Federal Student Loans and How They Work

Using loans to pay for college is a reality for most families, however, the loan information laid out in financial aid packages can be confusing, especially to understand the difference between federal and private student loans. Federal loans are provided by the Direct Loan program, which is funded by the government and serviced by private entities like Navient, Nelnet, and others. Federal student loans offer a few advantages over private student loans and due to their appealing repayment plans and flexible conditions, it’s generally good practice to take out federal loans before private loans. There are several different types of federal student loan options, all with different conditions and borrowing limits, so it’s important to review the options carefully.

Direct Subsidized Loans: Only undergraduate students are eligible for direct subsidized loans. Eligibility is based on financial need, as demonstrated by the family financial information provided on the Free Application for Federal Student Aid (FAFSA). For subsidized loans, the U.S. Department of Education pays the interest while the student is in school and for the first six months after they leave school (called the grace period). These loans also tend to offer more flexible repayment options. Students qualify for direct subsidized loans by demonstrating financial need through completion of the FAFSA. The amount that can be borrowed changes each year; first-year students can borrow $5,500, and no more than $3,500 of that can be subsidized. Second-year students can borrow $6,500, and no more than $4,500 of that can be subsidized. For third years and above, the amount students can borrow is $7,500, with no more than $5,500 subsidized. Interest rates on these loans change each year and are set in July for the upcoming academic year, however, the interest rate on borrowed loans remains fixed for the term of the loan.

Expert tip: If awarded, always take the subsidized loan before any other loan, as the loan is interest-free during school and the six-month grace period.

Direct Unsubsidized Loans: Both undergraduate and graduate students are eligible for Direct Unsubsidized Loans. These loans are through the U.S. Department of Education, however ‘unsubsidized’ means the government does not pay the interest on the loan while the student is in school; interest will accrue normally and students have the option to pay the interest while they’re in school or during repayment. Virtually all students can qualify for an unsubsidized direct loan as it does not require the student to show “financial need” based on their FAFSA information.  The interest rates and terms are the same as subsidized loans.

Expert tip: Make interest payments towards unsubsidized loans while the student is in school, which help reduce the repayment costs long-term.

Direct PLUS Loans: The name PLUS comes from the original acronym “Parent Loan for Undergraduate Students”, but now it defines two different types of loan programs.  First, there is the Parent PLUS Loan, taken out by the parent(s) of dependent undergraduate students. The second is the Grad PLUS loan, taken out by graduate level students. Both PLUS loan programs are intended to be used to help pay for educational expenses up to the cost of attendance minus any grant, scholarship or direct subsidized/unsubsidized loans awarded. The lender is the U.S. Department of Education and interest accrues as soon as the loan is disbursed. Direct PLUS loans do not require a document of ‘financial need’ through the FAFSA and though a credit score is not required for eligibility, borrowers must not have “adverse credit history” or delinquencies over 90 days listed on their credit report to be eligible.

Expert tip: For the Parent PLUS loan, keep in mind that the loan is in the parent’s name and cannot be transferred to the student.

Federal student loans offer an initial go-to source for guaranteed college funding. It’s important to make sure that whichever program is utilized the student understands the terms and only borrows what is needed.

To begin the process, students must file their FAFSA on time. Once presented with options, the student will select their loan options and coordinate completion of the Master Promissory Note and Entrance Interview online with https://studentloans.gov to complete the loan process.