their financial needs will be upon graduation, and they may lose borrower benefits or the opportunity for loan forgiveness by consolidating.
- Ensure the interest rate structure (fixed or variable) of the underlying loan programs and the interest rate structure of the consolidation loan program are the same.>
- Require borrower counseling to assure borrower understanding of the benefits and disadvantages of loan consolidation.
- Make borrower eligibility the same for Direct and FFELP consolidation loans by making only borrowers in grace or repayment eligible for Direct Consolidation Loans.
Proposal C: PLUS SAP Gap
Statutory Reference: Section 438(b)(2)(I)(7)
General Summary: The passage of the "2003 student loan interest rate fix" earlier this year had the unintended consequence of creating a new PLUS loan "SAP gap" issue. Specifically, the statute now imposes a potential new and expanded loss of up to 1.1% on providers of PLUS loans beginning on July 1, 2006.
Issues/Objectives: For most variable rate PLUS loans, special allowance is only paid if the borrower rate exceeds the 9% interest rate cap. The new statutory language, however, sets the borrower rate at 7.9% fixed for the life of the loan, but creates a new annual SAP trigger at 9% based on the lender formula (resulting in a new 1.1% cost to the lender).
Proposal: Eliminate subparagraph (vii) in Section 438(b)(2)(I)(7) so that PLUS loans are treated like Stafford loans and like existing, fixed-rate PLUS loans.
Proposal D: Technology Standards
Statutory Reference: Section 143
General Summary: A hallmark of the PBO at the Department of Education, in both the previous and current administrations, has been the introduction of sound technological practices into government to cut costs, create efficiencies and improve customer service to the American public. However, there is also recognition of the inherent challenge for governmental agencies to keep up with the accelerated pace of technological change and the vast array of new services. Harnessing the knowledge of practitioners and customers, from private enterprise to campus-based, to work in concert with the Department staff is an effective way to help keep the agency nimble and up-to-date in a manner consistent with the Administration's policies.
Rapidly changing technologies are fundamentally changing the way financial aid is delivered to schools and students. The higher education and student loan communities must play a formal role in the selection and establishment of the new technology and standards used to deliver financial aid.
- To ensure that the process of selecting, adopting, and implementing technology standards by the Department of Education for the higher education community occurs collaboratively with the members of those community groups affected by the changes.
- Assist the Department of Education and the higher education community in the establishment, implementation, and maintenance of technology standards.
- Facilitate the continued use of common information standards in the delivery of postsecondary aid.
- Ensure a smooth union between program innovation and delivery in the arena of federal financial aid.
Proposal: Create a formal advisory committee, the composition of which should include all facets of the community, which is focused on information technology standards within the arena of higher education student financial aid. Members of the committee would be responsible for recommending a course of action on technology selection and standardization for use in all data exchange processes between the Department (and its agents) and the members of the postsecondary education community, including educational institutions, lending partners, secondary markets, servicers, guaranty agencies, and other information trading partners. In this effort, the committee will be held responsible for identifying solutions that enable involved parties to harness the power of new technologies, maximize efficiencies, prevent duplicative or unnecessary investments, and improve customer service to the students and families served by the postsecondary community.
Proposal E: Require Negotiation of the Preamble in Negotiated Rulemaking
Statutory Reference: Section 492 (b)
General Summary: Negotiated rulemaking has been a valuable addition to the FFELP toolbox. It has helped educate both the program participants and the regulators as to the views of the other party, and the principles and experiences that inform those views. Communication is of paramount importance, and the negotiated rulemaking process has done an excellent job of fostering that communication.
Clarity and consistency in the rulemaking process are of the utmost importance. And the preamble is a useful tool in understanding the intent of a regulation when a question arises. However, in the past, some regulations have been undermined by preamble language which did not support the outcome of the negotiations.
Issues/Objectives: In the last negotiated rulemaking, issues came up at the very end of the process as the Department was writing the preamble. The community was able to comment and to consult informally with the Department as it worked out the final glitches, which proved very beneficial to all parties concerned. The preamble can be just as important as the regulatory language and is often consulted in determining the intent of the regulation. To ensure clarity and consistency between the preamble and the regulation, all preamble language should be subject to the negotiated rulemaking process.
Proposal: Require negotiation of the preamble language.
Proposal F: Administrative Wage Garnishment (AWG)
Statutory Reference: Section 488A
General Summary: Currently the HEA dictates the maximum percentage of a defaulted student loan borrower's disposable income that may be garnished by the Secretary or participating guarantors. The Department of Education issued a Notice of Proposed Rule Making on April 12, 2002, advising that the Department intended to use the AWG authority provided under the Debt Collection Improvement Act (DCIA) instead of AWG authority under the HEA. The Final Rule was published on February 19, 2003. The DCIA would permit the Department, but not participating guarantors, to increase the withholding percentage through wage garnishment from ten to fifteen percent. The proposal to adopt the DCIA guidelines creates an inequity between defaulted borrowers subject to AWG based solely on which entity holds the loan - a guarantor or the Secretary.
Issues/Objectives: There should be a uniform withholding percentage rate for Administrative Wage Garnishment. The Final Rule allows the Department, but not participating guarantors, to garnish wages under the authority provided by the Debt Collection Improvement Act of 1996, in an amount up to 15% of a borrower's disposable pay. This creates an inequity among borrowers based solely on the holder of their loans.
Another inequity would exist in that guarantors would be at a competitive disadvantage to the Department in terms of dollars collected using Administrative Wage Garnishment. This could result in pressure to initiate mandatory subrogation of defaulted accounts to the Secretary based solely on the Secretary's ability to garnish wages at a higher rate.
Guarantors and the Department should be subject to the same rules and regulations governing AWG. We do not necessarily believe that wage garnishment should be at a higher level than currently in effect, simply that the Secretary should be bound by the same rule as regards AWG.
Proposal: Establish a uniform withholding rate for administrative wage garnishment actions, regardless of whether the action is brought by guarantors or the Department.
Proposal G: Default Prevention and Recovery
Statutory Reference: Sections 428C(a)(3)(A)(ii)(III); 428F(a)(1); 455(a)
General Summary: At the same time that student loan volume has grown dramatically in recent years, default rates have steadily declined. The delinquency and default prevention efforts of the FFELP community are working better than ever. One recurring reauthorization issue is the need to enhance and expand default prevention and recovery tools so that delinquency and default rates remain low.
In response to a concern in recent years that too high a percentage of defaulted loans have been resolved through the direct loan consolidation program, guarantors and their collectors have shifted to a strategy that encourages more defaulted loans to be "cured" through an aggressive rehabilitation strategy. Rehabilitation, which is more effective in preventing re-default, requires a borrower to make twelve on-time payments before their loan is removed from default status. It is, however, a more difficult, expensive and labor intensive resolution process than consolidation, which requires no payments in the direct consolidation program and only three payments in the FFELP to resolve a default.
Issues/Objectives: Continue to resolve the maximum number of defaults, consistent with borrower-friendly practices, at the lowest cost to the taxpayer.
Proposal: More tools should be provided to enable defaulted borrowers to resolve their defaults. For example, a borrower's ability to rehabilitate a defaulted loan should be facilitated (by, for example, reducing the number of consecutive payments needed to qualify for loan rehabilitation). Other options should be explored and developed, and changes made, to assure that defaulted borrowers establish good repayment habits. Finally, successful default prevention should be provided greater support.
Proposal H: National Directory of New Hires
General Summary: Guarantors and the Department are allowed to use borrower address and employer information which the Department obtains from the National Directory of New Hires (NDNH) to assist in the collection of loans of borrowers who have defaulted on federally-backed student loans. This information is used to locate missing borrowers ("skips") and to initiate Administrative Wage Garnishment proceeding against borrowers who have the ability to repay their loans but refuse to do so. Address information should be made available on non-paying, pre-claim skip accounts as well, so that more borrowers could be counseled on the various repayment options available to avoid default.
The inability to locate borrowers continues to be a major factor leading to borrower default. Because lenders are unable to locate certain borrowers, lenders are unable to provide the borrowers with the assistance necessary to keep loans out of default. Lenders and guarantors are unable to offer these borrowers the various repayment options, deferments and forbearances designed to assist borrowers who are having difficulty in repaying their student loan obligations. Many borrowers, upon being located, assert they were not fully aware of the various opportunities available to prevent default. This lack of communication can lead to unnecessary default.
Issues/Objectives: The NDNH has proven to be very successful in locating skip borrowers. Unfortunately, the Department is only permitted to use information from this database on borrowers who have defaulted. By authorizing the Department to obtain address information from the NDNH database earlier in the delinquency cycle, i.e., during the guarantor's default aversion activities, and to provide this information to the guarantors, would enhance the collection tools available by helping them locate skip borrowers. Once located, these borrowers would be contacted and provided with the multitude of options available under the HEA to prevent default and keep loans in good standing.
Proposal: Expand the current authority to use NDNH address information to permit the Department to provide guarantors and lenders with address information on delinquent, pre-default skip accounts so that the borrowers can be located and counseled on available repayment options.
Proposal I: Budget Treatment of Student Loan Programs
General Summary: A decade ago, the budgeting of credit programs was dramatically changed through the enactment of the Credit Reform Act of 1990. The Act improved the budgeting of credit in the federal budget by accounting for all of the estimated costs of extending credit over the full life of that credit commitment in the same fiscal year as the decision to extend the credit. However, the administration of the Act introduced several new biases into the budget process, particularly in the treatment of federal student loan programs.
First, the administration of the Act now provides for disparate treatment of administrative costs based on whether loans are made by the government or by private lenders. While administrative costs in the FFEL program are built into the cost of making a loan, those for the Direct Loan program are excluded. As a result under credit reform, the budget underestimates the costs of direct loans, which are more costly to administer than guaranteed loans.
A second problem is that the budget "cost" of the student loan programs in each fiscal year is based on the estimates of cash payments and receipts over the life of the loans. The net present value of the cash flow estimates are recorded in the budget, as actual payments. However, these estimates do not appear to be recalibrated against actual performance of the loan programs. While the true financial performance of the program is utilized to update estimated figures from an historical perspective, the forecasting model for future years continues to rely on the earlier estimates instead of the updated figures. The result has been, as GAO found, that the budget optimistically forecasts receipts for the direct student loan program even though its cash performance has fallen far short of the estimates. The opposite has occurred in the FFELP where the budget estimates have failed to keep up with the significant improvement in default prevention and collections. As a result, the Department of Education was forced to make a one-time downward re-estimate of $4.7 billion in FFELP costs in 2001.
Finally, the Congressional Budget Office has introduced a methodology to capture the costs associated with the caps on interest rates. This methodology, known as probability scoring, has so far overestimated the costs of the interest rate caps and has had some unintended results, particularly when comparing fixed and variable rate loans.
- To assure the projections of federal student loan programs reflect the actual performance of those programs;
- To fully account for the lifetime cost of administering the loan programs; and,
- To reassess the use of probability scoring to assure the appropriate comparisons between loan types and interest rate formulas.
Proposal: The budget should be neutral in its treatment of guaranteed and direct student loans. It should be improved to better reflect the cost of administering student loan programs and the actual performance of the loan programs. The use of probability scoring should be reassessed to eliminate the distortions created by different loan formulas.