Student Loans Are Treated Differently In the Federal Budget

When the federal government spends money, the costs are presented, or "scored", in the budget on a "cash basis." This means that if $100 million is spent this fiscal year on a particular program, the cost is reflected in the federal budget as $100 million. Student loan costs, however, are not treated in this manner. The costs of the federal student loan programs are shown in the budget on a "net present value" basis, as per a budget rule enacted in the Federal Credit Reform Act of 1990. The lifetime cost of a student loan is shown in the year that the loan is made. Under net present value budgeting, all future costs are discounted to reflect the time value of money. Even though the loan may be paid back over ten years, any funds that the federal government spends to support the loan over the repayment time are all reflected up front – the year that the loan is made.

Why Treat Loans Differently?

Prior to enactment of the Federal Credit Reform Act in 1990, student loan costs were treated on a cash basis in the budget, just like all other federal programs. However, reporting student loan costs in this manner can be misleading, because it does not reflect the federal government’s future obligations associated with the loan. For example, if the loan is provided through a federal guarantee (i.e. a private lender makes the loan and the government pays if the borrower defaults), as they are in the Federal Family Education Loan Program, costs appear only when a borrower defaults. In other words, making a student loan through a guarantee costs nothing when the loan is made, even though the government has taken on risks that could result in costs in the future.

Recording costs on a cash basis when the government lends directly is also misleading. On a cash basis, when the government provides a loan directly, as is done under the Direct Loan Program, the loan principal is treated as a grant the year that the loan is made. When the borrower later pays back principal and interest, the funds are treated as receipts, appearing as positive cash flow in that year. If the loan is treated on a net present value basis, as is required under current rules, the disbursement of principal and all future payments are recorded in the year that the loan is made. This approach ensures that the total cost of making the loan is fully represented when the loan is made.

Example: $3,000 Loan Under Cash Budgeting

Consider how costs are recorded under cash budgeting for a $3,000 Stafford student loan provided as a direct loan and as a loan guarantee. In the year that the loan is made, government costs for guaranteeing the loan and subsidizing a private lender is $88. Making the loan directly from the federal Treasury costs $2,955. Note that these costs reflect only the first year of the loan. (Examples are taken from the Congressional Budget Office paper "Subsidy Estimates for Guaranteed and Direct Student Loans," Appendix A.)

Example: $3,000 Loan Under Net Present Value Budgeting

Now consider the same loans, but under net present value budgeting – the approach that is used to record student loan costs in the federal budget. Discounting the full 10-year costs associated with the loan to the year in which the loan is made results in a much different cost than when a cash budgeting approach is used. Using a guarantee to make the loan costs $450 and lending directly costs negative $66.

Loan Costs Presented as Subsidy Rates

Under the Credit Reform Act, total loan costs calculated on a net present value basis are translated into a subsidy rate. The subsidy rate reflects the lifetime cost of the loan as a percentage of the original loan amount. For the costs of the $3,000 loan calculated above, the subsidy rate for the guaranteed loan is 15 percent ($450 subsidy on a $3,000 loan). For the direct loan it is negative 2 percent (-$66 subsidy on a $3,000 loan).

Information on current cost estimates for the federal student loan programs, as well as an analysis of the controversy over student loan budget rules and cost estimates is available on the Student Loan Cost Estimates page.