Understanding Federal Education Loans (A Beginner’s Guide)

Understanding education loans can be challenging, especially when you aren’t familiar with the process. Oftentimes students or families will need to take out a loan in order to handle the cost of education. Loans must be repaid and will generally include an interest rate. Even though from the outside student loans may seem complicated, they are relatively manageable. All it takes is a little bit of education and guidance!

Understanding Federal Student Loans

The United States Department of Education provides federal student loans to borrowers through loan servicers that they partner with. A majority of students choose to get federal loans. In fact, according to the Institute for College Access and Success, federal loans accounted for around 84% of the Class of 2019’s student debt. Individuals usually prefer these loans because they:

  • Protect borrowers in repayment
  • Do not require a credit check (if you are an undergraduate)
  • Could have lower interest rates compared to other loan options

Applying for a Federal Student Loan

If you are interested in getting this type of loan then you will need to fill out the Free Application for Federal Student Aid (FAFSA). This is a form that will provide information to the government about your family’s financial standing. You may be eligible to receive additional financial assistance, and could find out using this form! Once you submit your application, the Department of Education will review it, and decide how much your family can afford. This number is referred to as your Expected Family Contribution (EFC). If you are an undergraduate, you will have to deal with borrowing limits that are set by the government. These limits vary by school year and financial status but can be between $5,500 and $12,500 (specifically for undergraduates).

Different Types of Federal Loans

There are a few different types of federal student loans that you can consider like Direct:

  • Unsubsidized Loans
  • Subsidized Loans
  • PLUS Loans
  • Consolidation Loans

Direct Unsubsidized Loans

Undergraduate, graduate, and professional students that are not in dire financial need usually choose this type of loan. There are limits for this option that range from $5,500 for first-year undergraduates to $20,500 for graduate and professional students.

Direct Subsidized Loans

Undergraduates that are in financial need typically choose this type of loan. When an individual gets a direct subsidized loan, the government will pay the interest while the student is in school at least half time and during a 6 month grace period after you leave school.

Direct PLUS Loans

Sometimes undergraduates, graduates, and professional students have parents that are willing to help out with the cost of education. This is the loan that was designed for those parents. These loans require a credit check and have higher interest rates and fees opposed to direct subsidized and unsubsidized loans.

Direct Consolidation Loans

If you have multiple federal student loans then a consolidation loan provides you the opportunity to combine them into one big loan. Borrower’s have the chance to better manage their monthly expenses and get a lower overall monthly payment with less total interest paid over the life of the loan. However, not all loan terms are the same so make sure it makes sense before deciding to consolidate!

Understanding Interest Rates for Federal Loans

So each loan option has their own average interest rate. Interest rates can change depending on federal regulation. Right now between July 1st, 2021,to July 1st, 2022, interest rates are:

  • Undergraduate Direct Loans: 3.73%
  • Graduate Direct Loans: 5.28%
  • PLUS Loans: 6.28%

Congress is the one who determines what these interest rates will be and decides them every year. Even if interest rates change, rate terms are fixed for the life of the loan. For example, if the interest rate that you got when you received your student loan was 2.11% but raised the next year to 3.88%, you would still have your original interest rate of 2.11%.

Understanding Fees Associated with Federal Loans

Some fees that you can expect are origination fees. The fee takes into consideration the total loan amount and varies by loan type. Loans disbursed on or after October, 1st, 2020 until September 30th, 2022 can expect these fees:

  • 1.057% for Direct Unsubsidized Loans
  • 1.057% for Direct Subsidized Loans
  • 4.228% for Direct PLUS Loans

How to Repay a Federal Student Loan

There are standard repayment plans that you can expect when it comes to handling a federal student loan. In a typical setup, your loan balance will be split into 10 years worth of payments. Unfortunately, not many people are expected to actually fully repay their loan. In fact, as of 2019, roughly 14% of all American adults had student debt, according to Experian. However, there are also other repayment options that you can consider like:

  • Extended Repayment Plan
  • Graduated Repayment Plan

Extended Repayment Plans

Individuals that need more time to repay choose this option. Borrowers can choose to increase their repayment time from 10 years all the way to 25 years. They also have the option to choose between fixed or graduated monthly payments!

Graduated Repayment Plans

In this repayment setup, the borrower starts off with lower monthly payments that gradually increase over the course of 2 years. However, the borrower still has 10 years to repay the loan in full.

What is Deferment and Forbearance?

These are options that an individual can consider if they need to take a break from handling their student loan debt for a specified period of time when they are dealing with financial hardship. It is important to keep in mind that even if the loan gets deferred, interest will still build. In the end, you can be responsible for repaying more money. If you are struggling to manage your payments then you may want to consider alternative repayment plans like:

  • Income-Based Repayment (IBR)
  • Income-Contingent Repayment (ICR)
  • Pay As You Earn (PAYE)
  • Revised Pay As You Earn (REPAYE)

Each plan has its own terms and conditions. Generally, you can expect these types of repayment options to reduce your bill down to a percentage of your income. These options also have forgiveness after between 20 years to 25 years of repayment. If you are looking to have your loans forgiven, you may be required to pay income tax on the total balance forgiven.

Income-Based Repayment (IBR)

This repayment option is a type of income-driven repayment (IDR) that can lower your monthly student loan payments. This is helpful to individuals that are struggling to handle their monthly payments. This repayment option is offered by the Department of Education as a form of relief to those in need. They can provide this relief by requiring the amount due to better work within your income limits.

Income-Contingent Repayment (ICR)

This is another form of IDR that has a repayment period of 25 years. Once that 25 years is complete, the borrower can have their loan balance forgiven (if applicable). Any remaining balance that is forgiven is considered a form of taxable income. Since it is taxable income, you may be responsible for a hefty tax bill at the end of 25 years. Your monthly payment for an ICR is determined by 20% of your discretionary income and the terms of your payment plan.

Pay As You Earn (PAYE)

PAYE is a repayment option that can make monthly payments more affordable. Monthly payments will be based on 10% of the borrower’s discretionary income, and there is loan forgiveness. After 20 years, any remaining loan balance will be forgiven . This is an IDR that focuses on helping those that struggle to manage their payments.

Revised Pay As You Earn (REPAYE)

REPAYE is another program that can help borrowers in need that focuses on income in order to determine monthly payments. This is a standard 10 year repayment plan but has generous interest rate assistance, flexible eligibility requirements, and is still an IDR option.

Federal Education Grant Options

While federal loans are one great way to handle your education, they don’t do a good job at reducing the amount you are responsible to pay. That is why many borrowers look for other educational assistance options like federal education grants. Grants are a great assistance option because they do not need to be repaid! The funds can go towards helping with the cost of education without increasing financial stress. Regardless of the grant you are interested in, make sure to do additional research to see if you can benefit from these options. There are a variety of grants available like:

  • Federal Pell Grants
  • Federal Supplemental Educational Opportunity Grants (FSEOG)
  • Teacher Education Assistance for College and Higher Education (TEACH) Grants

Federal Pell Grants

This is a grant option that eligible undergraduate students that face financial hardship can receive. Recipients do not have a bachelor’s, graduate, or professional degree. However, those that are enrolled in a post baccalaureate teacher certification program might still be able to receive this type of grant. The amount of this grant can change every year but as of July 1st 2022 to June 30, 2023, recipients can get up to $6,895 to go towards the cost of education.

Federal Supplemental Educational Opportunity Grants (FSEOG)

FSEOG provides students the option to receive between $100 to $4,000 every year depending on their financial need. Your school’s financial aid office will distribute these grants. It is important to note that not every school receives this grant opportunity. Your student aid office will have more information about whether or not it is an option that you can consider!

Teacher Education Assistance for College and Higher Education (TEACH) Grant

This is a grant option that provides up to $4,000 every year to eligible individuals. This TEACH grant requires that a student must fulfill a teaching obligation before they can receive a grant. If the recipient doesn’t fulfill the teaching obligation then the grant turns into a loan that recipients are responsible for.

Overall

Understanding federal education loan options may feel complicated, but luckily can be easy to learn! You have a variety of loan options to choose from and repayment plans that can work around your budget if you are dealing with financial hardship. There are other ways, like grants, that can help you reduce the overall cost of your education. Remember to work within your financial means and talk to your school’s financial aid office if you need any more assistance!

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