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Direct Loans vs. the FFEL Program


Federal education loans are available either through the William D. Ford Federal Direct Loan Program ("Direct Loans") or the Federal Family Education Loan Program ("FFEL Program" or "FFELP"). The FFEL Program is sometimes referred to as the federally-guaranteed student loan program.

The choice of loan program available to a borrower depends on the college. About three quarters of colleges participated in FFELP and one quarter participated in Direct Loans in FY2008. But about a third of the Direct Loan colleges also participate in FFELP to maximize borrower choice. Borrowers have a choice of lenders in the FFEL program but not in the Direct Loan program.

Both programs offer Stafford, PLUS and Consolidation loans, but there are some differences.

Differences between Direct Loans and FFELP

The following discussion summarizes the main differences from a borrower perspective:

  • Source of Funds. In the FFEL program the funds for the loans come from banks and other financial institutions. In the Direct Loan program the funds for the loans come directly from the US Department of Education, which in turn gets the funds from the US Treasury.

    (During the credit crisis many lenders, especially non-bank lenders and state loan agencies, are borrowing funds from the US Department of Education in order to continue making new loans. These lenders previously obtained funding from investors, but were unable to raise funds from the capital markets because of the credit crisis. Many banks, on the other hand, can rely on customer deposits as a source of funds and so are not as dependent on the US Department of Education for funding to continue making federal education loans. More than two-thirds (68%) of FFELP loan volume was funded in part by the US Department of Education in FY2008; almost one-third (32%) was not.)

    Overall, though, the source of funds does not matter much from a borrower's perspective. Money is fungible; it is green regardless of whether it comes from the federal government or a financial institution.

  • Consolidation Loans. Because the Ensuring Continued Access to Student Loans Act of 2008 (ECASLA) only addressed funding problems in the Stafford and PLUS loan programs, consolidation loans originated since October 1, 2007 are unprofitable to the FFEL program lenders. As a result, most FFEL program lenders have stopped offering consolidation loans. Consolidation loans remain available from the Direct Loan program at Borrowers in the FFEL program may consolidate their loans into the Direct Loan program.

  • Interest Rates. Congress sets the maximum interest rates in both the FFEL and Direct Loan programs. The interest rate on the Stafford Loan is identical in both programs. The interest rate on the PLUS loan, however, is 8.5% in the FFEL program and 7.9% in the Direct Loan program. The Higher Education Reconciliation Act of 2005 increased the interest rate in the FFEL program from 7.9% to 8.5% effective July 1, 2006 but did not implement a similar increase in the Direct Loan program.

  • PLUS Loan Approvals. There may be differences in the PLUS loan approval rates in the two programs, with parents more likely to obtain a PLUS loan approval in the Direct Loan program. Analysis of the 2007-08 National Postsecondary Student Aid Study (NPSAS) suggests that the Parent PLUS loan denial rate in the FFEL program was 42% in 2007-08, double the 21% Parent PLUS loan denial rate in the Direct Loan program.

    The PLUS loan program requires the borrower to not have an adverse credit history, as specified in Section 428B(a)(1)(A) of the Higher Education Act of 1965. The regulations at 34 CFR 682.201(c)(2) define an adverse credit history for the FFEL program as having had a default determination, bankruptcy discharge, foreclosure, repossession, tax lien or wage garnishment in the last five years or a current delinquency of 90 or more days. A similar definition appears in the regulations for the Direct Loan program at 34 CFR 685.200(c)(1)(vii). However, the FFEL program regulations at 34 CFR 682.201(c)(2)(iii) specifically permit lenders to establish "more restrictive credit standards" for the PLUS loan. At least one large FFEL program lender misinterprets the 90-day delinquency requirement as involving a five-year lookback instead of looking just for current delinquencies. But since FFEL lenders are permitted to adopt more stringent credit underwriting criteria, this error is technically permitted by the regulations. This tougher standard for an adverse credit history has a significant impact on PLUS loan denial rates. Some FFEL program lenders may also have implemented a debt to income ratio standard for PLUS loan approvals.

    From 1994-95 to 2005-06, Parent PLUS loan volume in the Direct Loan program represented 12.6% of non-consolidation loan volume, compared with 11.0% in the FFEL program. Parent PLUS loan borrowers represented 9.1% of unduplicated borrowers in the Direct Loan program and 8.0% in the FFEL program. This suggests that Parent PLUS loan borrowers are 12.1% (loan volume) to 12.5% (unduplicated borrowers) less likely to get a Parent PLUS loan in the FFEL program than in the Direct Loan program. (Data from 2006-07 onward was excluded to avoid the impact of the different interest rates in the two programs and the introduction of the Grad PLUS loan.) The program-specific marketshare for the Parent PLUS loan has been growing steadily since it was about equal in 1996-97, but it has been growing faster in the Direct Loan program.

  • Repayment Plans. Both Direct Loans and FFELP offer standard repayment, extended repayment and graduated repayment. Income-contingent repayment is available only in the Direct Loan program and income-sensitive repayment is available only in the FFEL program. A new repayment plan, income-based repayment, is available in both the FFEL and Direct Loan programs starting July 1, 2009. Income-based repayment usually yields a lower monthly payment than either the income-contingent or income-sensitive repayment plans.

    FFEL program lenders are required to allow borrowers to change repayment plans at least once a year. Some permit more frequent changes. The Direct Loan program allows borrowers to change repayment plans at any time.

  • Loan Forgiveness. Public Service Loan Forgiveness is available only in the Direct Loan program. However, FFEL program borrowers may obtain public service loan forgiveness by consolidating their loans into the Direct Loan program.

  • Loan Discounts. The FFEL program previously offered better front-end and back-end discounts than the Direct Loan program. Front-end discounts include fee waivers and graduation fee rebates. Back-end discounts include prompt payment discounts and auto-debit discounts. The credit crisis and cuts to lender subsidies caused most lenders to cut their discounts. Also, any lender that intends to sell its loans to the US Department of Education cannot offer better back-end discounts than those offered by the US Department of Education, namely a 0.25% interest rate reduction for having monthly payments automatically deducted from your bank account. So while some lenders may still offer better front-end discounts, none offer better back-end discounts.

    Because of all the conditions on loan discounts in both programs, the overall value of the discounts was more apparent than real. While some individual borrowers might benefit, the majority of borrowers do not realize significant savings.

  • Customer Service. The competition between the Direct Loan and FFEL programs has been healthy for both programs, leading to improved quality of customer service.

    The origination of new loans in the Direct Loan program is streamlined from a borrower perspective, since the colleges handle most of the administrative overhead as part of the financial aid awarding process, using the same disbursement system as the Pell Grant program. Although the FFEL program lenders also provide common loan certification and disbursement systems to streamline the loan origination process, this isn't quite the "one-stop shop" provided by the colleges' administration of the Direct Loan program. This yields a slight edge to the Direct Loan program in borrower satisfaction with the loan origination process.

    However, the advantage shifts to the FFEL program when the loans enter repayment. Borrowers complain about both programs in roughly equal numbers, but since FFEL handles three times the volume of the Direct Loan program, that suggests that there is somewhat better quality of customer service in the FFEL program after the loans enter repayment.

  • Preventing Defaults. The FFEL program does a slightly better job in preventing long-term loan defaults than the Direct Loan program, partly because of the default aversion role of state guarantee agencies and partly because FFEL lenders are more aggressive in presenting delinquent borrowers with deferment, forbearance and extended repayment options. The FFEL lenders offer better default aversion tools and borrower counseling. On a long-term basis borrowers in the FFEL program are about one-fifth less likely to default, but this is mostly due to a much lower long-term default rate on consolidation loans. When consolidation loans are excluded, the long-term default rates are much closer, with borrowers about 5% less likely to default in FFEL. While the US Department of Education claims a lower short-term default rate than the FFEL program for the FY2007 cohort, this is mostly due to the different mix of schools in the two programs, the restriction of income-contingent repayment to the Direct Loan program and a recent sharp increase in deferment and forbearance rates in the Direct Loan program.

  • Potential Change in Holder. Previously, some FFEL program lenders would sell their loans to another FFEL program lender, often shortly after origination. This does not generally occur very much these days, due to the very tight margins on these loans. However, about two-thirds of the FFEL program loan volume in 2008-09 was funded through the Ensuring Continued Access to Student Loans Act of 2008 and has been or will be sold to the US Department of Education. This is in contrast with the Direct Loan program, where federal education loans are held by the US Department of Education for the life of the loan and are not sold. The main practical impact on borrowers when a loan is sold is the potential for a change in the servicer on the loan, which would mean a different mailing address for monthly payments.

  • Outreach. The FFEL program does a better job of providing financial aid outreach to students in secondary schools and offers debt management and financial literacy workshops to college students. Such activities are part of the mission of the state loan guarantee agencies.

  • Other Products. Some FFEL program lenders offer other products and services, such as private (alternative) student loan programs and college savings programs, while the Direct Loan program does not. Some borrowers find these options helpful, but they can also be a source of confusion for borrowers who may not realize that the same private lenders offer both federal and private student loans.

College Preferences

Colleges that participate in the Direct Loan program and colleges that participate in the FFEL program are both extremely passionate about the respective programs.

Until the credit crisis there was a steady shift in marketshare from the Direct Loan program to the FFEL program. Most of the growth in loan volume occurred in the FFEL program while volume in the Direct Loan program remained flat to slightly decreasing. The credit crisis reversed this trend, with loan volume increasing by 40% in the Direct Loan program in FY2008 compared with a 12% increase in the FFEL program. (Overall loan volume increased 17% in FY2008 compared with a 7% increase in FY2007, mostly due to the increase in unsubsidized Stafford loan limits on July 1, 2008.) Nevertheless, volume in the FFEL program still exceeds the volume in the Direct Loan program by a factor of more than 3 to 1.

From a college perspective the customer service provided to the colleges is somewhat better from some (but not all) FFEL program lenders than the Direct Loan program. Using FFEL program lenders avoids the difficulties associated with post-disbursement changes and record reconciliation in the Direct Loan program, and there are better reporting capabilities available from FFEL program lenders. On the other hand, Direct Loans can be simpler to administer since the college has to deal with only one lender, the federal government, and the college's cash flow may be smoother. The process for returning Title IV funds is easier in the Direct Loan program since the college can net out any changes instead of having to return funds individually to each lender.

The use of the same Common Origination and Disbursement (COD) system that is used for the Pell Grant program makes the transition into the Direct Loan program relatively easy from a college perspective. The US Department of Education has also cut the bureaucracy associated with transitions into the Direct Loan program from months to days.

Which Program Costs Less?

There is an ongoing debate over which program costs the federal government less. A decade ago the FFEL program was clearly more expensive. But since then Congress has cut the lender subsidies several times, redirecting most of the savings to increases in federal student aid. This has made the FFEL program much less expensive to the federal government. The most recent cuts, in the College Cost Reduction and Access Act of 2007, when combined with the savings from the Ensuring Continued Access to Student Loans Act of 2008 (ECASLA), caused the FFEL program to cost less than the Direct Loan program in FY2008 on a per-dollar-lent basis even when certain types of high-risk consolidation loans are excluded from the analysis. On the other hand, the Direct Loan program is projected to be less expensive in FY2009. Which program is ultimately less expensive depends heavily on the economic assumptions one uses in a model of the program costs.

President Obama has proposed eliminating the FFEL program starting in 2010-11, in which case all loans would be funded by the Direct Loan program. He argues that this will save billions of dollars a year by eliminating the middleman. Most of the savings, however, is due to the federal government's lower cost of funds and to a cost comparison with a baseline that assumes that the ECASLA liquidity facilities will not be extended. Some of the FFEL program lenders have countered with proposals that would make ECASLA permanent and which yield at least three-quarters of the savings from President Obama's proposals, not counting any savings from FFELP lenders corporate income tax revenue to the federal government. (There is some disagreement between the non-bank FFEL program lenders and some of the banks on the manner in which ECASLA should be made permanent. This has to do with the self-terminating aspects of ECASLA, where lenders with a lower cost of funds are not currently required to rely on the US Department of Education's ECASLA financing. Requiring them to use federal financing for the federal loans would increase the savings to the federal government while decreasing the lender's profitability.)

The lenders also argue that their proposal avoids the potential delays and disruption associated with a transition to Direct Loans and also avoids the need for thousands of layoffs industry-wide. The transition risk is associated mostly with the prospect of quadrupling of origination volume in the Direct Loan program and not with the volume of loans entering repayment. Since loans enter repayment as students graduate, the number of new borrowers entering repayment in the Direct Loan program will increase more gradually. That gives the US Department of Education more time for hiring and training servicing staff. The Obama administration has also proposed contracting with some of the larger FFEL program lenders to service the Direct Loan program loans to mitigate this risk. Even so, maintaining a bit of redundancy will help avoid future disruptions caused by a single point of failure.


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