Student Loan Costs

The Congressional Budget Office (CBO) estimates and reports annually the cost of new federal student loans that are expected to be made in the current and future years. The Office of Management and Budget also reports estimated costs in the president's budget request to Congress each year. Typically, when the federal government spends money or policymakers propose a new program, the costs appear in the budget or cost estimates on a "cash basis." This means that if $100 million will be spent this fiscal year on a particular program, the cost is reflected in the federal budget as $100 million this year. This is not used for student loans because it does not accurately reflect the cost of the lifetime of that loan. Instead, rules in the Federal Credit Reform Act govern how budget agencies estimate and present loan costs. In the most basic terms, cost estimates for federal student loans under either accounting method include two components: subsidy rates and loan volume.

Budget agencies estimate student loan costs by first determining the average subsidy rate for all types of federal student loans. The subsidy rate represents the lifetime cost of the loan to the federal government, calculated to account for the time value of money, in the year the loan is made. The subsidy rates are intended to reflect such costs as the below-market interest rates charged to borrowers, loan forgiveness programs, and the expected losses the government might incur when borrowers fail to repay loans. The subsidy rates for the loans are presented as a percentage of the value of all the underlying loans that will be made. Most of the administrative costs that the federal government incurs for the loan programs are excluded from the subsidy amounts, a practice required by cost estimate rules.

The subsidy rate is then applied to the total volume of loans that will be originated in a given year to calculate the total cost of the loan program in a given fiscal year. Both CBO and OMB must estimate the number and value of loans that are likely to be originated in a future year. The agencies can then determine the total federal cost by multiplying the subsidy rate by the total value of the loans that will be made.

Prior to enactment of the Federal Credit Reform Act in 1990, student loan costs were reported in the budget on a cash basis, just like all other federal programs, and the effects were misleading. For example, loans provided by private lenders with federal guarantees against default or interest rate risk appeared to have no cost until the borrower defaulted. (Until 2010, most federal student loans were made through the Federal Family Loan Program, which provided guarantees to private lenders making student loans at terms set in law.) In other words, making a student loan through a guarantee cost nothing when the loan was made even though the government took on binding risks that could result in costs in the future. Recording costs on a cash basis when the government lent directly was also misleading. On a cash basis, when the government provided a loan directly, as is done under the Direct Loan program, the loan principal was treated as a grant the year that it was made. When the borrower later paid it back principal and interest, the funds were treated as receipts, appearing as positive cash flow in that year.

The examples below illustrate how cash budgeting provides misleading cost information and how net present value budgeting provides a more meaningful estimate of the cost of making a loan.

The Congressional Budget Office and other experts argue that while the Federal Credit Reform Act of 1990 improved how the federal government reports the cost of loan programs, it includes a provision that systematically understates the costs of loan programs.

Specifically, the law requires that budget analysts calculate the net present value of a federal loan using a discount rate that matches the government’s cost of borrowing. That is, once an agency has estimated the expected performance of a loan over its entire duration, it must translate that performance into a present value using the risk-free interest rate on U.S. Treasury debt. Experts argue that agencies should discount loan performance using a rate that reflects the riskiness of the loan performance itself, not the interest rate on U.S. Treasury debt, which by definition bears no relation to the risk taxpayers are exposed to when the government makes a loan. Using a risk-adjusted discount rate calculates the “fair value” of the government loan.

In a 2010 report, the Congressional Budget Office calculated the fair-value cost of an average federal student loan and found that over the subsequent ten years, the loans will be made at a 12 percent subsidy. In other words, the government will subsidize students at a rate of $12 for every $100 they borrow. A subsequent estimate done in 2013 projected that the average subsidy over the next 11 years would average 7 percent.