Foreign students were handed taxpayer-funded loans and grants worth £5.4m to which they were not entitled, a public spending watchdog revealed.
The payments were exposed by an investigation prompted by a huge surge in applications for financial help with living costs from European Union nationals, many from Romanians.
The Department for Business, Innovation and Skills (BIS) suspended payments and ordered 23 colleges to halt recruitment last year amid fears the system was being abused.
But the head of an influential Commons committee said the report exposed a failure to introduce proper controls on a significant expansion of private provision and accused the Government of failing to respond to clear warnings and danger signs.
Until September last year, the Student Loans Company (SLC) relied solely on the word of students that they had lived in the UK for the three years needed to qualify for maintenance support.
An emergency review of more than 11,000 applications found half could or would not provide proof - such as bank statements, payslips or utility bills - and that 992 of those had already been given the money before the stricter checks were imposed.
Of the potentially ineligible claims, 84% came from students registered for courses at just 16 "alternative providers" - private and charity-run institutions which do not receive state funding, the NAO said.
It also pointed to the fact that the drop-out rate at nine alternative providers - several of them among those accounting for the vast bulk of the suspect applications - was higher than one in every five students, five times the average for higher education.
But BIS had not set any threshold for what was an acceptable rate where students are receiving support from public funds, it noted.
It found as many as 20% of applicants from the alternative sector may not have been registered with the appropriate qualification-awarding body for Higher National Diplomas or Certificates - something SLC is unable to verify and oversight bodies had failed to look into.
The NAO also concluded that there was a "lack of clarity within BIS and its partner organisations about which courses were approved for student support" as there was a variety of separate lists.
Between 2012 and 2014, seven providers had payments suspended over concerns they had enrolled students on unapproved courses and in three cases, student support payments were stopped over suspected incorrect information about attendance.
Officials from BIS, SLC and the Higher Education Funding Council for England face a grilling by the Commons public accounts committee (PAC) over the issue and efforts to resolve it on December 15.
A push to increase diversity in higher education - including increasing the maximum tuition loan fee available from £3,375 to £6,000 - were announced in 2011 and helped fuel a rapid expansion of places concentrated across a relatively small number of colleges.
Claims for support from EU nationals have soared from 7,000 in 2010/11 to 53,000 in 2013/14 with the total approved in financial assistance rising from £50 million to £675 million over the same period.
The chair of the PAC, Labour MP Margaret Hodge, said it had been done without proper safeguards against abuse, branding the £5.4 million agreed in loans to ineligible students "incredible".
"The Department went ahead with its reforms to expand the role of private colleges without ensuring there were controls in place to ensure that taxpayers' money was used for its intended purpose of supporting higher education and not for private gain," she said.
"This extraordinary rate of expansion, high drop-out rates and warnings from within the sector ought to have set alarm bells ringing.
"As Government hands more and more taxpayers' money to private companies and institutions to deliver services for the public good, we have to be able to follow the taxpayers' pound wherever it is spent."
SLC said it had so far clawed back more than £1.4m and expected to have recovered all remaining overpayments by February 2015.
A BIS spokesman said: "Alternative providers give a wider choice of higher education to students. It is important that the high quality of our higher education system is sustained and the Government has taken a number of steps to improve the regulation of alternative providers.
"We will continue to investigate and take robust action against any provider failing to meet the high standards expected of them.
"From 2014/15 academic year, BIS introduced student number controls for alternative providers to impose limits on the growth in full-time student numbers. As the NAO report notes we have implemented new controls to ensure that there is a clear register of designated courses."
The Government would consider whether to introduce maximum drop-out rate thresholds, he indicated.