For most students, affording college would be impossible without borrowing money. As of the fall of 2018, there were nearly 20 million students enrolled in colleges and universities. And approximately 70% of
them will graduate or leave school with some amount of student loan debt. And the majority of debt will come from the U.S. Government in the form of federal student loans, the single-largest source of student loans.
Not all loans come from the government, though. There are also private loans, which are loans offered by banks, credit unions, and online lenders. Generally, it is recommended that a student exhaust all federal student loan options before moving to private loans, and this is because of the favorable terms offered by federal loans.
Federal loans usually have more flexible payment plans, the option for student loan forgiveness, and the option for deferment or forbearance. Also, interest rates on federal loans are locked in at a fixed rate, which means that the borrower won’t get bamboozled by a potential increase in the interest costs of the loan.
Below, we’ll explain the different types of federal loans, including who qualifies, maximum loan amounts available, and what your options are in the event your federal loans don’t cover the cost of your education.
What Types of Federal Student Loans Are Available?
There’s a lot of terminology being thrown around out there regarding student loans, and it can get confusing. Stafford and Perkins may sound like the names of Ivy League frat bros, but they’re actually federal student loan types. To clear up any confusion around federal student loan types, it is helpful to first split federal loans into two overarching categories: subsidized and unsubsidized.
Subsidized loans are given out on the basis of financial need. They are called “subsidized” because the government subsidizes—absorbs the cost of—some interest payments on the loan. For example, interest on subsidized loans is paid by the government while the student is enrolled (at least half-time), during the six-month “grace period” after graduation, and during periods of deferment.
Unsubsidized loans are not doled out based on need, and borrowers are responsible for the interest at all times. If a borrower chooses not to make interest payments, the interest that accrues is generally capitalizes in certain instances, like after a period of deferment or forbearance, or following the six-month grace period after graduation. When unpaid interest is capitalized, that means it is added to the balance of the loan. Then, borrowers are charged interest on top of that interest—another name for capitalized interest is compound interest.
Currently, there is only one type of subsidized federal loan offered, and several types of unsubsidized loans. Next, we will discuss the different types of federal loans and who typically qualifies for each type.
The Direct Loan Program
The U.S. Department of Education’s federal student loan program is called the William D. Ford Direct Loan Program. Under the Direct Loan Program, the U.S. Department of Education is your lender.
Direct Subsidized Loan (also known as a Stafford Loan)
Direct Subsidized Loans are for undergraduate students who have financial need. The maximum amount offered is between $3,500 and $5,500 depending on the academic year; students who need substantial assistance might not be able to cover their entire tuition with Direct Subsidized Loans. There is a loan fee for all Direct Subsidized Loans that is proportionally deducted from each loan disbursement.
Direct Unsubsidized Loan (also known as a Stafford Loan)
Direct Unsubsidized Loans are offered to undergraduate, graduate, and professional degree students, and financial need is not required. These are the most common type of federal student loan.
Undergraduate students can take out between $5,500 and $7,500 in unsubsidized loans each academic year (although any offer of subsidized loans would be subtracted from this amount).
The interest rate is higher for loans made to graduates and professional degree students and the maximum amount offered is higher, too. Grad students can take up to $20,500 in unsubsidized federal student loans each school year.
Direct PLUS Loan
Direct PLUS Loans are offered to parents paying for their dependent child’s undergraduate education and to graduate or professional degree-seeking students. Financial need is not a requirement to acquiring a Direct PLUS Loan.
Unlike with Direct Subsidized and Unsubsidized Loans, however, the borrower’s credit will be taken into consideration; a borrower may not have “adverse” credit history. Here’s what that means .
The maximum amount that the government awards in each school year is the total cost of attendance (which is determined by the school) minus all other financial aid that the student receives. There is a loan fee for all Direct PLUS loans that is proportionally deducted from each disbursement that the borrower receives.
Yep, the federal loans that a parent can take out on behalf of a student have worse terms than a loan made directly to the student through the Direct Subsidized or Direct Unsubsidized loan programs. Depending on your family’s financial situation, you’ll likely want to take this into consideration when choosing loans.
Direct Consolidation Loan
Somewhat different from the previously mentioned loans, a Direct Consolidation Loan allows the borrower to combine multiple federal loans into one loan. Why would a borrower do this? To merge multiple student loans into one, enabling them to make one payment towards one loan for easier management.
With a Direct Consolidation Loan, the weighted average of each individual loan is calculated to determine the new interest rate, rounded up to the nearest eighth of a percent.
It is always free to apply for a Direct Consolidation Loan; if you are contacted by a company offering to help you consolidate for a fee, be leery—this is a free service offered by the Department of Education.
Also remember, a Direct Consolidation Loan can only be used to consolidate federal student loans. Borrowers aren’t able to consolidate private loans, which aren’t issued via the government. (Refinancing is a different process that is able to consolidate both federal and private loans.)
Loans made through the Federal Perkins Loan program were low-interest loans for undergraduate and graduate students exhibiting exceptional financial need. The Perkins loan program ended on September 30, 2017, with disbursements for Perkins loans ending on June 30, 2018. Unless there is a change under federal law, the Federal Perkins Loan program will no longer be providing new loans to students.
What Federal Loans May I Qualify For?
Not all students may qualify for all types of federal loans. First, it is helpful to understand that loans are considered either need-based or non-need-based. Here’s how these calculations are made:
Direct Subsidized Loans are need-based federal student loans. To determine who qualifies, the Department of Education first determines a family’s Expected Family Contribution (EFC) .
The EFC takes into consideration a family’s assets, income, and the size of the family, and spits out a number called the EFC. The EFC is kind of confusing because it’s not actually how much a family is expected to contribute to a child’s education but is really just a number that is used to determine need-based aid.
To calculate financial need , a college will subtract the EFC from the Cost of Attendance, which the school determines. COA – EFC = A student’s “financial need.”
For example, if the COA is $30,000 and the EFC is $25,000, then the student is eligible for no more than $5,000 in need-based aid, including Direct Subsidized Loans. (Need-based aid may also include federal grants and work-study programs, which is money that does not need to be repaid.)
If you do not qualify for need-based loans or if need-based loans will not cover the full cost of attending college, you can access the next “tier” of student loan borrowing: non-need-based loans:
Direct Unsubsidized Loans and Federal PLUS Loans are non-need-based loans. To determine how much non-need-based loans a student qualifies for, a school will do the following calculation:
Non-needs-based loans are calculated by taking the Cost of Attendance (COA) and subtracting the sum of all financial aid awarded to the student so far, including scholarships or grants from the state or school.
For example, if COA is $30,000 and a student has $20,000 in financial aid from other sources, then they are eligible for $10,000 in non-need-based financial aid, including Direct Unsubsidized and PLUS Loans.
Because there are annual limits to the amount of need-based and non-need based federal loans for which a student qualifies, some students may not be able to cover the cost of their education via federal loans alone. What are students who find themselves without enough federal aid supposed to do?
Other Funding Options
The first option you might want to consider is sources of “free” money, such as scholarships, work-study, and grants. Just because you’re enrolled in school doesn’t necessarily mean you need to stop applying for scholarships.
Next, students could consider private student loans, which are loans offered through banks, credit unions, or online lenders. Generally, private student loans offer less flexible repayment terms and higher rates. (For example, they don’t necessarily offer things like income-driven repayment plans.)
The interest rates on private loans are generally tied to the borrower’s credit score and income, whether the borrower is the student, parent, or another family member.
If you think you may need to use private loans, don’t be discouraged and instead, be informed about your options. First, make sure that you shop around for your private loans. Lenders’ terms will vary widely, so be sure to get multiple quotes and ask about the interest rate (and whether it’s fixed or variable), the loan’s repayment terms, and what happens in the event you cannot make a payment.
Also, keep in mind that you may be eligible to refinance your student loans—both federal and private—once you’ve graduated and have an established income and improved credit score. Refinancing is the process of paying off one loan with another loan with new terms and a new—and hopefully lower—interest rate.
Online lenders like SoFi offer student loan refinancing without hidden fees and with competitive rates and loan terms.
Refinancing might not be the right option for those planning on using their federal loans’ unique benefits, such as forgiveness for work in certain professions or an income-driven repayment plan, as you would forfeit your access to those benefits if you refinance, but refinancing could be worth considering for any private loans that were obtained at high interest rates during college.
SoFi Student Loan Refinance
IF YOU ARE LOOKING TO REFINANCE FEDERAL STUDENT LOANS PLEASE BE AWARE OF RECENT LEGISLATIVE CHANGES THAT HAVE SUSPENDED ALL FEDERAL STUDENT LOAN PAYMENTS AND WAIVED INTEREST CHARGES ON FEDERALLY HELD LOANS UNTIL THE END OF SEPTEMBER DUE TO COVID-19. PLEASE CAREFULLY CONSIDER THESE CHANGES BEFORE REFINANCING FEDERALLY HELD LOANS WITH SOFI, SINCE IN DOING SO YOU WILL NO LONGER QUALIFY FOR THE FEDERAL LOAN PAYMENT SUSPENSION, INTEREST WAIVER, OR ANY OTHER CURRENT OR FUTURE BENEFITS APPLICABLE TO FEDERAL LOANS. CLICK HERE FOR MORE INFORMATION.
Notice: SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income-Driven Repayment plans, including Income-Contingent Repayment or PAYE. SoFi always recommends that you consult a qualified financial advisor to discuss what is best for your unique situation.
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