For most students, affording college would be impossible without borrowing money. As of the fall of 2020, there were nearly 20 million students enrolled in colleges and universities. And as of fall 2019 approximately 65% of college graduates borrowed student loans. And the majority of debt will come from the US 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 student loans, which are offered by banks, credit unions, and online lenders. 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 and borrower protections offered by federal loans.
Federal loans offer a variety of flexible payment plans, the option to earn student loan forgiveness, and the option for deferment or forbearance.
Also, interest rates on federal loans are locked in at a fixed rate, which is set annually by Congress, 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 Federal Student Loans
Subsidized loans are awarded 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 Federal Student Loans
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 capitalized 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 US Department of Education’s federal student loan program is called the William D. Ford Direct Loan Program. Under the Direct Loan Program, the US Department of Education is the lender, but they work with a few different loan servicers , who manage the loan.
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 types of federal student loans.
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 for Direct Subsidized and Unsubsidized Loans for the 2021-2022 school year is 3.73%, up from 2.75% for the 2020-2021 school year.
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.
The interest rates for the 2021-2022 school year for unsubsidized loans offered to graduate or professional students is 5.28%, up from 4.30% during the 2020-2021 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 acquire 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. The interest rates on PLUS Loans offered to parents and graduate/professional students is 6.28% for the 2021-2022 school year, up from 5.30% for the 2020-2021.
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. This allows the borrower 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.
There is never any cost 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.
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.
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 can be 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 to shop around for private loans. Lenders’ terms may vary widely, 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 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.
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 access to federal benefits is forfeited when federal loans are refinanced.
Federal loans can be either subsidized or unsubsidized. Subsidized student loans are offered based on financial need and do not accrue interest while the borrower is enrolled in school (at least half time).
Unsubsidized loans do accrue interest while student borrowers are enrolled in school. Only undergraduate students are eligible for subsidized student loans.
There are unsubsidized options available to undergraduate, graduate or professional students, and parents.
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