Federal student loans

How Federal Student Loans Work: Ultimate Guide

how do federal student loans work

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If you’re heading off to college, you might be wondering, How do federal student loans work? Well, federal student loans are provided by the government to help students (or their parents) pay for college or graduate school.

There are several federal student loan types, some of which have better terms than others. For most federal loans, you can postpone payments while you’re in school and for six months after you graduate.

Let’s take a closer look at how federal student loans work and whether they’re the right choice for you and your family.

How do federal student loans work?

Federal student loans are available to any U.S. citizen or eligible noncitizen enrolled at least half-time in a qualifying school. They’re provided by the Education Department’s Federal Student Aid to help you pay for tuition, fees, supplies, and living expenses.

While you usually don’t have to start paying back loans while you’re still in school, you will have to pay them back after you graduate — with interest.

Since interest charges can seriously add up, it’s important to avoid taking out too much in student loans. Otherwise, you could be left with burdensome debt that’s difficult to pay back after graduation.

As long as you borrow responsibly, though, federal student loans can be the best type of loan for your education. They come with relatively low, fixed interest rates, and you typically don’t have to pass a credit check to get one.

Plus, they’re eligible for a variety of repayment plans and protections, which can be a big help if you can’t afford your monthly payments on the standard 10-year plan. What’s more, your federal loans could be eligible for loan forgiveness depending on your profession.

Federal student loan types

Federal Student Aid offers several federal student loan types for undergraduate and graduate students, as well as parents who want to help their child pay for school. Here are the main ones:

  • Subsidized Direct loans: available for undergraduates with demonstrated financial need. These loans don’t accrue interest during periods of deferment, such as while you’re enrolled in school or for six months after you graduate.
  • Unsubsidized Direct loans: available for both undergraduate and graduate students. These loans accrue interest from day one.
  • Grad PLUS loans: available for graduate students who have maxed out the borrowing limit for Direct unsubsidized loans and need additional money for college.
  • Parent PLUS loans: available for parents or guardians who want to borrow a student loan to help their child pay for college.

In the past, the government also lent Perkins loans, which were need-based, subsidized loans, but it stopped offering Perkins loans in September 2017. If you borrowed one before that date, it’s worth looking into your options for Perkins loan forgiveness.

Federal student loan interest rates

Federal student loan interest rates dropped big-time between 2019 and 2020. If you borrow on or after July 1, 2020 and before July 1, 2021, you can enjoy these low interest rates:


Interest rate for 2020-21

Direct subsidized loan 2.75%
Direct unsubsidized loan 4.3%
Grad PLUS loan 5.3%
Parent PLUS loan 5.3%

These rates are fixed, so they won’t change over the life of your loan (unless you decide to refinance with a private lender).

In the past, rates were closer to 5% for subsidized and unsubsidized Direct loans and 7% for PLUS loans, so current students are getting a much better deal than past borrowers.

Pro tip: Student loan interest is not a one-time fee. It accrues on a daily basis, so the faster you can pay off your loan, the less interest you’ll pay overall. 

Note that federal student loans also come with a one-time origination fee —

  • 1.062% for subsidized and unsubsidized Direct loans
  • 4.236% for PLUS loans.

This amount is subtracted from the amount you borrow. So if you take out a $10,000 PLUS loan, you’ll actually get $9,576.40 once the fee is subtracted. Take this origination fee into account when you borrow to make sure you get the funds you need.

Requirements for federal student loans

So, what are the requirements for federal student loans? To be eligible, you must,

  • Be enrolled at least half-time in a school that participates in the Direct loan program
  • Be enrolled in a program that leads to a degree or a certificate
  • Meet the requirements to receive federal financial aid, such as,
    • Be a U.S. citizen or eligible non-citizen
    • Have a valid Social Security number, unless you’re exempt
    • Have a high school diploma or GED, or have completed homeschooling
    • Maintain satisfactory academic progress
    • Register with Selective Service if you’re male

To qualify for subsidized loans, you also must demonstrate financial need. There is no financial need requirement for unsubsidized loans.

What’s more, neither loan type checks your credit. Any eligible student can borrow them for school, regardless of their credit score or history.

PLUS loans, on the other hand, do have a credit requirement. They require that you don’t have “adverse credit,” which basically means that you haven’t defaulted on a loan or gone bankrupt in the past five years or missed payments for 90 days or more on a debt of $2,085 or more.

If you have a problem with your credit, you could try applying with an endorser (aka, another adult whose good credit makes up for your weak credit).

Federal student loan limits

Federal student loans are your best option for borrowing for school, since they have few requirements, low interest rates, and flexible repayment plans. But they also come with borrowing limits, so you can only take out so much.

Here are the federal student loan limits for undergraduates and graduate students:

  • Direct subsidized student loans: $5,500 – $7,500 per year for dependent undergraduate students
  • Direct unsubsidized student loans: $2,000 per year for dependent undergraduate students; $20,500 per year for graduate students
  • Grad PLUS loans: Up to the cost of attendance of your program, minus any other financial aid already received
  • Parent PLUS loans: Up to the cost of attendance of your child’s program, minus any other financial aid they’ve already received

Note that the loan limits are higher for independent undergraduate students.

If you’ve maxed out the limits for federal student loans and need more money for college, it could make sense to borrow a private student loan. But again, be careful not to take on too much debt, as this could cause a major financial headache down the road.

How to apply for federal student loans

Applying for federal student loans is simple: All you need to do is submit the Free Application for Federal Student Aid (FAFSA).

This free application collects your and your parents’ financial information to determine your eligibility for federal aid. It becomes available on October 1 every year.

After you submit your information, the FAFSA will generate your Estimated Family Contribution (EFC). This is the amount your family is expected to contribute toward your education.

Federal Student Aid then sends your information to your college. Your college’s financial aid office will crunch the numbers and send you a financial aid award letter. This letter will detail how much federal aid you’re eligible for, including grants, work-study, and student loans.

Note that you’re NOT obligated to accept all the loans you’re offered. Even though the letter might call it an “award,” loans do need to be repaid with interest, so it’s not a good idea to borrow more than you need.

If you’ve won a bunch of external scholarships, for example, you might not need to accept your full loan offer. Whatever you decide, you’ll notify the school’s financial aid office about how much you want to accept.

Your next step will be to complete student loan entrance counseling (an online program that explains how your student loans work) and sign a student loan Master Promissory Note (your student loan contract that outlines the terms of your debt).

Federal Student Aid will send the money to your school, which will apply it toward tuition and fees (and room and board if you live on campus). If there’s any left over amount, the office will send it your way. You can use this money on living expenses or return any surplus money to Federal Student Aid.

Student loan repayment plans

Now that you know how to borrow loans, let’s take a closer look at how federal student loans work when it comes to repayment. Fortunately, federal student loans are eligible for a variety of student loan repayment plans.

Unless you choose an alternative, your loans will automatically on the standard 10-year plan when you graduate. This plan involves fixed payments each month, and it will get you out of debt in 10 years.

If your loans are too expensive, you could opt for an alternative plan, such as,

If you can’t afford your loan payments at all, you could consider pausing them through deferment or forbearance.

Alternatively, if you can afford to pay extra, you can make extra payments at any time without penalty. Making extra payments will get you out of debt faster and save you money on interest.

Federal student loan forgiveness programs

Most federal student loans are also eligible for forgiveness, such as Public Service Loan Forgiveness and Teacher Loan Forgiveness.

These programs will forgive part or all of your student loans in exchange for qualifying service. The PSLF program, for instance, typically provides full forgiveness after 10 years of working in public service, while the Teacher Loan Forgiveness program offers partial forgiveness after five years of teaching in a low-income school.

For more options, head to this complete list of student loan forgiveness programs.

Federal student loans vs. private student loans: key differences

As mentioned, federal student loans should be your first stop for borrowing. This is because they come with low fixed rates, usually don’t require a credit check, and are eligible for a variety of federal repayment plans and protections.

If you need additional funding though, private student loans can come in handy. Unlike federal loans, which are issued by the government, private student loans are issued by banks, credit unions, or online lenders. Here are some other key differences:

Private student loans have a credit check 

Private lenders have underwriting requirements before approving you for a loan, meaning they look at your credit score and income. Most college students can’t qualify on their own, so they apply with a cosigner, such as a parent.

Rates could be fixed or variable 

The rate you get on a private student loan will largely depend on how good your (or your cosigner’s) credit is. Usually, you can choose between a fixed rate, which stays the same over the life of your loan, and a variable rate, which usually starts lower than a fixed rate but could rise over time.

They’re not eligible for income-driven repayment 

Private student loans aren’t eligible for federal repayment plans, such as income-driven repayment. Some private lenders might let you pause payments if you run into financial hardship or go back to school, but they’re usually not so flexible about letting you change your repayment plan.

They don’t qualify for federal forgiveness programs 

Plus, private student loans aren’t eligible for federal forgiveness programs, though they might qualify for some student loan repayment assistance programs. For these reasons, you should probably only turn to private loans after you’ve maxed out your federal student loan limits.

Note that both federal and private student loans are eligible for refinancing, which is one way to get a new interest rate and change your repayment terms. Head here to learn more about student loan refinancing.

Tips to avoid borrowing too much money

No one wants to be paying back student loan debt for the rest of their life. Here are some steps you can take to reduce the amount you need to borrow in student loans:

  • Apply to scholarships. Scholarships are a great way to lower tuition costs, since you don’t have to pay back these awards. Use scholarship search engines to find opportunities, and ask your school counselor about any local scholarship awards you might not have heard of.
  • Save, save, save. If you work during the summers in high school, save that money to use toward your cost of living during college. Parents can also make the most of 529 savings plans or prepaid tuition plans to cover college costs.
  • Submit the FAFSA. Not only does the FAFSA help you access loans, but it also puts you in the running toward need-based aid, such as grants and work-study.
  • Work part-time. If you can swing it, working a part-time job while you study could bring in enough income that you won’t have to use loan money to cover living expenses.
  • Keep your expenses low. Find ways to save money as a student, such as buying used books. Avoid using student loan money on non-essentials, like restaurants or spring break. Remember, whatever you spend now will have to be paid back in the future with interest.
  • Consider a less expensive college. If your college has a huge price tag, it might be worth considering a more affordable school.

Students often get the message to attend the “best-ranked” college they get into without thinking about the financial aspect of their decision. But the ranking might not matter that much if it means you’re going to end up with massive debt.

It’s important to strike a balance between a high-quality education and affordability so you don’t end up regretting your choice when you graduate and have to start paying back your student loans.

How federal student loans work: Bottom line

If you need a student loan to pay for college or graduate school, a federal student loan is probably your best bet. It’s relatively easy to access, has a low interest rate, and comes with various protections that could come in handy when it comes time to pay back your loan.

Just make sure you understand what you’re getting into before signing on the dotted line. Read over the terms in your Master Promissory Note carefully, and use an online student loan calculator to estimate your future monthly payments and interest costs.

By educating yourself about how your loan works, you can have a clear understanding of what you’ll need to do to pay it back. And if you can afford to make small payments before you graduate, you could cut down on interest and make repayment even easier on yourself after you graduate.

For a closer look at the difference between subsidized and unsubsidized loans, head to this guide

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