Everything You Need to Know About Federal Student Loans
Many people take out student loans to help pay for higher education. In fact, the most recent census data published in September 2022 shows that approximately one in five Americans (17.4%) have student loan debt. The vast majority of these loans — about 92% — are federal loans owned by the U.S. Department of Education.
If you're in college or planning to enroll soon, statistics suggest that you'll borrow money to pay for your degree. A 2022 NerdWallet analysis of National Center for Education Statistics data predicts that first-year college students will borrow an average of $39,500 over four or five years to earn a bachelor's degree and significantly more for a graduate degree. Given the likelihood that you'll be taking out a federal student loan, it's essential for you to understand how these loans work.
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.
Direct Subsidized Loans
Subsidized loans are available to eligible undergraduate students who demonstrate financial need. These loans can be used for tuition and other costs at colleges and career schools. The government covers the loan payments while the borrower is still in school and for six months after graduation. Undergraduates can take out a maximum of $23,000 in subsidized loans and graduate students a maximum of $65,500, so those who need additional funding will need to seek out other types of loans or alternate sources.
Direct Unsubsidized Loans
Unsubsidized loans are typically offered to undergraduate, graduate, and professional students. Eligibility is not based on financial need. Borrowers must start paying interest from the time of the first disbursement, making this type of loan somewhat less appealing than a subsidized loan. If you choose not to make interest payments while in school, the interest will accrue and be capitalized once you leave. The government sets additional limits on the yearly and aggregate amounts that a borrower can take out in unsubsidized loans, which varies depending on the amount of subsidized loans taken out by the borrower.
Direct PLUS Loans
If a student's financial aid package does not cover all of their expenses, they may be eligible for a Direct PLUS loan. These loans are available to the parents of undergraduate students, as well as graduate and professional students. A credit check is required to qualify, and borrowers with an adverse credit history may be required to make special arrangements. However, Direct PLUS loans often have higher interest rates and fees, so borrowers may want to look into private loans, mortgages, or other financing options before choosing one of these loans.
Direct Consolidation Loans
Students who end up with multiple loans may be able to refinance their federal student loans and combine them into a single loan with a single loan servicer. The advantages of a consolidation loan are the ability to lock in a fixed interest rate and make just one monthly payment. Borrowers, however, may lose their progress toward loan forgiveness by consolidating.
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.
1
Apply for financial aid. The first step in the process is to fill out and submit a Free Application for Federal Student Aid, or FAFSA. Government representatives will evaluate your application and forward their findings to the school you attend. Your school's financial aid counselors will then evaluate your application to determine if the school can provide any additional funding. Eventually, your school will send you a financial aid offer letter, which may include one or more types of federal student loans.
When you're a first-year student submitting a FAFSA form, the government's assessment of your application will go to all of the schools you've applied to, and each school that has accepted you for enrollment will send you a financial aid offer letter.
2
Apply for private scholarships. One way you may be able to reduce the amount of student loans you need is to obtain money through private scholarships. Many professional, civic, and philanthropic organizations offer scholarships — some based on financial need and some on merit. When you consider how much you'll have to pay in interest, you can see how even the smallest scholarships can benefit you by reducing the amount of money you need to borrow.
3
Compare offers. First-year students will receive financial aid offers from all the schools where they've been accepted. Compare these offers carefully, as one school may offer a more favorable package that leaves you with less debt.
Even if you're not a first-year student and have received just one offer from the school where you're enrolled, you should still examine each aspect of the offer carefully. If loans are involved, be sure you understand the terms and repayment plan. Use a student loan calculator to determine how much you'll ultimately pay, and research the salary potential of your desired career to evaluate whether you'll be reasonably able to pay it off. If you need help understanding an offer letter, contact the school's financial aid office to get more information.
4
Negotiate and accept your financial aid offer. Students should avoid borrowing more money than they need to complete the academic year, so before you accept an offer, make sure you've considered any loans in the context of money you've received through private scholarships or other sources. You may be able to minimize the amount of your student loan or eliminate it altogether. Your financial aid counselor can help you make these final adjustments before you sign off on your financial aid package.
5
Complete any loan-related paperwork. If you're getting a federal student loan, you may need to complete something called entrance counseling that will explain your financial responsibilities as a borrower. You'll then need to sign a master promissory note for each loan. Keep in mind that by signing that promissory note, you're committing to paying off the loan, even if you don't graduate from college or have a hard time making payments in the future.
6
Apply for private student loans, if needed. Despite all of the grants, scholarships, and federal loans you've received, you may still need more money to cover tuition and other expenses for the academic year ahead. If so, you may need to apply for a private student loan from a bank or lending institution.
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.
Repayment Plans
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.
Repayment Pauses
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:
| Federal Student Loans | Private Student Loans | |
|---|---|---|
| Interest rates | Fixed interest rates and fixed monthly payments | Fixed or variable |
| Borrowing limits | Strict borrowing limits based on degree level, loan type, and dependent status | Up to 100% of the school-certified cost of attendance |
| Credit checks | None for Subsidized and Unsubsidized loans; required for most PLUS loans | Credit checks and good credit history required; co-signer may be required |
| Monthly payments | May begin when you graduate, leave school, or drop below half-time status | May begin during school or after graduation |
| Subsidies | With Subsidized loans, the federal government makes interest payments while you're still in school | None; interest starts accruing immediately |
| Prepayment penalties | None | Varies by lender |
| Hardship assistance | Students may be eligible for deferment or forbearance programs | Students rarely qualify for deferment or forbearance programs |
| Forgiveness options | Students may be eligible for income-driven repayment plans, PSLF, and other forgiveness programs | No access to federal repayment plans or forgiveness programs |