The Root Cause of Your Student Loan Miseries….The 9.5 Percent Special Allowance Payment Subsidy

Intended to Cut Lender Subsidies, It Created a Windfall

In the guaranteed student loan program, lenders receive interest payments from both students and the government. Under the 1980 law, the government payments (known as “special allowance payments”) assured lenders a quarterly return on their guaranteed student loans equal to the average bond-equivalent yield on 91-day Treasury bills plus 3.5 percentage points. Any quarter when borrower payments were insufficient, the government would make up the difference. (Loans made today receive the 91-day commercial paper rate plus 2.34 percentage points during repayment.) For loans backed by tax-exempt bonds, the 1980 formula cut subsidy payments in half but guaranteed at least a 9.5 percent return. In other words, lenders receive the greater of either (a) one-half the regular subsidy payments or (b) the amount necessary to provide a 9.5 percent return.[1]

Example 1: In times of high interest rates, the formula reduces subsidies.

Under interest rates prevalent in 1979, the new formula cuts lender returns from 13.5 percent to 10.25 percent.10

 

Regular Loans:

 

Student Rate                                        Special Allowance:                       Lender Return:

7.0%                                                        6.5%                                       13.5%

 

Loans Made with Tax-Exempt Bonds:

Special Allowance:                                                                                  Lender Return:

3.25%                                                                                                   10.25%

Example 2: But with the lower rates that have been more typical in recent years, the 9.5 percent floor creates windfall profits.

In the second quarter of 2004, regular loans earned a 3.57 percent return, including only 0.15 percentage points in federal subsidies. Loans eligible for the 9.5 percent floor collected 25 times more in federal subsidies.[2]

 

Regular Loans:

 

Student Rate                                          Special Allowance:                 Lender Return:

3.42%                                                      0.15%                                      3.57%

 

 

Loans Made with Tax-Exempt Bonds:

Special Allowance:                                                                             Lender Return:6.08%                                                                                                  9.5%

 

 

The 1993 Attempt to Repeal 9.5 Loans

In early 1993, the borrower interest rate on regular new student loans fell to 6.15 percent, highlighting the absurdity of guaranteeing a 9.5 percent return on tax-exempt loans.12 Congress decided to try again to fix the problem.The Omnibus Budget Reconciliation Act of 1993 eliminated the 1980 formula for all loans financed with new student loan bonds. However, responding to arguments that bond investors need stable, assured returns, it kept the 1980 formula for loans backed by existing bonds, including loans made with collections from earlier loans. It seemed like a limited liability, confined only to pre-existing bonds, and involving non-profit and government entities.[3]



[1]Money for Nothing • Skyrocketing Waste of Tax Dollars • A Report by TICAS:The Institute for College Access and Success


[2]Author’s calculations based on U.S. Department of Education,“Federal Family Education Loan Program Special

Allowance Rates for the Quarter Ending June 30, 2004,” July 6, 2004.


[3] General Accounting Office and U.S. Department of Education, Final Report Regarding the Findings of the Study Group on the Feasibility of Using Alternative Financial Instruments for Determining Lender Yield under the Federal Family Education Loan Program, January 19, 2001, pp. 120, 123.

 

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Filed under 9.5 percent, 9.5 percent SAP, federal direct loans, FFELP, PLUS, Stafford, student loan lenders, student loan program, student loan scandal, student loans

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