Federal Student Loans
By Mark Kantrowitz
Students should borrow federal first, because federal student loans are cheaper, more available and have better repayment terms than private student loans.
Federal borrowing options for education financing include the Federal Stafford Loan, the Federal PLUS Loan and Federal Consolidation Loans. These loans are made by the U.S. Department of Education's Direct Loan program, the William D. Ford Federal Direct Loan Program.
The student must be enrolled on at least a half-time basis in an eligible college or university to qualify for federal student loans. The student must file the Free Application for Federal Student Aid (FAFSA) and sign a Master Promissory Note (MPN) to obtain these loans. The student must be maintaining Satisfactory Academic Progress (SAP) and satisfy other general eligibility requirements for federal student aid. For example, the student and borrower must be U.S. citizens or permanent residents.
This table summarizes the key terms of the federal student loan programs for the 2015-2016 award year and are subject to change on or after July 1, 2016.
Federal student loans are eligible for the student loan interest deduction.
Federal Stafford Loans
The Federal Stafford Loan is the most popular student loan program, with $71.5 billion disbursed in 2014-2015, compared with $17.9 billion of Federal PLUS loans and $10.1 billion of private student loans. About two-thirds of the Federal Stafford loans were made to undergraduate students (split evenly between subsidized and unsubsidized loans) and one-third to graduate and professional school students.
There are two types of Federal Stafford loans, subsidized and unsubsidized. The interest rates on subsidized and unsubsidized Federal Stafford loans are the same. However, the federal government pays the interest on subsidized loans during the in-school and grace periods, as well as other deferment periods.
Eligibility for the Federal Stafford loan is not based on the borrower's credit history, credit scores or debt-to-income ratios, unlike private student loans. Eligibility for the subsidized Federal Stafford loan does depend on demonstrated financial need. Eligibility for the unsubsidized Federal Stafford loan and Federal PLUS loan does not depend on financial need. Even wealthy students may qualify for these unsubsidized loans.
Only undergraduate students are eligible for subsidized Federal Stafford loans. Graduate and professional school students have not been eligible for subsidized Federal Stafford loans since July 1, 2012. Both undergraduate and graduate/professional students are eligible for unsubsidized Federal Stafford loans.
Federal PLUS Loans
There are two versions of the Federal PLUS loan. The Federal Grad PLUS loan is borrowed by graduate and professional school students. The Federal Parent PLUS loan is borrowed by parents of dependent undergraduate students.
To be eligible for the Federal PLUS loan, the borrower must not have an adverse credit history. A borrower is considered to have an adverse credit history if any of the following conditions apply:
A borrower is not considered to have an adverse credit history if the borrower does not have a credit history.
Eligibility for the Federal PLUS loan does not depend on having credit scores or income above a minimum threshold, or debt-to-income ratios or debt-service-to-income ratios below a maximum threshold.
A borrower can qualify for a Federal PLUS loan despite an adverse credit history by bringing delinquent accounts current, by getting an endorser who does not have an adverse credit history to cosign the loan (excluding the student), by documenting errors in the credit report that lead to the adverse credit history determination or by documenting extenuating circumstances. Extenuating circumstances include demonstrating that the derogatory event occurred more than five years ago, demonstrating that the debt was someone else's responsibility due to divorce or the borrower was an authorized user and not the primary borrower, documenting that the debt has been paid in full, consolidated, rehabilitated or that satisfactory repayment is in progress, documenting that the bankruptcy was a Chapter 13 filing and not a Chapter 7, 11 or 12 bankruptcy, or documenting that the derogatory event has been reversed, released or ended. To appeal an adverse credit history based, call 1-800-557-7394 or visit StudentLoans.gov (select "Document Extenuating Circumstances").
Federal Consolidation Loans
Borrowers can obtain a federal direct consolidation loan to combine multiple federal student loans into a single loan. This will simplify and streamline the repayment process, since a borrower may have as many as a dozen federal student loans (or more, if the student also borrowers for a graduate or professional school education).
Only loans borrowed by the same borrower can be combined in a federal consolidation loan. Private student loans may not be included in a federal consolidation loan.
The interest rate on a federal consolidation loan is based on the weighted average of the interest rates on the loans included in the consolidation loan, rounded up to the nearest 1/8th of a percentage point.
Federal consolidation loans do not charge any fees. Borrowers can consolidate their federal student loans on their own for free at StudentLoans.gov.
Consolidating can reset the clock on deferments and forbearances, since the consolidation loan is a new loan with a new time limit.
After a borrower's loans have been consolidated, the borrower will no longer be able to target the loan with the highest interest rate for quicker repayment. Generally, a borrower should not include the loan with the highest interest rate in a consolidation loan if the borrower will be able to prepay it quickly and it has a much higher interest rate than the interest rates on the other loans. As a good rule of thumb, if the weighted average of the interest rates on the other loans is lower than the interest rate on the consolidation loan, the borrower is better off financially if he or she can accelerate repayment of the highest interest rate loan.