The federal government makes subsidized federal financing for higher education widely available. The extent of the subsidy varies over time with interest rate and credit market conditions. A loan provision that has added considerably to the size and volatility of the subsidy is the consolidation option, which allows students to convert floating rate federal loans to a fixed rate equal to the average floating rate on their outstanding loans. We develop a model to estimate the option's cost and to evaluate its sensitivity to changes in program rules, economic conditions, and borrower behavior. We model borrower behavior using data from the National Student Loan Data System, which provides new insights on the responsiveness of consumers to financial incentives.
G28: Financial Institutions and Services: Government Policy and Regulation
H31: Fiscal Policies and Behavior of Economic Agents: Household
H23: Taxation and Subsidies: Externalities; Redistributive Effects; Environmental Taxes and Subsidies