What is a federal Direct Loan?

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Attending college can take a toll on your finances, with most students paying upward of $20,000 annually. Students can look to scholarships, grants and work-study programs to help pay for the cost, but many students also need to explore student loans. A federal Direct Loan is a type of student loan issued by the Department of Education that both undergraduates and graduates can use to cover the cost of education. Keep reading to learn how a federal Direct Loan works and who it’s best for.

What is a federal Direct Loan?

The William D. Ford Federal Direct Loan Program, more simply referred to as a “Direct Loan,” is the U.S. government’s student loan program. These federal loans are available to undergraduate students, graduate and professional students and parents of undergraduate students. There are four types of federal Direct Loans, which include need-based loans and loans that aren’t based on financial need.

How does it work?

To see whether you’re eligible for Direct Loan financial aid, you’ll need to complete and submit the Free Application for Federal Student Aid (FAFSA) by the form’s deadline. Your school might also have its own FAFSA deadline to determine your financial aid award, so ask your financial aid office for due dates.

Once your school reviews your FAFSA, it determines which types of aid you’re eligible for based on your expected family contribution, financial need and other factors. If you’re eligible for federal Direct Loans and have been awarded aid by your school, you’ll see the offer in your award letter.

You can choose to take a portion or all of the Direct Loan aid offered to you. You’ll need to complete entrance counseling, which reminds you of your responsibility upon accepting federal Direct Loans. Borrowers are also required to sign a Master Promissory Note, which outlines the details of your loan, including important information about repayment.

Once these steps are complete, the Department of Education will disburse the funds directly to your school. The school will then apply funds toward tuition and fees and other costs that you owe. If there are any remaining loan funds, the school will disburse it to you or your parent (for Direct PLUS Loans).

Types of Direct Loans

There are a few different Direct Loans; the type you choose depends on your financial need and academic level.

Direct Subsidized Loan

A Direct Subsidized Loan is only available to undergraduate students who’ve demonstrated financial need on their FAFSA. It offers the biggest advantage for student borrowers, since interest is subsidized by the federal government (meaning the Department of Education pays for accruing interest) during the following scenarios:

  • When the student is enrolled at least half time in school.
  • During the first six months after graduating or leaving school.
  • When the loan is in deferment.

By default, Direct Subsidized Loans are placed on a standard repayment plan. This plan divides your federal student loans into fixed, equal payments over a 10-year term. But you can change your repayment plan for free at any time. Currently, the interest rate on Direct Subsidized Loans is 2.75 percent, and a small loan fee based on a percentage of your loan amount will be deducted before funds are disbursed.

Direct Unsubsidized Loan

Eligible undergraduate, graduate and professional students have access to Direct Unsubsidized Loans. Like their name suggests, Direct Unsubsidized Loans are similar to Direct Subsidized Loans, but they don’t subsidize interest.

Instead, interest accrues, and students are responsible for any interest as soon as funds are disbursed. However, while a student is enrolled at least half time in school, or in deferment or forbearance, they can choose to not make interest payments. This will cause the accrued interest to capitalize — in other words, be added to the total loan balance.

Interest on Direct Unsubsidized Loans is also 2.75 percent for undergraduate borrowers and 4.3 percent for graduate students. Both rates are fixed for the entire term, and an origination fee applies prior to loan disbursal. These loans are placed under the standard repayment plan automatically, but you can choose to change your repayment plan at any time.

Direct PLUS Loan

A Direct PLUS Loan is available to eligible graduate or professional students or eligible parents of an undergraduate student. Depending on the borrower, it’s commonly referred to as either a “grad PLUS loan” or a “parent PLUS loan.”

It’s not a need-based loan; in fact, it requires a credit check, and you must meet the Department of Education’s borrower requirements to be approved for a Direct PLUS Loan. However, applicants who don’t have strong credit might still be awarded funding if they can provide an endorser for the loan. An endorser is similar to a co-signer who guarantees that they’ll repay the loan if you can’t. You might also be awarded a PLUS Loan despite poor credit history if you have proof of an extenuating circumstance that led to your adverse credit.

Most schools require a separate online application process for this type of Direct Loan, but students should still submit their FAFSA by the deadline. The interest rate on grad PLUS and parent PLUS loans is a fixed 5.3 percent, and an origination fee will be deducted before funds are disbursed to the school.

Direct Consolidation Loan

Borrowers who’ve taken out multiple federal student loans can simplify their repayment experience through a Direct Consolidation Loan. This type of loan combines all of your eligible outstanding federal loans into one loan, with one monthly payment and one fixed interest rate. To consolidate your loans, they’ll need to be in repayment.

It’s free to apply for a Direct Consolidation Loan, and you have the option of extending your loan term up to 30 years. This reduces your monthly payment, but it also means that you’ll pay more toward your student debt over time.

There are other downsides to a Direct Consolidation Loan. Your fixed interest rate is determined based on the weighted average of all loans being consolidated, so you won’t necessarily save on interest costs using this method. Consolidation also adds any outstanding interest on the original loans into the new consolidation loan’s principal balance.

Finally, if you’re working toward Public Service Loan Forgiveness, a Direct Consolidation Loan will erase credit toward the 120 payments required for forgiveness. You’ll need to start the process over again.

How much money can I borrow in a federal Direct Loan?

Federal Direct Loan borrowing limits vary depending on the Direct Loan type and student status.

  • Dependent undergraduate students may borrow up to $31,000 total in Direct Loans, $23,000 of which may be subsidized.
  • Independent undergraduate students may borrow up to $57,500 total in Direct Loans, $23,000 of which may be subsidized.
  • Independent graduate or professional students may borrow up to $138,500 in Direct Unsubsidized Loans and up to the total cost of attendance with grad PLUS loans.

Who a Direct Loan is best for

A Direct Loan is best for students and parents who’ve exhausted grant and scholarship opportunities but still need additional aid to supplement education costs. Since most federal Direct Loans don’t require a credit check, it’s ideal for borrowers who haven’t built up their credit yet or who have adverse credit.

It’s also the best option particularly for those who have demonstrated financial need and qualify for Direct Subsidized Loans. And since all interest rates on Direct Loans are fixed, it’s ideal for borrowers who prefer predictable monthly payments.

Final considerations

It’s best to avoid student loan debt, if possible. But as college costs continue to rise, it might be necessary to take out student loans to pursue your desired educational path. If you must borrow money for school, leverage federal Direct Loans first. You’ll secure borrowers protections, like income-driven repayment plans, loan forgiveness and extended deferment or forbearance that private student loans don’t typically offer.

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Written by
Jennifer Calonia
Contributing writer
Jennifer Calonia is an L.A.-based writer and editor. She's covered topics like debt, saving money and credit cards. You can find her work on Business Insider, Forbes and more.
Edited by
Student loans editor