The ultimate guide to federal student loans

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For prospective students, the long-term economic benefits of attending college have never been higher, but so have the costs: Attending a four-year college during the 2018–19 school year cost $9,200 on average at public schools and $35,800 on average at not-for-profit private schools. If you don’t have the cash to pay the entire bill upfront, federal student loans can be a good place to turn. Here’s what you should know about your options.

Types of federal student loans

Federal student loans are currently available under the William D. Ford Federal Direct Loan Program. Within that program, you can choose from four main types of loans.

Direct Subsidized Loan

Undergraduates who can demonstrate financial need may qualify for subsidized loans, which come with an interest rate of 2.75 percent for the 2020–21 academic year. The U.S. Department of Education will pick up your interest tab during school (as long as you’re enrolled half time), for the first six months after you’re done with school and during a deferment period.

Direct Unsubsidized Loan

Direct Unsubsidized Loans are for undergrads and grad students, along with those pursuing a professional degree. There is no financial need requirement. You’re on the hook for all interest charges, which come at a rate of 2.75 percent for undergraduates and 4.3 percent for graduate and professional students.

Direct PLUS Loan

Direct PLUS loans come in two types. Grad PLUS loans are available for professional students and graduate students who have maxed out their Direct Unsubsidized Loan limits, and parent PLUS loans are for parents of undergraduate students. Applicants can borrow up to the full cost of attendance, less other financial aid, and the interest rate for 2020–21 is 5.3 percent.

Direct Consolidation Loan

If you have several types of federal student loans, you can combine all of them into one loan with one interest rate and monthly payment using a Direct Consolidation Loan.

Federal loan interest rates

The U.S. Congress sets the federal student loan interest rates each year. Interest rates may vary each year, but they’re fixed once you receive the loan funds. Interest rates on federal student loans for the 2020–21 school year are as follows:

  • Direct Subsidized Loan: 2.75 percent.
  • Direct Unsubsidized Loan: 2.75 percent (undergraduate) or 4.3 percent (graduate).
  • Direct PLUS Loan: 5.3 percent.

Since 2013, interest rates on federal loans have been tied to the 10-year Treasury note. For Direct Subsidized and Direct Unsubsidized Loans, interest rates are the 10-year yield plus 2.05 percent or 3.6 percent for undergraduate and graduate students, respectively. For Direct PLUS loans, interest rates are the 10-year yield plus 4.6 percent. The 10-year Treasury is a gauge of investor outlook for economic growth, which means that a faster-growing economy makes it more expensive for people to go to college and an economic downturn makes it cheaper.

“The 10-year Treasury note is of comparable maturity to student loans,” says Mark Kantrowitz, Savingforcollege.com publisher and vice president of research. “The goal was to match the interest revenue of the student loans to the interest expense as closely as possible.”

How much can I borrow with a federal student loan?

The amount you can borrow partly depends on your status as an independent or dependent student, which is based on whether your parents financially support you. How much you can borrow is also based on your year in school, and only a certain amount may be subsidized each year.

If you’re an undergrad student and your parents don’t qualify for a parent PLUS loan, you may be able to borrow up to the independent undergraduate limits.

Dependent undergraduate student Independent undergraduate student Graduate or professional degree student
Year 1 $5,500 (up to $3,500 may be subsidized) $9,500 (up to $3,500 may be subsidized) $20,500
Year 2 $6,500 (up to $4,500 may be subsidized) $10,500 (up to $4,500 may be subsidized) $20,500
Year 3 and beyond $7,500 (up to $5,500 may be subsidized) $12,500 (up to $5,500 may be subsidized) $20,500
Lifetime maximum limit $31,000 (up to $23,000 may be subsidized) $57,500 (up to $23,000 may be subsidized) $138,500, including federal undergraduate loans (up to $65,500 may be subsidized)

Benefits of federal student loans

Federal student loans come with several borrower protections, which can make it easier to manage your debt once you graduate. Some of the benefits include:

  • Easier qualification. Direct Subsidized and Direct Unsubsidized loan borrowers won’t have to go through a credit check during the application process. So if you’re new to credit, your lack of credit history won’t stop you from borrowing money to pay for school.
  • Flexible repayment terms. The standard repayment plan lasts 10 years, but you can apply for one of eight different repayment plans if the standard plan doesn’t fit with your budget — for instance, you may choose a repayment plan that increases monthly payments over time or one that is based on your income.
  • Debt forgiveness options. There are a few different ways to access loan forgiveness programs with federal student loans. Income-driven repayment plan forgiveness, for example, forgives any balance remaining after a 20- or 25-year repayment period. Public Service Loan Forgiveness, on the other hand, discharges your loan if you work for the U.S. government or a nonprofit and you make 120 on-time payments.
  • Hardship options. With federal student loans, you can receive a forbearance or postponement if you lose your job, endure a health scare or go back to college.

Drawbacks of federal student loans

Federal student loans are generally more consumer friendly than private student loans, but they do come with drawbacks, including:

  • Lower borrowing limits. Both federal and private student loans come with borrowing limits, but they’re lower with federal student loans. You’ll need to supplement your federal student loans with other sources of aid if you hit these limits.
  • Origination fees. All federal Direct loans come with an origination fee, which is taken from the loan proceeds. For the 2019–20 school year, the fee is 1.059 percent for Direct Subsidized and Direct Unsubsidized loans and 4.236 percent on Direct PLUS loans.
  • Not available for all schools: Applicants can only use federal Direct loans to pay for education at accredited postsecondary institutions. If your school does not qualify, then you’ll have to find some other type of financial aid.
  • Credit check for certain loans. The Department of Education does run a credit check for Direct PLUS loan applicants. If you have an “adverse credit history,” you’ll need to either find a co-signer who will take on the responsibility of paying the loan if you cannot or prove to the Department of Education, with documentation, that your poor credit report is due to circumstances beyond your control.
  • Higher interest rates: Graduate students, professional students and parents of undergrad students may apply for a Direct PLUS loan, which comes with an interest rate of 5.3 percent. But borrowers with strong credit may get a better interest rate on a private student loan, as long as they’re okay relinquishing the built-in protections of a federal loan.

How to apply for federal student loans

Applying for a federal student loan is free, and it starts with submitting the Free Application for Federal Student Aid (FAFSA). The application opens on Oct. 1 each year, and submission deadlines depend on your school and state. The FAFSA should be your first step when searching for financial aid for college, since it won’t affect your credit score as an application for private student loans might.

What to expect after you submit the FAFSA

Here are some of the steps you’ll take when applying for a federal student loan:

  1. Fill out the FAFSA. Applicants will need to complete and submit the Free Application for Federal Student Aid (FAFSA) form. If you complete the form online, your application will be processed within three to five business days. Processing a paper application will take about seven to 10 days.
  2. Receive your SAR. After you submit the FAFSA, the Department of Education will send you a student aid report (SAR), which explains your eligibility for federal student aid.
  3. Read your offers. The colleges you listed on your FAFSA will have access to your financial information. They’ll use it to calculate your financial aid offer, which may include federal student loans, federal grants and work-study programs. These offers vary with each school.
  4. Accept the financial aid. Contact your school to accept the financial aid. If it includes federal student loans, the school will tell you how to accept them.
  5. Attend loan counseling. Before you receive your loan funds, you’ll need to complete entrance counseling.
  6. Sign for the loan. Read through and sign the master promissory note, which includes the terms of the loan.
  7. Renew your application. You’ll need to submit a new FAFSA each school year.

The bottom line

Because federal student loans come with so many borrower protections, it’s a good idea to start with this type of aid when you need to pay for school. Federal student loans generally come with borrowing limits, so you may need to supplement these loans if you attend an expensive school.

To apply for federal student loans, you’ll need to fill out the FAFSA form and submit it before the deadline each year. Before accepting any federal student loan funds, make sure you understand the loan terms and how you’ll repay the money.

Featured image by Zak Kendal of Getty Images.

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