The Administration of the Federal Family Education Loan and William D. Ford Direct Loan Programs: Background and Provisions

Order Code RL33674

CRS Report for Congress

Received through the CRS Web

The Administration of the Federal Family

Education Loan and William D. Ford Direct Loan

Programs: Background and Provisions

September 29, 2006

Adam Stoll

Specialist in Social Legislation

Domestic Social Policy Division

Congressional Research Service ˜ The Library of Congress

The Administration of

the Federal Family Education Loan and William D. Ford

Direct Loan Programs: Background and Provisions

Summary

The federal government operates two major student loan programs: the Federal

Family Education Loan (FFEL) program, authorized by Part B of Title IV of the

Higher Education Act (HEA) and the William D. Ford Direct Loan (DL) program,

authorized by Part D of Title IV of the HEA. These programs provide loans to

undergraduate and graduate students and the parents of undergraduate students to

help them meet the costs of postsecondary education.

Together, these federal student loan programs provide more direct aid to support

students’ postsecondary educational pursuits than any other source. In FY2005, these

programs provided $56.2 billion in new loans to students and their parents.

Under the FFEL program, loan capital is provided by private lenders, and the

federal government guarantees lenders against loss through borrower default, death,

permanent disability, or in limited instances, bankruptcy. FFEL program loans are

originated by private lenders. That is, private lenders work directly with students and

families to initiate the loan. Private lenders also are responsible for billing borrowers

and collecting loan payments. State and nonprofit guaranty agencies receive federal

funds to play the lead role in administering many aspects of the FFEL program. In

particular, the guaranty agencies provide many of the administrative services related

to the loan guarantee, including providing technical assistance and training to schools

on loan certification and to lenders on loan procedures, providing credit and loan

rehabilitation counseling to borrowers, reimbursing lenders when loans are placed in

default, and initiating collections work.

Under the DL program, the federal government provides the loans to students

and their families, using federal capital (i.e., funds from the U.S. Treasury), and owns

the loans. Under the DL program, schools may serve as loan originators, or the loans

may be originated by contractors working for the U.S. Department of Education

(ED). ED hires contractors to service the loans: i.e., to monitor student enrollment

and loan repayment status, process loan payments, and initiate collections work for

delinquent and defaulted loans.

The DL program was initially introduced to gradually expand and replace the

FFEL program. However, the 1998 amendments of the HEA removed the provisions

of the law that referred to a “phase-in” of the DL program. Currently, both programs

are authorized. They draw on different sources of capital and utilize different

administrative structures, but essentially disburse the same set of loans: subsidized

and unsubsidized Stafford loans for undergraduate and graduate students; PLUS

loans for parents of undergraduate students and for graduate students; and

Consolidation loans that offer borrowers refinancing options. This report will be

updated as program changes occur.

Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Postsecondary Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Institutional Eligibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Institutional Eligibility and Default Rates . . . . . . . . . . . . . . . . . . . . . . . 3

FFEL Program: Introduction to How the Program Is Administered . . . . . . . . . . . 4

Lender Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Lender Responsibilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Loan Disbursement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Credit Checks and Endorsement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Notifications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Prohibitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Collections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Lender of Last Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Payments to Lenders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Interest Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Special Allowance Payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Quarterly Special Allowance Formulas . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Default Claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Lender Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Guaranty Agency Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Guaranty Agency Responsibilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Loan Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Default Aversion Assistance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Collections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Assignment of Defaulted Loans

to the Federal Government (Subrogation) . . . . . . . . . . . . . . . . . . 14

Payments to Guaranty Agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Administrative Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Default Aversion Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Default Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Reinsurance Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Collection Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Reserves and Solvency Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Voluntary Flexible Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Direct Loan Program: Introduction to How the Program

Is Administered . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Provisions Related to DL Program Administration . . . . . . . . . . . . . . . . . . . 19

Loan Origination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Disbursement of Funds to Borrowers . . . . . . . . . . . . . . . . . . . . . . . . . 20

Loan Servicing, Delinquency Processing and Default Collections . . . 21

Payments for Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

List of Figures

Figure 1. Basic Elements of the FFEL Program Model . . . . . . . . . . . . . . . . . . . . 7

Figure 2. Basic Elements of the DL Program Model . . . . . . . . . . . . . . . . . . . . . 19

The Administration of the Federal Family

Education Loan and William D. Ford Direct

Loan Programs: Background and Provisions

Introduction

The federal government operates two major student loan programs: the Federal

Family Education Loan (FFEL) program and the William D. Ford Direct Loan

(DL) program. These programs can trace their roots to the Guaranteed Student Loan

(GSL) program, which was enacted as part of Title IV of the Higher Education Act

(HEA) of 1965, to promote access to postsecondary education by making low-interest

loans available to students from low- and middle-income families.

The FFEL program, formerly named the GSL program, is authorized by Part B

of Title IV of the HEA. Under the FFEL program, loan capital is provided by private

lenders, and the federal government guarantees lenders against loss through borrower

default. FFEL program loans are originated by private lenders, and state and

nonprofit guaranty agencies receive federal funds to play the lead role in

administering many aspects of the FFEL program.

The federal government provides lenders a variety of incentives to invest private

capital in FFEL student loans. For example, to ensure that private capital will be

consistently available to support FFEL loans, the program provides private lenders

with a loan subsidy known as a “special allowance payment.” This loan subsidy,

which is tied to a financial market index, ensures that private lenders receive a

specified level of return on student loan investments.

In addition, the federal government helped establish a secondary purchase

market for FFEL loans. To help ensure that the FFEL program would be fully

capitalized, the federal government created the Student Loan Marketing Association,

also known as Sallie Mae.1 Sallie Mae was created to purchase loans from lenders

seeking to sell them, thereby providing liquidity to help ensure that the FFEL

program is fully capitalized.

The DL program, authorized under Part D of Title IV of the HEA, established

in 1993, was intended to streamline the student loan delivery system and achieve cost

savings. The DL program was originally intended to gradually expand and replace

1

Up until very recently, Sallie Mae was a government sponsored enterprise, a federally

chartered shareholder owned corporation established for the purpose of creating a secondary

purchase market for federally guaranteed student loans. Under the provisions of P.L. 104208, Sallie Mae has completed the process of fully privatizing.

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the FFEL program. The DL program provides the same set of loans as the FFEL

program, but uses a different administrative structure and draws on a different source

of capital. Under the DL program, the federal government essentially serves as the

banker — that is, the federal government provides the loans to students and their

families, using federal capital (i.e., funds from the U.S. Treasury), and owns the

loans. Under the DL program, schools may serve as direct loan originators, or the

loans may be originated by contractors working for the U.S. Department of Education

(ED). ED also hires contractors to service the loans.

While the DL program was originally introduced to replace the FFEL program,

the 1998 amendments of the HEA removed the provisions of the law that referred to

a “phase-in” of the DL program and those which specified the proportion of new

student loan volume to be made through the DL program in particular academic

years. Currently both programs are authorized. Postsecondary institutions apply to

participate in one program or both. Borrowers borrow annually under one program.

The program they borrow under is determined by the postsecondary institution they

attend.

Together, these federal student loan programs provide more direct aid to support

students’ postsecondary educational pursuits than any other source. In FY2005, these

programs provided $56.2 billion in new loans to students and their parents. In that

year, the FFEL program provided 10,323,000 new loans averaging approximately

$4,193 each and the DL program provided 2,971,000 new loans averaging

approximately $4,352 each.

The loans made through the FFEL and DL programs are low-interest fixed rate

loans. Interest rates are determined by statutory provisions. The loans disbursed

through these programs include subsidized and unsubsidized Stafford loans for

undergraduate and graduate students; PLUS loans for parents of undergraduate

students and for graduate students; and Consolidation loans that offer borrowers

refinancing options.

This report discusses the major provisions of law pertaining to the

administration of the FFEL and DL programs. The primary emphasis is placed on

discussing the provisions of the law that outline the roles and responsibilities of

participating postsecondary institutions, guaranty agencies, private lenders, and ED

contractors. A companion report, titled RL33673, Federal Family Education Loan

Program and William D. Ford Direct Loan Program Student Loans: Terms and

Conditions for Borrowers, has been prepared to discuss provisions related to

borrower eligibility, loan terms and conditions, borrower repayment relief, and loan

default and its consequences for borrowers. Both reports provide background

information on the FFEL and DL programs. This report provides updated

information through August 2006, and includes information on the HEA amendments

enacted in P.L. 109-171, the Higher Education Reconciliation Act (HERA).

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Postsecondary Institutions

Postsecondary institutions play a central role in administering the federal student

loan programs. The role postsecondary institutions play and provisions of the law

relating to their role will be discussed within the context of the FFEL and DL

programs in subsequent sections of this report. The discussion that follows outlines

the provisions of the HEA relating to institutional eligibility to participate in the

student loan programs.

Institutional Eligibility

Students taking out subsidized or unsubsidized Stafford loans or PLUS loans,

must be enrolled in a postsecondary institution that is eligible to participate in the

federal student loan programs. Similarly, parents may only take out a PLUS loan to

support a dependent student who is enrolled in an eligible postsecondary institution.

Eligible institutions may include public and private, non-profit colleges and

universities, community colleges, and trade and technical schools. Most of the trade

and technical schools are proprietary (private, for profit) schools offering programs

of vocational or occupational training lasting less than two years. For an institution

to be eligible to participate in the FFEL or DL program, the institution has to meet

certain general Title IV eligibility requirements, i.e., the institution must:2

!

!

!

Be accredited by an agency recognized for that purpose by the

Secretary of Education (Secretary);

Be licensed or otherwise legally authorized to provide postsecondary

education in the state in which it is located; and

Be deemed eligible and certified to participate in federal student aid

programs by ED.

While not eligible to participate in other Title IV programs, schools with 300

hour programs (minimum 10 weeks) that are not graduate or professional programs

or that do not require at least an associate’s degree for admission may be eligible to

participate in the student loan programs. To be eligible, these short-term programs

must satisfy regulatory criteria prescribed by the Secretary, including having verified

completion and employment placement rates of at least 70%.3

Institutional Eligibility and Default Rates. In an effort to reduce default

costs, Congress has enacted provisions linking institutional eligibility and default

rates. As a result, institutions with a pattern of high loan default rates become

ineligible to participate in the FFEL and DL programs.

2

Institutions outside of the United States that are approved by the Secretary of Education

are also eligible for FFEL program participation.

3

For more detailed information about institutional eligibility for Title IV assistance see CRS

Report RL31926, Institutional Eligibility for Participation in Title IV Student Aid Programs

Under the Higher Education Act: Background and Issues, by Rebecca R. Skinner.

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To determine institutions’ rates of default, a cohort default rate is calculated.

An institution’s cohort default rate is the number of borrowers last attending that

institution entering repayment on a Stafford (subsidized or unsubsidized) loan, or the

portion of a consolidation loan that is used to repay such loans, in a given year who

default (defined as an insurance claim having been paid on their loan) by the end of

the succeeding fiscal year divided by the total number of those borrowers entering

repayment in the given year. The Secretary of ED is required to report annually on

cohort default rates by institutional sector. Schools with few borrowers as

determined by a statutory formula (participation rate index) are exempt from

sanctions.

Institutions with cohort default rates of 25% or higher for each of the most

recent three fiscal years are ineligible to participate in the FFEL and DL programs for

the remainder of the fiscal year through the two following fiscal years.

Postsecondary institutions have the right to appeal the loss of eligibility and ED may

waive the provision if there are statutorily defined exceptional mitigating

circumstances or other exceptional mitigating circumstances as defined by the

Secretary.4 Postsecondary institutions also have the right to appeal the loss of

eligibility if the institution demonstrates that the calculation of its default rate is

inaccurate. Institutions may include in their appeal a defense based on improper loan

servicing.5

FFEL Program: Introduction to

How the Program Is Administered

FFEL program loans are financed by commercial and nonprofit lenders.

Commercial lenders include banks, savings and loans, credit unions, and insurance

companies. Nonprofit lenders include postsecondary institutions or agencies

designated by states.6

4

The statutorily defined exceptional mitigating circumstances include cases in which at least

two thirds of an institution’s students who were enrolled at least half time were eligible to

receive at least one half of the maximum Pell Grant award or whose adjusted gross income

is less than the Health and Human Services poverty level. In such cases, for an institution

to qualify for an “exceptional mitigating circumstances” exemption, a degree granting

institution must have a completion rate of at least 70% among full time students scheduled

to complete their programs, and a nondegree granting institution must have an employment

placement rate of 44%. For the Secretary’s definition of these circumstances, see 34CFR,

Section 668.17.

5

In such cases, the Secretary is required to give institutions access to a representative

sample of relevant records for a reasonable time and if the evidence demonstrates

inaccuracies, the Secretary must recalculate a rate based on correct data. Also, guaranty

agencies must afford schools the opportunity to review and correct records before they are

submitted to the Secretary for calculation of the default rates.

6

Under provisions enacted in the Higher Education Reconciliation Act, only those

postsecondary institutions that have made FFEL program loans on or prior to Apr. 1, 2006

may operate as FFEL program lenders. For additional information on school as lender

(continued...)

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Originating lenders — the lenders who make the loans — often sell their FFEL

loans on the secondary market in order to secure new capital to make more loans.

The largest of these secondary market purchasers, holding about one-third of

outstanding FFEL paper, is Sallie Mae,7 which up until recently was a federally

sponsored private for-profit corporation or government-sponsored enterprise (GSE).8

Other loan purchasers are banks, and nonprofit state-level agencies or institutions

dealing exclusively in student loans and which often buy loans from lenders in their

own state or region.

Originating lenders, or the secondary market loan purchasers who hold a loan,

work with postsecondary institutions to track students’ enrollment and loan eligibility

status. Once loans are in repayment, loan holders bill borrowers and collect loan

payments.

State or national nonprofit guaranty agencies administer the federal insurance

which protects lenders against loss stemming from borrower default, death or

disability. Guaranty agencies also provide other services to lenders such as assistance

in preventing delinquent borrowers from going into default. Guaranty agencies are

state agencies created by state governments, or private nonprofit agencies operating

only within a state or nationally. Each state has a guaranty agency selected to serve

as the “designated” guarantor of FFELs for students going to schools in the state or

state residents going to schools elsewhere. Other guarantors, however, may serve

state students and residents also.

The primary function of the guaranty agency is to service the federal loan

insurance that is provided to lenders in the FFEL program. Under agreements with

lenders holding the loans, guaranty agencies are responsible for paying the principal

and accrued interest on defaulted loans. Through a reinsurance agreement with the

federal government, the guaranty agency is reimbursed for direct insurance claims it

6

(...continued)

requirements see HEA Section 435(d)(2).

7

Sallie Mae holdings as of Sept. 30, 2005 were reported to be $102 billion, see Greentree

Gazette, May 2006, p.10. Total outstanding FFEL volume as of Sept. 30, 2005 was $307

billion, see U.S. Department of Education, FY2007 Justifications of Appropriations to the

Congress, vol. II, p.Q16.

8

Sallie Mae was established to help correct market failures that existed in the early years

of the GSL program during which participating lenders experienced difficulty in selling their

student loans. Sallie Mae was given certain tax exemptions and borrowing privileges (from

the U.S. Treasury) that enabled it to profitably purchase and market loans even during times

when secondary market demand for student loans may not have been high. This has helped

originating lenders who needed to be able to sell loans in order to raise capital to originate

new loans. P.L. 104-208, the Student Loan Marketing Association Privatization Act of

1996, authorized Sallie Mae to fully privatize. Under the act, the GSE could continue to

function as a subsidiary of a private holding company through Sept. 30, 2008, after which

the GSE would cease to exist. On Dec. 29, 2004 Sallie Mae completed the process of fully

privatizing.

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pays to lenders for such losses.9 These agencies also administer the loan discharges

available for borrower death, disability, bankruptcy (in limited instances), and school

closures. Guaranty agencies also recruit lenders to participate in the FFEL programs

to assure the access of students in the state to the loans, provide assistance to lenders

in collecting loans before they enter default (preclaims assistance), may act as a

lender of last resort, and may provide technical assistance to lenders.

Figure 1, presented below, depicts the basic elements of the FFEL program

model.

9

For much of its first two decades of existence, the federal Stafford Loan program (then the

Guaranteed Student Loan program) operated under both state agency guarantees and direct

federal guarantees through the Federally Insured Student Loan (FISL) program. At times,

fewer than half of the loans made each year in this program were directly guaranteed by

state guaranty agencies with federal reinsurance. Legislative changes in 1976 (Education

Amendments of 1976, P.L. 94-482) made it more attractive for states and others to establish

guaranty agencies. The last FISLs were made during FY1984.

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Figure 1. Basic Elements of the FFEL Program Model

Loan applicants

Supply of loan capital

Students and

Parents:

Complete

necessary

forms to apply

for loans.

Originating Lenders:

Originate loans,

supplying private loan

capital to students and

their parents.

Secondary Market Loan

Purchasers: Purchase

loans from originating

lenders thereby

providing an infusion of

capital which originating

lenders can use to make

new student loans.

Loan disbursement, servicing

& program administrationa

Schools: Assess students’ levels of

financial need and certify borrower

eligibility for loans; disburse funds

(received from ED) to student and

parent borrowers and notify ED of

those disbursements; provide

periodic reports to the National

Student Loan Data System

Confirming students’

enrollment/eligibility status; provide

loan counseling to borrowers.

Originating Lenders: Work with

borrowers and schools to obtain

completed loan applications and with

guaranty agencies to secure loan

guarantees; Obtain completed

promissory note from borrowers;

disburse loan funds to borrowers

(through school.)

Loan Holders (either the originating

lender or secondary market loan

purchaser): Monitor student

enrollment/eligibility status; bill

borrowers; collect loan payments;

conduct initial collection services if

loans become delinquent.

Guaranty Agencies: Work with

borrowers to rehabilitate delinquent

and defaulted loans; reimburse

lenders for defaulted loans and

collect reinsurance payment from

ED; perform collections work;

provide summary information to ED

on loans guaranteed.

Source: Prepared by the Congressional Research Service.

a. Many of the administrative jobs performed in the FFEL program are handled via subcontracts. This

is particularly true with regard to loan servicing tasks (i.e., many of the administrative tasks identified

above as work originating lenders and loan holders and guaranty agencies are responsible for

completing). Several guaranty agencies and secondary market loan purchasers have developed large

servicing operations and typically secure many of the servicing contracts from loan holders.

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Lender Provisions

The lender-related provisions of the law discussed below apply to any holder of

a FFEL loan, regardless of whether the loan holder originated the loan or bought it.

Lender Responsibilities

Loan Disbursement. Disbursement requirements are generally designed to

prevent fraud by assuring that the school has some control over the distribution of the

loan proceeds for student expenses. Lenders must send Stafford loan proceeds

directly to the institution of higher education. The check or other instrument used to

deliver the loan proceeds to the institution must require the endorsement of the

student and be payable directly to him or her, and may not be made co-payable to the

institution and borrower. If the student is studying abroad in a program approved for

credit by his or her home institution in the United States funds may be delivered

directly to the student upon request, and may be endorsed or a fund transfer

authorized through a power-of-attorney.

PLUS loans must be disbursed by means of an electronic funds transfer (EFT)

from the lender to the institution or in a check co-payable to the institution and

borrower.

Multiple disbursement provisions are designed to lower defaults among students

who never attend the school in which they are enrolled or who drop out of

educational programs shortly after enrollment. The lender must disburse any Stafford

loan in two or more installments, none of which exceeds one-half the loan amount.

The interval between installments is required to be at least half the period of

enrollment unless this interferes with disbursement at the beginning of a semester,

quarter, or similar academic division. If a borrower ceases to be enrolled at the

institution prior to the second disbursement, the disbursement must be withheld and

credited to the borrower’s principal as a prepayment. Further, if a student receives

an over-award the institution must return the excess funds to the lender and the lender

must credit the funds to the borrower’s principal as a prepayment.10 Lenders may not

sell loans to secondary markets or other entities before the final disbursement of loan

proceeds unless the sale of the loan does not change the identity of the party to whom

payments are made and the first disbursement has been made. The law authorizes

lenders other than the holder of the loan, as well as guaranty agencies, to act as

escrow agents for loan disbursements.

Also, as a default reduction measure, disbursement to first-time, first-year

Stafford borrowers must be delayed until 30 days after the borrower begins his or her

course of study. For other students, loans may not be disbursed prior to 30 days

before the beginning of the period of enrollment for which the loan is made.

Consolidation loans are not subject to many of these disbursement requirements,

including the multiple disbursement or the 30-day delayed disbursement

requirements. Postsecondary institutions with cohort default rates of less than 10%

10

An over-award is an award in excess of the amount for which the student is eligible.

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for each of the past three fiscal years for which data are available, are also exempt

from many of these disbursement requirements.

Credit Checks and Endorsement. As a general rule lenders are neither

prohibited from evaluating nor required to evaluate a prospective Stafford borrower’s

financial condition through a credit check in order to make a decision regarding the

size of the loan based on such information. Lenders are required, however, to do

credit checks for prospective borrowers applying for PLUS loans, because program

eligibility is restricted to those borrowers with no adverse credit history.

Disclosures. The law requires lenders to make certain disclosures to

borrowers before disbursement of the loan proceeds and prior to the beginning of the

repayment period. Upon approval of a Stafford or PLUS loan, lenders must issue a

statement to the borrower on his or her rights and responsibilities with respect to the

loan and the consequences of defaulting on the loan, including that the defaulter will

be reported to credit bureaus. Before disbursement, the lender must disclose to the

borrower certain detailed information such as the principal owed, any additional

charges made, the interest rate, an explanation of the repayment requirements, the

total cumulative balance of the loans owed the lender by the borrower, and the

projected monthly balance (given the cumulative balance), prepayment rights, default

consequences, and any collection costs for which the borrower may become liable.

This disclosure, which must be in a written form, must contain a statement in bold

print that the borrower is receiving a loan that must be repaid.

The lender must provide other written information to the borrower not less than

30 days nor more than 240 days (these limits do not apply to PLUS and consolidation

loans) before the repayment period begins. This information generally relates to loan

repayment information such as who is to receive the payments, total interest charges,

what monthly payments will be, what repayment options may be available such as

consolidation or refinancing, prepayment rights, fees, etc. For PLUS and

unsubsidized Stafford loans, lenders may project monthly payments with or without

capitalization.

Notifications. Loan holders are required to notify Stafford borrowers no later

than 120 days after they leave school of the date their repayment period begins.

Upon the sale or transfer of any FFEL loan when the borrower is either in a grace

period or in repayment, the old and new holders, either jointly or separately, are

required to notify borrowers of the sale or transfer within 45 days from the date the

new holder will have an enforceable right of repayment from the borrower. The

notification must include such information as the identity of the new holder, the

address where payment must be sent and the telephone numbers of the original and

new holders. The new holder must also notify the guaranty agency and, if requested,

the institution the student attended, of the sale/transfer.

Lenders are required to report to national credit bureaus on the amount of a

FFEL loan made to an individual and the loan’s status.

Prohibitions. The law prohibits lenders from offering inducements for loan

applications, conducting unsolicited mailings for applications, using FFEL loans as

an inducement to a prospective borrower to buy life insurance, or engaging in

CRS-10

fraudulent or misleading advertising. Lenders are also prohibited from practicing

discrimination in their FFEL credit practices on the basis of race, national origin,

religion, sex, marital status, age, or disability status.

Collections. Under the insurance agreement, lenders are primarily responsible

for enforcing the repayment of loans they hold. If a borrower misses a payment and

a loan becomes delinquent, the lender must undertake certain federally prescribed

“due diligence” efforts to collect on the loan over a 270-day period.11 At the request

of a lender, guaranty agencies must assist the lender in pursuing borrowers with

delinquent FFEL accounts prior to the lender filing a default claim.

Lenders, loan servicers, and guaranty agencies are all required to pursue

delinquent or defaulted student loan accounts with “due diligence” as prescribed by

federal regulation. If irregularities are found in complying with these regulations, the

insurance payment on a default to a lender or a reinsurance payment to a guarantor

is jeopardized. Regular reviews associated with servicing and collection

requirements may be conducted on any loan. Once a loan being repaid in monthly

installments has been delinquent for 270 days, the lender files a default claim.12 If

the guarantor determines that the lender exercised the required diligence in

attempting to collect on the loan, the guaranty agency pays the claim. Once this

claim is paid, the lender ceases to have an interest in the loan.

Lender of Last Resort. Borrowers in certain geographic areas and borrowers

seeking loans that are less appealing to lenders (such as low-balance loans)

sometimes encounter difficulty securing loans. To ensure that qualified borrowers

will be able to secure FFEL loans, the law provides for “lenders of last resort” (LLR).

Guaranty agencies must act as a lender of last resort to serve otherwise eligible

applicants for subsidized Stafford loans who have been unable to secure a loan. The

Secretary is authorized to provide advances to guarantors to ensure they will make

LLR loans.

Payments to Lenders

Interest Payments. Lenders receive interest income from FFEL loans.

Lender yields are determined through statutorily established rate-setting formulas.

For loans disbursed from April 1, 2006, onward, lender yields are determined by

lender rate formulas (described below). In practice, the lender receives monthly

interest payments on loan principal from borrowers (or from the federal government,

during in-school periods, grace periods, and deferment periods, in the case of

subsidized Stafford loans). Borrower interest rates are determined by statute.13 On

11

Due diligence is following procedures specified in 34 C.F.R. 682.411 in an attempt to

secure repayment of a loan.

12

For loans being repaid in less frequent than monthly installments, a default claim is filed

after 330 days of delinquency.

13

For additional information on the interest rates for various types of loans see CRS Report

RL33673, Federal Family Education Loan Program and William D. Ford Direct Loan

(continued...)

CRS-11

a quarterly basis, special allowance calculations are performed to determine the

amount a borrower rate is above or below the lender rate. When the borrower rate

is below the lender rate, the federal government pays a special allowance equal to the

difference. When the borrower rate is above the lender rate, the lender rebates the

excess interest amount to the federal government.14

Special Allowance Payment. A key component of the FFEL program for

lenders is the special allowance payment. It is a payment of additional interest on a

student loan that is made by the federal government when the borrower’s interest rate

does not meet a statutorily specified level of return to the lender. The provision dates

to the early days of the GSL program when the return on student loans was low

compared to what lenders could receive from other types of consumer credit, and

Congress wanted to provide an incentive for lenders to put their capital in GSLs. The

special allowance compensates the lender for the difference between the statutorily

set interest rate charged to borrowers and the market rate of return. In essence, the

Special Allowance Payment is in place to keep student loan investments appealing

to private lenders during periods when the statutorily capped interest rates for

borrowers would provide a lower rate of return than other investments. The special

allowance payment has been sustained to ensure that the program is consistently fully

capitalized.

The special allowance payment amount is determined quarterly under a statutory

formula. The special allowance paid for each loan is dependent on the formula in

effect when the loan was disbursed. The federal government pays any special

allowance due lenders from the time the loan is disbursed through the entire

repayment period.

Effective for Stafford, PLUS and Consolidation loans for which the first

disbursement was on or after January 1, 2000,15 the special allowance payment

amount is determined through the use of a series of special allowance payment

formulas (displayed below). Each formula establishes a lender rate based on a

market index — three-month Commercial Paper (CP) rates16 — to keep lender yields

sensitive to market conditions. As is shown below, each of the formulas establish

13

(...continued)

Program Student Loans: Terms and Conditions for Borrowers, by Adam Stoll.

14

On loans made prior to Apr. 1, 2006, lenders are not required to rebate excess interest.

The excess interest provisions, which affect loans made on or after Apr. 1, 2006, were

enacted in the HERA.

15

The Ticket to Work and Work Incentives Improvement Act of 1999 (P.L. 106-170, Dec.

17, 1999) included an amendment to the HEA enacting these formulas for calculating the

special allowance for loans disbursed on or after Jan. 1, 2000 and before July 1, 2003. P.L.

107-139, adopted Feb. 8, 2002, included provisions that extend these formulas to loans

disbursed on or after July 1, 2003.

16

The “CP rate” used in the special allowance calculation is based on the average bond

equivalent rates of the daily quotes of the three-month commercial paper rates for each of

the days in a quarter.

CRS-12

a lender rate from which the borrower rate is subtracted;17 and then a quarterly

adjustment is made.

Quarterly Special Allowance Formulas

Stafford loans

lender rate [3 - month CP rate + a premium (1.74 or 2.34)] - borrower’s interest rate

4

PLUS and Consolidation loans

lender rate [3- month CP rate + a premium (2.64)] - borrower’s interest rate

4

In these formulas, the CP rate represents the cost of borrowing to banks (i.e.,

banks borrow the funds that are used to make loans at roughly this rate); the premium

reflects other costs associated with making and servicing loans as well as a return rate

subsidy (i.e., an agreed upon minimum profit margin deemed to be appropriate to

keep the loans appealing to lenders); the borrower’s interest rate reflects the interest

rate the borrower is paying the bank on the loan; and the denominator (4) reflects the

fact that the calculation is done to derive a quarterly payment.

If the result of this special allowance calculation is positive, the lender receives

a payment of this additional interest from the federal government, by multiplying the

result times the outstanding principal on the loan. If it is negative the lender receives

no quarterly special allowance payment, and for loans made on or after April 1, 2006,

the lender would rebate to the federal government the excess interest received. The

amount of excess interest that must be rebated is determined by subtracting the lender

rate from the borrower rate, multiplying the result by the average daily principal

balance during a quarter and dividing by four. For example, if the average daily

principal balance on a loan during a quarter was $1,000 and the borrower rate and

lender rate were 6.8% and 5.8% respectively, the amount of excess interest rebated

would be determined as follows: ($1,000 x 1%)/4 = $2.50.

For Stafford loans first disbursed on or after July 1, 1998 and before January 1,

2000, the special allowance rate is the sum of the average bond equivalent rates of

the 91-day T-bills auctioned during the quarter and 2.2% in school, and 2.8% in

repayment. The PLUS and Consolidation loan rate for loans disbursed during that

time period is based on the 91-day T-bills auctioned during the quarter plus 3.1%.

17

FFEL Stafford and PLUS loans disbursed on or after July 1, 2006, are fixed rate loans

with borrower rates of 6.8% and 8.5%, respectively. Consolidation loans have fixed rates

based upon the weighted average of the rates in effect on the underlying loans at the time

of consolidation. Stafford and PLUS loans disbursed in earlier periods (prior to July 1,

2006), have variable rates. For more complete information on borrower rates, see CRS

Report RL33673, Federal Family Education Loan Program and William D. Ford Direct

Loan Program Student Loans: Terms and Conditions for Borrowers, by Adam Stoll.

CRS-13

The special allowance is available for all types of FFEL loans. For the most

part, it is only paid on outstanding variable interest rate PLUS loans if the calculation

of borrower’s interest exceeds the interest cap (the cap is 9% for loans disbursed on

or after October 1, 1998 and before July 1, 2006).18 For Consolidation loans, the

borrower’s new interest rate on the consolidation loan is the basis for the special

allowance calculation, not the original interest rates of the individual loans that were

consolidated.

Default Claims. Lenders are insured against borrower default for 97% of the

outstanding loan principal. Lenders, loan servicers, and guaranty agencies who the

Secretary of Education finds have a 97% or greater compliance with due diligence

requirements may be designated as having “exceptional performance,” and relieved

from regular review for compliance with servicing and collection requirements. With

this designation, lenders and servicers also receive 99% reimbursement for their

default claims and guaranty agencies receive the appropriate level of reimbursement

from the federal government with no added review. The designation lasts for a

one-year period or until revoked by the Secretary, and annual audits of the lenders,

services and guarantors are required specific to the designation.

Lender Fees

In recent years, numerous provisions designed to reduce federal costs in the

FFEL program have been enacted. These include fees charged to lenders and holders

of FFEL loans. In essence, these fees pass along some of the federal costs associated

with insuring and subsidizing student loans to lenders.

All lenders/loan holders are required to pay to the Secretary a loan fee

(subtracted by the Secretary from the quarterly interest and special allowance

payments due to lenders) equal to 0.5% of loan principal on all new FFEL loans for

which the first disbursement was on or after October 1, 1993. This fee is often

referred to as a “lender origination fee.” In addition, holders of consolidation loans

for which the first disbursement was made on or after October 1, 1993, must pay to

the Secretary, on a monthly basis, a rebate fee calculated on an annual basis, equal

to 1.05% of the loan principal plus accrued interest.19

18

The one exception to this is PLUS loans disbursed on or after July 1, 1994, and before

July 1, 1998 for which the rate cap restrictions do not apply.

19

The 1998 HEA amendments reduced the lender rebate fee on FFEL consolidation loans

based on applications received from Oct. 1, 1998 through Jan. 31, 1999 from 1.05% to

0.62% of principal and accrued interest on student loans.

CRS-14

Guaranty Agency Provisions

Guaranty Agency Responsibilities

Loan Insurance. A central function of guaranty agencies is administering

federal loan guarantees. When loans are in default, and when loans are eligible for

a discharge (e.g., in instances of death or permanent disability), the guaranty agency

pays the lender’s insurance claim. The guaranty agency subsequently files a claim

with the federal government for a reinsurance payment.

Default Aversion Assistance. Upon receiving a request from a lender, not

earlier than the 60th day after a loan has become delinquent, a guaranty agency is

required to provide the lender with default aversion assistance. This assistance is

aimed at preventing default by the borrower.

Collections. After the guaranty agency pays a lender’s insurance claim on a

defaulted loan, the note is assigned to it and the agency becomes responsible for

making efforts to collect on the loan. As part of its reinsurance agreement with the

federal government a guaranty agency is, like the lender, required to exercise

diligence in pursuing defaulters for repayment of principal and accrued interest due

on their loans under many of the same procedures required for lenders during loan

delinquency.20 When a guarantor is assigned a loan, it can convert the loan from

defaulted status by rehabilitating it through loan rehabilitation or consolidation, or

the guarantor can collect on the loan.

Assignment of Defaulted Loans to the Federal Government

(Subrogation). At any time, the Secretary may require a guaranty agency to assign

the defaulted loan to the federal government for collection under the assumption that

the federal government will have more success in collection on a particular loan or

group of loans than the guaranty agency. Once a loan is assigned to the federal

government, the guaranty agency receives no further payment resulting from any

collections on that loan.

ED has established certain categories of loans for mandatory assignment such

as aged accounts and defaulted loans of federal employees. Also, loans that may be

collectable through the offset of the defaulter’s federal tax refund are temporarily

assigned to the federal government.

Payments to Guaranty Agencies

Administrative Payments. Guarantors receive payments as compensation

for the varied administrative tasks they perform as intermediaries within the FFEL

program. For loans originated on or after October 1, 1998 and before October 1,

2003, the Secretary paid guaranty agencies a loan processing fee equal to 0.65% of

the total amount of loan principal for the loans on which insurance was issued in each

fiscal year. The loan processing fee, which is paid quarterly, dropped to 0.40% for

20

34 CFR 682.410(b)(6).

CRS-15

insured loans originated on or after October 1, 2003. In addition, the 1998 HEA

amendments established an account maintenance fee that is paid quarterly by the

Secretary to guaranty agencies. For fiscal years 1999 and 2000, the payment equaled

0.12% of outstanding loan principal. For fiscal years thereafter through 2011, the

payment equals 0.10% of outstanding principal.

Default Aversion Payments. The 1998 HEA amendments established a

default aversion fee, that is intended to provide added incentive for guarantors to

work with borrowers to rehabilitate loans in danger of going into default. Under the

provisions, guaranty agencies are paid a default aversion fee equal to 1% of unpaid

principal and accrued interest on a loan for which a default claim is not paid within

300 days after the loan is 60 days delinquent — because the loan has been

successfully brought into “current status.” It should be noted that statutory and

regulatory provisions offer divergent guidance with regard to how default aversion

fees are calculated and paid.21

Default Fees. The HEA requires guaranty agencies to assess a federal default

fee equal to 1% of loan principal. This fee helps defray some of the federal cost of

insuring loans. The fee is a borrower fee that must be assessed. It can be either

deducted proportionally from the proceeds of the loan received by borrowers, or paid

on the borrower’s behalf from non-federal sources (e.g., the lender or guarantor may

pay the fee).

Reinsurance Payments. When a loan has gone into default, and a guaranty

agency has paid a lender’s insurance claim, the guaranty agency files a claim with the

federal government for a reinsurance payment. Reinsurance payments are deposited

in the guarantor’s Federal Fund — its locally held federal reserves. For loans

disbursed on or after October 1, 1998, reinsurance payments cover 95% of the cost

of the claim plus certain administrative costs, provided that overall reimbursements

don’t exceed 5% of the loans (in repayment) that are insured by the guaranty agency.

The reinsurance rate drops if the guarantor has default claims that are high compared

to the loans in repayment. If more than 5% of the guarantor’s loans (in repayment)

are in default in any fiscal year, the reimbursement rate drops to 85%; and if default

claims exceed 9% of loans in repayment status, the reimbursement rate drops to 75%.

For lender of last resort loans, the reinsurance rate is 100%.

Collection Payments. The guaranty agency is authorized to retain the

complement of the reinsurance percentage in effect when the reinsurance payment

was made plus a percentage of any collections it makes to pay for its costs associated

21

Regulatory provisions, developed in response to concerns raised at negotiated rulemaking, created a “netting out process” whereby guarantors may transfer default aversion

fees from their Federal Fund to their Operating Fund equal to 1% of principal and accrued

interest owed on all loans submitted by lenders to the guaranty agency for default aversion

assistance during a period (e.g., that quarter) minus 1% of unpaid principal and accrued

interest on loans for which default claims were paid during that time period (i.e., on those

loans for which default aversion fees have previously been paid). See HEA Section 428(l)

and 34 CFR 682.404(k).

CRS-16

with the collection.22 The reinsurance complement is deposited in the guarantor’s

Federal Fund. Prior to October 1, 2003, the percentage of collections the guaranty

agency was authorized to keep was 24%. On or after October 1, 2003, the guaranty

agency is authorized to keep 23%. For defaulted loans resold through rehabilitation,

the guaranty agency may retain 18.5% of the proceeds from the loan sale. The

guarantor may keep an additional amount equal to up to 18.5% of principal and

accrued interest from collection fees assessed to the borrower.23 For a loan that is

consolidated out of default, the guaranty agency may charge an amount equal to up

to 18.5% of principal and accrued interest in collection fees assessed to the borrower.

An amount equal to the lesser of 8.5% or the amount charged must be remitted to the

federal government and the remainder may be kept by the guaranty agency.24

Reserves and Solvency Requirements

In order to pay insurance claims on defaulted loans, guaranty agencies must

maintain a certain level of reserves in their Federal Fund. The HEA specifies:

!

!

!

!

the level of reserves a guaranty agency must maintain;

the actions that may be taken in the event of guaranty agency

insolvency;25

the mechanisms the federal government will use to oversee the

financial conditions of guaranty agencies;

and the terms under which “excess reserves” may be recalled by the

federal government.

Guaranty agencies are required to maintain reserve funds to protect against the

risk involved in administering the federal guaranty. An agency’s reserve level is its

cumulative revenues minus expenses. Its annual reserve ratio is calculated in

percentage terms as current reserves divided by the original principal of outstanding

loans guaranteed. Current law provides for a minimum ratio of 0.25%, and under

current law, reserves above 2.0% are considered “excess reserves” which are subject

to being recalled by the federal government.

In an effort to create clear separation between reserve funds and operating funds,

the 1998 HEA amendments required all guaranty agencies to establish two funds: a

Federal Fund; and an Operating Fund. The following payments are to be placed in

the Federal Fund: federal default fees, reinsurance payments from ED, and the

reinsurance complement from collections and rehabilitations.

22

For example, the complement of the reinsurance percentage in effect when the reinsurance

payment was paid would be 5%, if the reinsurance percentage in effect was 95%.

23

A borrower must make nine on-time repayments in a 10-month period to rehabilitate their

loan.

24

A borrower must make on-time repayments for three consecutive months for their loan to

be consolidated out of default.

25

In 1990, the largest student loan guarantor, the Higher Education Assistance Foundation

(HEAF) became insolvent because it did not have funds to meet its insurance obligations.

CRS-17

The law specifies that the Federal Fund, including its earnings, is the property

of the United States. The Federal Fund may be used to pay lender claims and to pay

default aversion fees into the guaranty agency’s Operating Fund.

The Operating Fund is to be used to support operating expenses and may also

be used by the guarantor to support discretionary student aid activities. The

Operating Fund, with the exception of funds temporarily transferred in from the

Federal Fund to support the fund’s establishment, is the property of the guaranty

agency. Guaranty agencies are authorized to deposit the following revenues into the

Operating Fund: loan processing and issuance fees, account maintenance fees, the

agency’s percentage of any collections on defaulted loans, compensation for

defaulted loan rehabilitations and consolidations, and default aversion fees

transferred from the Federal Fund.

In years leading up to the 1998 amendments, student loan defaults had declined,

and consequently guaranty agency reserves had grown. Hence there was increased

interest in recalling reserves. The Balanced Budget Act of 1997 required the return

of $1 billion from guaranty agency reserves by 2002. The 1998 HEA amendments

required the recall of an additional $250 million by FY2007. ED is required to report

annually to congressional authorizing committees on the fiscal soundness of the

guaranty agency system.

Voluntary Flexible Agreements

The 1998 HEA amendments included provisions that allow for up to six

guaranty agencies to enter into voluntary flexible agreements (VFAs) with the

Secretary in fiscal years 1999, 2000, 2001 to pilot new ways for guaranty agencies

to operate and receive fees for their services.26 As of FY2002 any guaranty agency

may enter into a VFA. Under the provisions of the HEA, the Secretary is afforded

considerable discretion in awarding statutory and regulatory waivers for VFAs and

establishing fees for services, except that the cost of the agreement “reasonably

projected” cannot exceed the cost as similarly projected in the absence of the

agreement.

Direct Loan Program: Introduction to

How the Program Is Administered

Capital for the DL program is provided by the federal government and disbursed

to borrowers through schools. Schools seeking to participate in the DL program

apply to the Secretary. Participating schools originate loans for their students and

must be specifically approved by ED for this purpose. All participating schools must

certify borrower eligibility for the loans. Schools may choose whether to handle their

own paper promissory notes and whether they originate their own funding requests

26

The VFAs were introduced in an attempt to find new ways to tie guaranty agency

reimbursement to default prevention activities.

CRS-18

(i.e., “drawdown” their own money).27 For DL schools choosing not to handle these

tasks, or not approved for that purpose, these loan origination services are performed

by ED’s Common Origination and Disbursement (COD) system contractor. ED staff

play an important monitoring role in relation to the disbursement of funds to schools,

ensuring that schools drawdown appropriate sums.

ED has also hired a contractor to serve as the DL program’s loan servicer. It

performs all of the DL program’s servicing, accounting and delinquency processing

work. The Common Services for Borrowers (CSB) contract supports integrated

“back-end” operations. The contractor is responsible for DL loan servicing,

consolidation, and debt collection functions.

In general, schools participating in the DL program often assume more direct

administrative duties related to loan origination and servicing than they would have

as participants in the FFEL program. At the same time, they are freed of many tasks

associated with finding lenders for their students and working with an assortment of

lenders and guaranty agencies. Figure 2, presented below, depicts the basic elements

of the DL program model.

27

The DL program now uses a Master Promissory Note (MPN) which is available on ED’s

website. Many students use an e-MPN which can be used to make loans 10 years after it is

first disbursed against. When students complete their promissory notes on-line, the number

of promissory notes processed by schools goes down, thus lowering the schools’ burden.

CRS-19

Figure 2. Basic Elements of the DL Program Model

Loan applicants

Supply of loan capital

Students and

Parents:

Complete

necessary

forms to apply

for loans.

The Federal

Government: ED

secures funds from the

U.S. Treasury and

supplies loan capital

to students and their

parents.

Loan disbursement, servicing

& program administration

Schools: Assess students’ levels of

financial need and certify borrower

eligibility for loans; disburse funds

(received from ED) to student and

parent borrowers and notify ED of

those disbursements; provide

periodic reports to the National

Student Loan Data System

confirming students’

enrollment/eligibility status; provide

loan counseling to borrowers.

Loan Originators (either the school

or the loan organization contractor):

Obtain completed promissory notes

from borrowers; request loan funds

from ED; perform fund management

task - including reconciling all

accounts on a monthly basis.

Loan Servicing Contractor: Monitors

student enrollment/eligibility status;

bill borrowers; collects loan

payments; conducts initial collection

services if loans become delinquent;

transfers defaulted loans to ED’s

debt collection system.

ED: Reviews requests for federal

loan capital and transfers funds;

monitors loan servicing and

collection activities; ensures

compliance with the law and

program regulations; monitors

institutional default rates.

Source: Prepared by the Congressional Research Service.

Provisions Related to DL Program Administration

Under the HEA, the Secretary is authorized to contract for origination, servicing,

default collections, data systems and sundry services connected with the operation

of the DL program. The contracts are briefly described below.

The COD origination services contract is a “share in savings” contract. The

contractor is paid a set fee for each DL loan they originate and a set fee for each

unique record processed on the database until a threshold is met after which the fee

CRS-20

paid is reduced substantially for additional records processed.

performance incentives in the contract.

There are no

The CSB loan servicing contract has a tiered pricing structure so that as work

volume increases unit cost generally decreases. In addition, it features performance

incentives. The contractor receives a higher unit rate for borrowers maintained in a

current repayment status compared to borrowers in delinquent or default status. The

contract also provides disincentives for failing to meet performance standards related

to costumer service.

Loan Origination. To enhance financial controls and accountability, ED has

set up three levels of loan origination: standard origination, under which schools

have the least responsibility and control over funds; and two levels of school

origination. Schools must meet additional criteria beyond those for participating in

the DL program to have full authority to originate loans. Any school eligible to

participate in the Direct Loan program may operate under the standard origination

option, in which case the loan origination contractor, not the school, is responsible

for preparing the promissory note, obtaining the completed note from the borrower,

and initiating the drawdown of funds for the school to disburse to the student. To be

eligible for either of the two school origination options, which allows schools greater

control over funds, institutions must meet additional criteria that include participating

in the Pell Grant program; not being on the reimbursement system in the Pell Grant,

Work Study, or Perkins Loan programs; and demonstrating fiscal responsibility, as

determined by the Secretary. The Secretary has the authority under the final

regulations to require a change to standard origination based on evaluation of a

school’s performance.

Under school origination option 1, the school would be responsible for the

promissory note, but the contractor would continue to be responsible for initiating

drawdown of funds. Under school origination option 2, the school would have full

responsibility for all aspects of the origination function, including determining

funding needs and initiating funds drawdown.

Federal funds for direct student loans are delivered to participating schools and

students in essentially the same manner as Pell Grants,28 and other fiscal control and

record keeping practices by schools are the same for all HEA Title IV programs. ED

has developed loan origination software and training for schools, as well as entrance

and exit counseling materials.

Disbursement of Funds to Borrowers. Direct loans are disbursed to

students by first applying the loan to the student’s account with any remainder being

disbursed to the student. Parallel to a requirement in the FFEL program, a 30-day

delay in the distribution of loan proceeds to first-year, first-time borrowers also

applies to DL program loans.

28

For a description of the Pell Grant delivery system, see CRS Report RL31668, The

Federal Pell Grant Program of the Higher Education Act: Background and

Reauthorization, by Charmaine Mercer.

CRS-21

Loan Servicing, Delinquency Processing and Default Collections.

Under the DL program, loan servicing and delinquency processing are handled by

the DL program’s loan servicing contractor. The servicing contractor bills borrowers

whose loans are in repayment, processes loan payments, and processes deferments,

forbearances and discharges.

If a DL borrower fails to make any installment payments on a loan, the loan

becomes delinquent and the servicing contractor is responsible for exercising due

diligence in attempting to locate the borrower to initiate loan rehabilitation efforts.

Ultimately, if a DL loan becomes 270 days delinquent, the loan goes into default and

the ED’s Debt Collection Service (DCS) is responsible for conducting collections on

the defaulted loan. If the borrower chooses not to rehabilitate the loan, ED may take

any action authorized by law to collect a defaulted loan, including garnishing the

borrower’s wages; requesting the IRS to offset the borrower’s federal income tax

refund; or filing a lawsuit against the borrower. All defaulted loans are reported to

national credit bureaus.

Payments for Administration

Prior to FY2007, funds for federal administrative costs (program operations by

ED, servicing contracts and related costs) for Direct Loans are mandatory spending

with a permanent appropriation. In accordance with the provisions of the HERA, for

FY2007 through FY2011, such sums as may be necessary to cover DL administrative

costs may be provided through discretionary appropriations.