Federal Student Loans Review
The Best Option
Fees hurt the score on federal loans, but borrower perks like Income-Driven Repayment and loan forgiveness make it a winner.
Editor’s Note: Today’s review of federal student loans will cover all federal loans including direct, subsidized, unsubsidized, and Graduate PLUS loans. The one type of loan not covered in this review will be Parent PLUS loans as these loans are significantly different from the other federal loans.
Federal student loans are often considered to be the best student loan option available. While these loans definitely have a ton of advantages, they are not without their warts. For the purposes of this review, we will assume that a student has determined that borrowing money is essential… if there is a way to avoid student loans, it is a wise decision.
Federal Student Loan Basics
In order to get federal student loans, borrowers simply need to fill out the FAFSA. Unlike private loans where their is a strict credit evaluation, qualifying for a federal loan is much easier. Additionally, there is no cap on income such that an interested borrower cannot sign up for a federal loan.
Once approved for a loan, the funds are sent directly to the school’s financial aid office. If the borrower is getting the money to pay for housing, books, or food, the financial aid office of the school will normally cut a check for the amount of the loan in excess of the schools tuition and fees. The exact process varies from school to school.
Federal student loan borrowing for undergraduates is typically limited to $5,500 for freshman, $6,500 for sophomores, and $7,500 for all other students. The total cap for undergrad borrowing is $31,000, and at most $23,000 can be subsidized. However, the borrowing limits are raised for independent students and students whose parents cannot qualify for Parent PLUS loans. Graduate students have significantly more borrowing power as these programs can be very expensive.
Federal Student Loan Interest Rates
The rates on federal student loans are set by Congress. Current student loan interest rates can be found on the Department of Education’s Student Loan Page. Generally speaking, federal student loan rates are slightly higher than the rates offered by those in the private sector. At present they are 3.76%, which is an excellent interest rate. However, for Graduate and PLUS loans the rates are a couple point higher, currently set at 5.31% and 6.31%.
All federal student loan interest rates are currently fixed-rate loans. This means that the interest rate will not go up or down during the life of the loan. However, each year the student loan interest rates on new loans are recalculated based upon market conditions. If interest rates go up while you are in school, the interest rate on future loans could be higher.
Federal Student Loan Fees
One of the big downsides to federal student loans is the origination or disbursement fees. For all direct subsidized and unsubsidized loans, the fee is just over 1%. This means that for every $1,000 you borrow, the government keeps $10 right off the top. The fee for PLUS loans is a much more brutal 4.276%.
We hate to see fees associated with student loans and any private lender would lose major points in a review due to fees of this nature. However, we still think borrowers should willingly accept these fees due the unique advantages that go with federal student loans.
Overview of the Federal Student Loan Advantages
There are two main advantages to having federal student loans instead of private loans.
The first advantage is that borrowers can select repayment plans based upon their income rather than how much they owe. Most borrowers are able to get their payments lowered to 10% of their monthly discretionary income. This perk is not offered by any private lender. This means that if you finish school and cannot find work or lose your job at some point, you will not have to worry about defaulting on your student loans. The income-driven repayment plans are a very valuable protection for all borrowers. This is especially true considering the fact that each year about a million college students will drop out, many more will graduate and be unable find a job. Nobody heads off to college expecting to fail, but success is far from a certainty. The robust federal protections set themselves apart from all other student loans.
The second advantage is the student loan forgiveness programs. Borrowers who are on income-driven repayment plans can have their loans forgiven after 20 to 25 years of payments. While this is a long time to be paying an extra portion of your income to the government, it is a valuable resource to people who find themselves in too deep on their student loans. Additionally, borrowers who work in public service can have their loans forgiven after 10 years. This allows graduates the opportunity to pursue jobs in the public interest without having to worry that they will not be able to pay off their student loans.
Review of Federal Student Disadvantages
Even though we do think the federal student loans are by far the best option, there are a couple significant downsides that all borrowers should understand before they sign up.
Problem number one is our elected representatives. Repayment plans, forgiveness programs, and borrower options are all at the mercy of Congress and the President. In just the past couple of years we have seen a new repayment plan created, and seen forgiveness programs called into question. If you borrow federal loans, you are at the mercy of the federal government and any changes they wish to make to the program.
Problem number two is the companies that are hired to service these loans. Government contracts normally go to the lowest bidder, and the quality of service that borrowers get often leaves much to be desired. Getting answers to simple questions, or having payments properly processed can be a real challenge. In addition to the headaches that these servicers can cause, their incompetence can often result if late fees and other charges.
The combination of a moving target and poor loan servicing can make things difficult for borrowers. The recent issues with the public service loan forgiveness program illustrate the point. For some borrowers, their servicer certified that their monthly payments were counting towards the public service student loan forgiveness program. For years these borrowers stayed at their current jobs, making less money, counting on the fact that they were working towards public service loan forgiveness. The Department of Education then changed their interpretation of the law and told these borrowers that their job did not count and that the prior payments were no longer certified.
Even though there are very real concerns with Federal student loans, they are unquestionably the best option for student loan borrowing, especially at the undergraduate level. The borrower protections are so strong that they outweigh the many problems.
For this reason we suggest that students opt for federal loans, borrow the absolute minimum necessary, and expect a few headaches along the way.