Recognizing the rising cost of earning a degree, the federal government began guaranteeing student loans through a network of banks and private lenders in 1965.
The original Federal Family Education Loan program (FFEL) was meant to offer assistance to those who could not pay for college expenses out of pocket through affordable loans.
While the reasoning for federal student loans remains the same, the loan programs of today look different.
With the passage of the Health Care and Education Reconciliation Act of 2010, students and their parents were eligible to borrow through the Federal Direct Loan Program through the Department of Education. Individuals can borrow funds up to certain limits to fund their college aspirations with benefits such as low fixed interest rate, a variety of repayment options, forgiveness opportunities, and no check of credit.
Currently, federal student loans account for 90% of the $1.4 trillion outstanding student loan debt across more than 43 million borrowers.
What Are the Different Types of Federal Student Loans?
There are several different types of federal student loans available to a variety of borrowers. These include Direct Stafford Loans, Perkins Loans, Grad PLUS Loans, Parent PLUS Loans and consolidation loans, and each type has specific criteria for who is eligible, the interest rate offered, loan amounts, and repayment programs.
Direct Stafford Loans
Federal student loans categorized as Direct Stafford Loans comes in two broad types: subsidized and unsubsidized loans. With Direct Subsidized loans, undergraduate students that have a financial need can borrow from the Department of Education so long as they are attending school at least half-time at an accredited college or university. Borrowers have a fixed interest rate of 4.45%, and repayment does not begin until six months after leaving school at least half-time. Direct Subsidized loans that are in deferment while a student is still attending school accrue interest, but this is paid by the federal government, making them more affordable for borrowers who have a financial need.
Direct Unsubsidized loans are available to both undergraduate and graduate level students, and there is no requirement to prove financial need to receive funding. The interest rate offered to undergraduate students requesting Direct Unsubsidized loans is a fixed 4.45%; graduate or professional degree students receive a fixed interest rate of 6%.
Unlike Subsidized loans, borrowers with Unsubsidized loans accumulate interest on loan balances from the time a loan is funded. Should the interest remain unpaid while a student is in school, that amount is capitalized or added on to the total loan amount that must be repaid over time.
Borrowing limits for students enrolled in an accredited school are aggregate and based on how far along they are in their degree program and dependent status. First-year undergraduate students may borrow up to $5,500, with no more than $3,500 in subsidized loans if they are claimed as a dependent by their parents. Independent first-year students can borrow up to $9,500, with no more than $3,500 made up of subsidized loans. Second-year undergraduate dependent students can borrower $6,500, with no more than $4,500 in subsidized loans; independent students may borrower $10,500, with the same $4,500 subsidized loan limit.
Undergraduate students completing their third year or beyond may borrow $7,500 for the year, with no more than $5,500 in subsidized loans as a dependent. The total loan amount increases to $12,500 for independent students, with the same subsidized limit. Graduate and professional students are all considered independent and therefore can borrow up to $20,500 per year in unsubsidized loans. The aggregate loan limit for undergraduate students for all years is $57,500 with no more than $23,000 in subsidized loans; graduate and professional students may borrow up to $138,500 including undergraduate loans, with no more than $65,500 in subsidized loans.
Another option for students to finance their education is the Perkins Loan program. With a Perkins Loan, undergraduate, graduate, and professional degree students may borrow if they can show a financial need and there are federal funds available at the college or university at which they are enrolled. In this case, the school is the lender, not the Department of Education, and repayment is made directly to the institution.
The interest rate for Perkins Loans is a fixed 5%, and undergraduate students may borrow up to $5,500 per year with a lifetime limit of $27,500. Professional and graduate degree students can borrow up to $8,000 per year, with a lifetime limit of $60,000 including any Perkins Loans taken out for undergraduate expenses. Perkins Loan borrowers do not owe payments during their time at school, or for a six-month grace period after leaving school.
Grad PLUS Loans
Graduate students may borrow funds for their education through the Grad PLUS program, so long as they are enrolled at least half-time in an accredited college or university. Grad PLUS loans are offered through the Department of Education, and borrowers with a strong credit history are eligible to request funds through the program.
Borrowers receive a fixed interest rate of 7% with Grad PLUS loans, and they may borrow up to the full cost of attendance for fulfilling their graduate degree program, less any other financial aid received. Interest accrues on Grad PLUS loans from the time funds are dispersed, but borrowers do not owe payments until six months after leaving school.
Parent PLUS Loans
Parent PLUS loans are similar to Grad PLUS loans, but the parent of the student is the primary borrower. This program was made available to parents who want to pay for a child’s education but do not have the funds to contribute out of pocket. Like Grad PLUS loans, Parent PLUS loans are not based on financial need but rather strong credit history.
Parent PLUS loans have a fixed interest rate of 7%, and interest starts accruing when the loan funds are received. Parents can request a deferment on repayment while their child is attending school at least half-time and for an additional six months after the child graduates. The maximum amount a parent may receive in Parent PLUS loans is the total cost of attendance, minus any other financial aid received by the child.
Federal Consolidation Loans
Federal student loans are dispersed periodically over the time a student is attending school, meaning borrowers may end up with several federal student loans at graduation. A consolidation loan through the federal government is available to help streamline these multiple loans. With a consolidation loan, borrowers may request a single, larger loan to replace multiple, smaller loans with a single monthly payment and a single interest rate.
Nearly all federal student loans are eligible for consolidation, and borrowers do not have to provide evidence of a strong credit history to qualify. The interest rate offered on consolidated federal student loans is fixed but varies for each borrower because it is the weighted average of the interest rates on outstanding loans included in the consolidation, rounded up to the nearest one-eighth percent.
Consolidating federal student loans makes borrowers eligible for additional repayment plans, discussed below. There is no grace period or deferment period on consolidated loan repayment because consolidation only takes place once the student has left at least half-time status or graduated.
How to Apply for Federal Student Loans
Applying for federal student loans follows a simple process, but borrowers need to be aware of what to expect. First, every student applying for federal student loans must complete the Free Application for Federal Student Aid (FAFSA) either online or via paper submission. When completing the process online, borrowers need to create an FSA ID which is used to confirm identity and electronically sign federal student loan documents. The FAFSA is available beginning October 1 each year, and a completed application is due by the end of June.
The FAFSA asks for information about the borrower, including social security number, date of birth, address, and financial circumstances including recent tax year numbers. Several questions are also asked about the borrower’s parents which help determine if a borrower is a dependent or an independent student. This information must be provided each year to determine the amounts of financial aid available to each student, based heavily on their financial situation and contributions from family.
Once the FAFSA is completed, it is shared with colleges or career schools the borrower included so that the financial aid office at the school can identify funds that may be available to the borrower. Federal student loans of all types are included in the FAFSA review, as well as work-study and grant opportunities.
After reviewing a student’s FAFSA, the school will send out an award letter detailing the types of aid available as well as the amounts. These are based on the cost of attendance for each school, the expected family contribution (EFC), the student’s year in school, and his or her enrollment status. Federal student loans accepted by the student are dispersed from the school directly, not the Department of Education, at the time the student begins the academic year.
Benefits of Federal Student Loans
Federal student loans come with several benefits that help borrowers throughout the life of the loan. The most attractive advantages to federal student loans include numerous repayment programs, interest rates, financial hardship tools, and long-term student loan forgiveness.
Flexible Repayment Options
One of the most notable benefits with federal student loans is the ability to enroll in one of eight different repayment programs. Ranging from a standard ten-year repayment to an income-driven option that extends repayment over 20 or 25 years, borrowers can select a repayment program that works best for their current and future financial situation, with the help of their student loan servicer. Borrowers also have the option to change a repayment program at any time at no cost.
All federal student loans carry an interest rate and requirement to repay principal plus interest based on the type of loan funded. In general, federal student loan interest rates represent a lower-cost option than other lending vehicles, like private student loans, because they range from 4.45% to 7%. All federal student loan interest rates are fixed, unlike other lenders who may offer a variable interest rate option to borrowers.
Many student loan borrowers owe a significant amount, and depending on the type of repayment program they select, keeping up with monthly payments can be a challenge. When there is a loss of job, disability, or other circumstance causing a financial hardship, federal student loan borrowers have the opportunity to request a forbearance or deferment of their payments for a set period. Forbearance allows student loan borrowers to put payments on hold for one year at a time, although interest may still accrue on the unpaid balance. With a deferment, borrowers can lower or postpone payments for a total of three years.
Only federal student loan borrowers may be eligible for loan forgiveness. Individuals who participate in an income-driven repayment program, work at a non-profit organization, or work for the federal government may qualify to have their loan balances forgiven after a set number of years on on-time, consecutive payment. The Public Service Loan Forgiveness program dissolves federal loan balances after ten years; income-based repayment forgiveness dissolves remaining loan balances after 20 or 25 years.
Alternatives to Federal Loan Options
There are alternatives to federal student loans that may benefit some borrowers. These alternatives include Pell Grants, Federal Supplemental Education Opportunity Grants, Teacher Education Assistance for College and Higher Education Grants, Iraq and Afghanistan Service Grants, work-study programs, and private student loans.
Undergraduate students may be eligible for federal Pell Grants when they can show significant financial need. Pell Grants may be awarded up to $5,920, depending on the cost of attendance, financial need, enrollment status, and time in school. Unlike federal student loans, Pell Grants do not need to be repaid.
Federal Supplemental Educational Opportunity Grant (FSEOG)
FSEOG funds are administered by each participating school’s financial aid office and made available to undergraduate students with a significant financial need. FSEOG funds range from $100 up to $4,000 per year, depending on the student’s need, when the FAFSA is submitted, and the amount of other financial aid received. FSEOG funds do not need to be repaid.
Teacher Education Assistance for College and Higher Education Grants (TEACH)
Students who plan to become teachers in a high-need field in a low-income area may qualify for a TEACH grant. This grant provides up to $4,000 per year to students enrolled in coursework needed to begin a career in teaching, and grant funds do not need to be repaid so long as the student teaches for at least four complete academic years within eight years after completing the degree program for which the grant was received.
Iraq and Afghanistan Service Grants
Individuals who are not eligible for a Pell Grant but are younger than 24 and had a parent who was a member of the U.S. armed forces and died as a result of military service in Iraq or Afghanistan after 9/11 may be eligible for an Iraq and Afghanistan Service Grant. The award amount is equal to the amount of the maximum Pell Grant award but cannot exceed the total cost of attached for the year in which it is received. Like other grants, the Iraq and Afghanistan Service award does not have to be repaid.
Federal Work-Study Programs
Undergraduate and graduate students with a financial need may qualify for a work-study program. This allows a student to earn money to help pay education expenses through a part-time job administered by schools participating in the Federal Work-study Program. The amount of work-study earnings is dependent on when a student applies, the level of financial need, and the funding level of the school.
Private Student Loans
When financial aid through federal student loans, grant programs, or work-study programs are not available to students, private student loan lenders may be a viable option. In most cases, private student loans are available to any student with a strong credit history, up to the total cost of attendance of their selected schools. Because some students do not have established or good credit, a co-signer may be used to help qualify for a private student loan.
Interest rates for private student loans are either variable or fixed and may be higher than federal student loan programs. Private student loan lenders do not offer flexible repayment plans like federal student loans, nor do many offer financial hardship solutions to borrowers. Private student loans should be used when federal student loans, grants, and work-study programs are already maximized.
Federal Repayment Programs
There are a total of eight federal student loan repayment programs, including income-driven repayment plans, made available to borrowers that can help with the management of paying back loan balances over time.
Borrowers with Direct Stafford loans, both subsidized and unsubsidized, those with PLUS loans, or consolidation loan may opt for the standard repayment program. With a standard repayment, monthly payments are fixed based on a ten-year repayment term, or up to a 30-year repayment term for consolidation loans. All borrowers qualify for the standard repayment option. For those who do not qualify for a forgiveness program, the standard repayment plan is the most cost-effective as it relates to the total cost of borrowing. This is because borrowers pay less over time with a standard repayment plan, given that no unpaid interest is capitalized back into the loan each year.
With a graduated repayment program, federal student loan borrowers with Direct Stafford Loans, subsidized or unsubsidized, PLUS loans, or consolidation loans have a fixed monthly payment that adjusts every two or three years. Payments are lower during the early years and gradually increase over time. Repayment may extend up to ten years or up to 30 years for borrowers with a large outstanding loan balance. Borrowers pay more over the life of the loan repayment because of interest accrual in the years when payments are lower.
Borrowers with Direct Stafford loans, subsidized or unsubsidized, PLUS loans, or consolidation loans may opt for the extended repayment plan. Payments with an extended program are either fixed or graduated, and repayment extends up to 25 years. This program is intended for borrowers with at least $30,000 in outstanding loans. Because monthly payments are lower than they would be on a standard or graduated repayment plan for the life of the loan, borrowers pay more over the repayment period.
Revised Pay As You Earn (REPAYE)
The Revised Pay As You Earn or REPAYE program is available to borrowers who have outstanding Direct Stafford loans of any kind, PLUS loans (for students only) or consolidation loans that do not include PLUS loans made to parents. With the REPAYE program, monthly payments are capped at ten percent of the borrower’s discretionary income, recalculated every year based on income and family size. For married borrowers, both spouses’ income and loan debts are taken into consideration.
Repayment may extend up to 20 or 25 years, depending on the loan balance. As an income-driven repayment program, borrowers may be eligible for forgiveness after consecutive on-time payments for the life of the loan. Monthly payments may be higher for high-income earners and lower for those with a smaller income, but most borrowers will pay more over the life of the loan due to a longer repayment period. Additionally, loan forgiveness is taxable as income to the borrower in the year balances are dissolved.
Pay As You Earn (PAYE)
Borrowers who select a Pay As You Earn repayment program are eligible if they have Direct Stafford Loans, subsidized or unsubsidized, Direct PLUS loans to students, or consolidation loans that do not include PLUS loans made to parents. The monthly payment with the PAYE option is capped at ten percent of discretionary income, and payments are recalculated every year based on income and family size. The loan debt of a married borrower’s spouse is only considered if taxes are filed jointly.
Any borrowers on the PAYE program has the option to request forgiveness of outstanding loan balances at the end of 20 years of on-time, consecutive payments. Borrowers must have taken out federal student loans on or after October 1, 2007, to qualify, and debt relative to income must be high. The total cost of borrowing can be significantly higher for borrowers who select the PAYE program because of interest accrual during periods when income and therefore monthly payments are low. Also, forgiveness of federal student loan debt is taxable as income in the year outstanding loan balances are canceled.
Income-Based Repayment (IBR)
With an income-based repayment program, borrowers with Direct Stafford loans of any kind, PLUS loans to students, or consolidation loans not including Parent PLUS loans have monthly payments capped at ten or 15 percent of discretionary income. Each year, payments are recalculated based on updated income and family size, and spouse’s income and debt is only considered in the calculation when taxes are filed jointly.
After 20 or 25 years, any remaining student loan balance is forgiven. Borrowers must have a high debt load compared to annual income to qualify. The IBR program will result in a higher total cost of borrowing over the life of the loan due to interest accrual, and any balance forgiven is taxable to the borrower.
Income-Contingent Repayment (ICR)
Under an income-contingent repayment program, borrowers with Direct Stafford loans of any kind, PLUS loans made to students, and consolidation loans have their monthly payment based on the lesser of 20 percent of discretionary income or the amount due on a repayment plan with a fixed payment over 12 years, adjusted for income. Payments can extend up to 25 years and are recalculated each year based on income, family size, and the amount remaining on federal student loans. Married borrowers only have spousal income and federal student loan debt considered when taxes are filed jointly or when they opt to pay federal loans jointly with that spouse.
Forgiveness of remaining unpaid balances is available after 25 years. While the monthly payment may be more cost-effective than a standard or graduated repayment plan, borrowers may pay more over the life of the loan in interest accrual. Like other federal student loan repayment programs eligible for forgiveness, any amount dissolved is taxable as income to the borrower.
Borrowers who have Direct Stafford loans that are either subsidized or unsubsidized, FFEL PLUS loans, or FFEL consolidation loans may qualify for an income-sensitive repayment plan. The monthly payment is based on annual income, and repayment may extend up to 15 years. This repayment program is not eligible for forgiveness. Borrowers will pay more over the life of the loan than in a standard repayment plan, although monthly payments are often lower due to the extended repayment term.