What Are Federal Student Loans?
Student loans are one of the most common forms of financial aid offered to undergraduate and graduate college students. These loans can be divided into two categories: 1) federal student loans that are funded by the government and administered by the U.S. Department of Education, and 2) private student loans that are funded and managed by banks and other private lenders.
Once you accept a federal student loan, the money will be sent to your school to be used for tuition and possibly other expenses for one academic year. You'll have to re-submit an application for each year that you expect to need financial aid, which means you could end up with multiple student loans by the time you graduate. Depending on your repayment plan, you'll be required to pay back the money — including interest — in monthly installments after you graduate or when your enrollment drops below half-time status.
In general, federal student loans are preferred over private loans because they typically feature lower interest rates, offer more flexibility in repayment terms, and may be partially or wholly forgiven or discharged for a variety of reasons.
Federal Loan Interest Rates
Interest is defined as "the cost of borrowing money." You can also think of it as the additional fees you pay for the privilege of borrowing money. Interest rates can be fixed, meaning they're locked in for the period of time when you'll be repaying the loan, or variable, which means they can fluctuate — sometimes dramatically — over the life of the loan. Variable interest rates can make it hard to predict how much you'll actually have to pay for the loan.
Because loan interest can add substantially to the total cost of your college education, you need to understand interest rates before you agree to a loan. The four federal student loan types have different fixed interest rates, which currently range from 4.99%-7.54%. These rates may vary over time, depending on when you take out your loan, but once you've accepted a federal student loan, your interest rate will remain the same throughout the life of your loan. Compared to private student loans that may have fixed or variable rates as high as 14%, federal student loans are often a more appealing option.
Federal student loan borrowers are also required to pay loan fees on these loans, currently ranging from about 1%-4.2%. However, these are taken out of the loan disbursement, and are not included in your loan repayments.
Federal Student Loan Servicers
If you take out a government student loan, your loan will be assigned to one of several authorized servicers that will manage your account. These servicers currently include CornerStone, FedLoan Servicing, Great Lakes Educational Loan Services, Inc., and approximately six others, but the list changes from time to time. Borrowers have no control over which servicer receives their loan, and the assignments cannot be changed.
Types of Federal Student Loans
Over the years, there have been several federally funded student loan programs. Occasionally, you may see references to Stafford loans or Perkins loans, but these programs are no longer issuing new loans. Currently, there is just one overall federal program — the William D. Ford Federal Direct Loan program, commonly known as Direct Loans. Within this program, four types of loans are available. Depending on your or your family's income, you may be offered one or more of these loan types as part of your financial aid package.
How To Apply for Federal Student Loans
Applying for a federal student loan is part of the larger process of applying for financial aid. For some students, the amount of aid offered by each school — and specifically the amount of student loans needed — may influence their decision about which school to attend.
Federal Student Loan Repayment
As with any type of loan, it's important to make your monthly loan payments on time and in full. If you miss more than nine payments, your loan will go into default, which can have serious repercussions on your credit history. Rather than defaulting on your loan, contact your loan provider to discuss possible options, such as deferment and a change to your repayment plan. Visit StudentAid.gov for a detailed explanation of your repayment options.
The Department of Education offers quite a few federal student loan repayment plans, some of which are tied to the borrower's income. Initially, you'll be assigned to a plan based on your circumstances, but you'll probably be able to change plans if your circumstances change. Be sure to notify your loan servicer whenever you go through a significant life change, such as graduating from college, switching schools, or changing your name or address.
The following plans are available for new Direct loans:
Under the Standard Repayment Plan, you'll be required to make monthly payments for up to 10 years. If you've consolidated several loans into one, you may have a loan period of up to 30 years. You'll make higher monthly payments, but you'll save money on interest. However, this plan does not qualify for Public Student Loan Forgiveness.
Similar to the Standard Repayment Plan, this plan requires you to pay off the loan in monthly installments over 10 years or over 30 years for consolidated loans. However, you'll start with smaller payments that gradually increase every two years. It's based on the assumption that your income will increase over time. This plan also does not qualify for Public Student Loan Forgiveness.
If you've borrowed more than $30,000 in Direct loans, this plan that requires monthly payments over 25 years may be a good option for you. Your federal student loan payments will be lower, but you'll pay more in interest. This plan features fixed or graduated payment options. This plan also does not qualify for Public Student Loan Forgiveness.
The REPAYE plan caps your monthly payments at 10% of your discretionary income, and your payments are recalculated each year based on income and family size. You'll be required to make payments for 20 years on an undergraduate loan and 25 years for a graduate or professional loan.
The PAYE plan also limits your monthly payments to 10% of your discretionary income, and your payments are also recalculated each year based on income and family size. After making payments for 20 years, you may qualify for loan forgiveness on the balance of the loan. Direct Loans and many consolidated loans qualify for this plan.
Under an IBR plan, your monthly payments will be 10-15% of your discretionary income for 20-25 years. If your annual income meets the eligibility criteria, you may qualify for loan forgiveness on the balance. This is often a good option for those who have high debt relative to their income.
With this plan, your monthly payments will be either 20% of your discretionary income or an income-based amount based on 12 years of payments, whichever is lower. Here again, payments are recalculated each year based on income and family size. However, these payments will be stretched out over 25 years.
If borrowers ever experience economic hardship or have trouble making their federal student loan payments, they should contact their loan servicer. The servicer may be able to help by offering a deferral or some other solution.
In response to the economic hardship caused by the Covid-19 pandemic, the Department of Education decided to defer monthly payments on all student loans. It also temporarily reduced the interest rate to 0% and discontinued collections on defaulted loans. The Supreme Court deciding whether to rule in favor of President Biden's broader student debt relief plan or not. At this time, these policies are scheduled to end either 60 days after June 30, 2022, or 60 days after the Supreme Court makes a ruling, whichever comes earlier. Borrowers are welcome to continue making payments in the meantime if they choose.
Federal Student Loan Forgiveness
Under certain circumstances, federal student loans may be partially or fully forgiven or discharged. For instance, if a borrower becomes permanently disabled, declares bankruptcy, or dies before paying off the loan, the government discharges the debt, meaning that the borrower or the borrower's family is no longer responsible for making federal student loan payments.
There are also a number of federal student loan forgiveness programs designed to provide student loan relief. Perhaps the best known of these programs is the Public Service Loan Forgiveness (PSLF) program, which forgives the remaining debt for individuals who take on qualifying public service jobs and have made at least 120 qualifying payments on their student loans. Special federal and state government programs also exist to relieve the student loan debt for people in specific professions, such as teachers, nurses, doctors, and lawyers.
Last year, the Biden administration took dramatic action to stimulate the economy by announcing a major student loan forgiveness program. By applying to the Student Loan Debt Relief program, borrowers may have up to $20,000 forgiven, depending on their income and the terms of their original financial aid agreement. Applications for student debt relief are currently on hold while the program waits for a decision from the Supreme Court on the legality of this program. Any applications previously submitted are being held during this pause.
Federal Student Loans vs. Private Student Loans
Although the federal government sets limits on the amount of money students can borrow, which may force some students to seek additional funding through private student loans or other sources, federal student loans offer a number of clear advantages:
Federal loan interest rates are usually lower than private loan rates, and they are usually fixed rates. Borrowers know exactly how much they'll have to repay over time.
Federal loan applicants are generally approved right away without a credit check. Private loan applicants need to undergo a more extensive approval process, and they may need a co-signer to get approved.
The government offers a range of repayment plans for federal student loans, many of which are based on income. Borrowers can also switch plans throughout the life of their loans as needed to adapt to changing circumstances.
The government is also able to provide support during periods of financial difficulty, and it is willing to forgive some or all of a student's loans under certain criteria.
The following table provides additional information regarding the difference between federal and private student loans: