Because guaranty agencies often have federal, state, and agency-specific responsibilities, it is in the interest of federal taxpayers that money designated for the FFEL program, such as default payments, not be used for other activities. To address this issue, Congress enacted a change in the 1990s that required guaranty agencies to hold funds in one of two discrete accounts: the federal fund and the operating fund.

The federal fund is an asset of the U.S. government and is primarily used to pay private lenders for default losses on FFEL loans. The guaranty agency thus acts as a custodian of the federal fund, and can only use it to cover specific FFEL program costs. In practice, FFEL administrative payments that the federal government owes a guaranty agency are transferred from the federal fund to the guaranty agency's operating fund. By law, an agency's federal fund must hold reserves equal to 0.25 percent[1] of the outstanding FFEL loan volume it guarantees. This requirement helps to ensure that a guaranty agency can pay private lenders for default losses on FFEL loans.

The operating fund is an asset of the guaranty agency and supports FFEL administrative activities other than default insurance. The operating fund typically covers borrower assistance, collection, school and lender training, or other financial-aid related costs. Federal regulations do not specify that an operating fund meet any minimum balance requirement.

Guaranty Agency Fees

Guaranty agencies both pay and receive fees to and from the federal government under the FFEL program, and in some cases, also assess charges to borrowers. These fees can be disaggregated into three categories: those received on every FFEL loan; those received and paid only if borrowers struggle to make payments or default on a loan; and those for loans of last resort. The fees and charges discussed below only apply to FFEL loans.

Fees Received or Paid on Every FFEL Loan

• Loan Processing and Issuance Fee Every quarter, the Department of Education pays guarantors a loan processing and issuance fee equal to 0.40 percent of new loan volume. This fee is paid into the operating fund, and covers the cost of creating a loan's default guarantee.
• Insurance Premium Guaranty agencies collect fees from borrowers in the form of a 1 percent insurance premium on each loan dispersed. This money is placed in the agency's federal fund to cover the cost of default payments.
• Reinsurance Fee When a loan is first disbursed, the guaranty agency must pay a reinsurance fee to the Education Secretary. The amount paid is equal to 0.25 percent of all new loans that were guaranteed that year, and it is divided into four equal quarterly payments. If too much of a guarantor's loan volume defaults, the reinsurance fee rises to 0.50 percent.
• Account Maintenance Fee Once a loan is disbursed, the guaranty agency starts receiving an account maintenance fee each quarter. This fee is equal to 0.06 percent of the original principal of any outstanding loans, and is deposited in the federal fund.

Fees Associated with Distressed or Defaulted Loans

• Default Aversion Fee When borrowers fall between 60 and 120 days late on their payments, their lender is required to contact the guaranty agency for default aversion assistance. These are defined as "the activities of a guaranty agency that are designed to prevent a default by a borrower who is at least 60 days delinquent and that are directly related to providing collection assistance to the lender."[2] In exchange for providing this assistance, the guaranty agency may transfer an amount equal to 1 percent of the outstanding principal and interest from its federal fund into its operating fund. If, however, that borrower later defaults, then the guaranty agency must return an amount equal to 1 percent of the current outstanding principal and interest from the operating fund to the federal fund.
• Federal Reinsurance Once a borrower has gone 271 days without making a loan payment, the lender has 89 days to file a reimbursement claim with the guaranty agency. Once the claim is filed, the loan officially enters default, and the guarantor pays the lender for 97 percent of the loan's unpaid principal and interest (the reimbursement rate is slightly higher for older loans). This money is paid out of the federal fund, meaning that the guaranty agency manages the loan insurance but does not use its own funds to pay the claim.

Once a guaranty agency pays a default claim, it takes control of the loan. It then submits a reinsurance claim to the Department of Education, which will replenish the federal fund with an amount equal to 95 percent the defaulted loan's outstanding principal and interest (the reimbursement rate is lower if the guaranty agency pays too many loan claims). A guarantor has two options when it holds the loan title: (1) negotiate a payment plan with the borrower and rehabilitate the loan, or (2) collect on the defaulted loan. Either choice results in additional compensation for the guarantor, while also partially repaying the federal government for its reinsurance payment.

Loan Rehabilitation If a guaranty agency gets a borrower to make nine on-time payments over 10 months, the agency has the opportunity to rehabilitate the loan by selling it to another lender. The guaranty agency is also allowed to charge the borrower collection costs of up to 18.5 percent before the loan is sold. Nevertheless, rehabbing a loan benefits the borrower, who is ineligible to receive more federal student aid when a loan is in default. Guaranty agencies also benefit from rehabilitating a loan because they get to keep a portion of the sale proceeds. Funds received from a loan sale are split in the following manner: the Education Secretary is given an amount equal to 81.5 percent times the insurance rate it provided the guaranty agency (often 95 percent). The guaranty agency is then allowed to transfer the remaining sale proceeds into its operating fund.

Loan Collection If no payment plan is worked out, the guarantor begins collecting on the loan from the borrower. The first step in this process is charging collection costs, which are assessed immediately as a percentage of the loan (often 20 percent or more). The collection fee is recalculated as the balance grows. Collected loan amounts are distributed in the following manner. The guarantor deposits a percentage amount equal to 100 minus the reinsurance rate into its federal fund. (In the case of a 95 percent reinsurance rate the payment would be 5 percent). The guarantor is then allowed to take 16 percent of the remaining amount for its operating fund, and the rest is returned to the Secretary.

FFEL Loans of Last Resort

In addition to managing federal insurance and helping prevent student default, guaranty agencies also serve as the FFEL program backstop by providing FFEL loans to students who cannot get them through conventional means. A guaranty agency must provide these loans of last resort (LLR) to students whose loan applications have been denied at least once. (Each state sets its own LLR standards, though none can require more than two denials to qualify.)

There are three ways LLR can be issued: (1) by the guarantor using its own funds; (2) by a lender that is chosen by the guarantor; or (3) by the guarantor using federal advances.

Lender or guarantor issued LLR using own funds. If a guaranty agency issues an LLR using its own capital, then the fee structure is the same as if it were holding a conventional FFEL loan, with one major exception. The guarantor still receives all special allowance payments and guaranty agency fees (loan processing and issuance, etc.), but the loan is 100 percent guaranteed by the federal government. A defaulted LLR, therefore, does not result in any cost to the guarantor. The same is also true if a loan company is tasked with offering LLR by the guaranty agency. For that to occur, however, the lender must first explain why it is willing to make LLR, but not conventional FFEL loans.

LLR issued by a guarantor using federal advances. If a guaranty agency does not have enough funds to make an LLR, it can request federal advances from the Secretary. Loans issued using these funds are federal assets, meaning they do not receive special allowance payments and may be reclaimed by the Secretary at any time. Guaranty agencies are paid a flat fee of $20 for offering these types of LLR.