Federal student loans are educational loans backed by the federal government. They're available at all educational levels to students of varying financial means.
Understand how federal loans work and the different types of loans and their benefits to get the funds you need to cover your education.
What Are Federal Student Loans?
Federal loans are loans for college, career school, or graduate school that are made by the U.S. government—specifically, the U.S. Department of Education. Federal law dictates the terms (such as the interest rate) and conditions (like when payments must begin) of these loans. Generally, these terms make federal student loans more advantageous to the borrower than private student loans made by a bank or other private organization.
The label "student loans" is generally reserved for federal educational loans that only students can take out. However, some federal educational loans are available to parents of dependent undergraduates.
How Federal Student Loans Work
Like other loans, federal student loans represent borrowed money you have to repay with interest. However, the way you apply for one of these loans and repay it is different from what you might experience with other types of personal loans.
The following example illustrates how a student can take advantage of a federal student loan:
- Jane needs a small loan to fund her final year of college. She completes a Free Application for Federal Student Aid (FAFSA) form to determine whether she'll be eligible for a federal student loan. The forms asks her to include personal and financial information and list some schools to share that information with in order to determine the types and amount of federal aid she can expect to receive (loans and other types of aid) along with aid from the state or schools.
- Several schools that Jane listed in her FAFSA form determine that she is eligible for a federal student loan but not for scholarships or grants. Each sends her a financial aid offer.
- Since Jane didn't receive any free money, and, thus, plans to use a loan, she calculates the out-of-pocket costs and the debt she would incur by attending each school. She then considers the interest rates and other terms of the loans on offer and decides to obtain a Direct Subsidized Loan.
- Jane responds to her chosen school with the loan and loan amount she wants to accept by the deadline. Jane must sign a promissory note indicating that she promises to repay the loan, and since this is her first federal loan, she is also asked to take loan entrance counseling so that she understands how she will receive and repay the loan.
- Given the type of loan Jane took out, when she graduates, she has a six-month grace period before she must start making payments on her loan.
Federal student loans represent just one type of federal aid. Other options include free money like grants or scholarships, When considering which types of aid to choose, prioritize free money over loans. If you must take out a loan, only borrow as much as you need, and choose a loan with terms you can afford.
History of Federal Student Loans
The first attempt by the U.S. government to offer student loans came in 1958 through the National Defense Education Act (NDEA), a response to the perceived threat of the Soviet space program. In order to achieve scientific advances, the government wanted to enroll more students in postsecondary education, and the NDEA offered a loan program to do so.
But student loans as we know them today got their start through the Higher Education Act (HEA) of 1965. The Federal Student Aid program was implemented to help students achieve their goals of getting undergraduate, graduate, and professional degrees.
The program was further refined in 1980, which saw the HEA reauthorization that resulted in the creation of PLUS loans. This gave parents the ability to borrow on behalf of their dependent students, which was later uncapped in 1992 to diversify the amount parents could take out in loans. As a result of the development of the FAFSA application, the Federal Student Aid program processes over 20 million applications a year and manages fund distribution at over 6,000 schools domestically. Currently providing over $120 billion in financial aid, the federal student loan program is the largest financial aid provider in the U.S.
Types of Federal Student Loans
Today, there are four main types of loans available through the U.S. Department of Education's federal student loan program.
- Direct Subsidized Loans: Subsidized loans are available to eligible undergraduate students who demonstrate financial need. The government may even pay the interest on your loan during certain periods—for example, while you're enrolled in school on an at least half-time basis.
- Direct Unsubsidized Loans: This is a federal student loan offered to undergraduate, graduate, and professional students whether or not they have financial need.
- Direct PLUS Loans: PLUS loans are available to graduate or professional students as well as parents of dependent undergraduate students. They aren't based on financial need, though a credit check is necessary.
- Direct Consolidation Loans: Such a loan combines multiple federal student loans into one and leaves you with a single loan servicer.
The U.S. Department of Education acts as your lender for all of the above federal student loans but will assign you a loan servicer, which is a company that administers your loan and collects your loan payments.
Pros and Cons of Federal Student Loans
While federal student loans offer borrowers important benefits, they're not without their drawbacks.
Potential for subsidized interest costs
Flexible and forgiving repayment plans and terms
Limited loan amount
Potential for wage garnishment
- No credit check: With the exception of PLUS loans, you don't need to undergo a credit check to get a federal student loan.
- Fixed interest: The rate on federal student loans is fixed throughout the life of the loan and often lower than that of a private student loan and significantly lower than that of a standard credit card.
- Postponed payments: You don't have to start repaying the loan until after you graduate or otherwise leave school or switch to less than half-time enrollment status.
- Potential for subsidized interest costs: If you qualify for a Direct Subsidized Loan, the government may cover the interest on your loan during certain periods.
- Flexible and forgiving repayment plans and terms: You may be able to tie your monthly student loan payment to your income or choose from one of many other repayment plans. You may even be able to have your loan forgiven in part or whole.
Fixed interest rates enable the borrower to map out exactly how much they’ll owe with added interest at the completion of their loan term. Variable interest rates are subject to change, so don’t offer the same opportunity to plan for exactly how much you’ll owe.
- Limited loan amount: Depending on your grade level and dependency status, you can borrow up to $5,500 in Direct Subsidized Loans or $20,500 in Direct Unsubsidized Loans (less any subsidized loans taken out in the same period). However, PLUS Loan borrowers can take out a loan up to the cost of attendance (less other aid you receive).
- Potential for wage garnishment: The government may seize part of your wages or tax refund if you default on your federal student loan.
- A federal student loan is an education loan made by the government.
- Applying for a federal student loan requires filling out a FAFSA form and choosing the loan type and amount that's right for you.
- There are four main types of federal student loans, each designed for borrowers with different educational levels and financial situations.
- While student loans offer perks like fixed interest rates and flexible repayment plans, they can limit the amount you borrow.