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Federal Student Loans Review – The Pros and the Cons of Federal Loans

Federal student loans are not the best way to pay for college, but they are significantly better than any private student loan.

Written By: Michael P. Lux, Esq.

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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.

Student loan experts and borrowers usually agree that federal loans are the best student loan option available. However, while there are many advantages to federal loans, they are not without their warts.

For this review, we will assume that a student has determined that borrowing money is essential. Before selecting any student loan, the first step is to determine if any student loan is necessary.

Federal Student Loan Basics

To get federal student loans, borrowers need to fill out the FAFSA. Unlike private loans with a strict credit evaluation, qualifying for a federal loan is much easier. Additionally, there is no cap on income for federal loan borrowing. Financial need is only a factor in determining federal interest assistance.

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 school’s financial aid office will normally issue a refund. The exact process varies from school to school.

Federal student loan borrowing limits depend upon the student’s education level. A college senior can borrower more than a freshman, and graduate students can usually borrow as much as they need. Additionally, independent students will have higher borrowing limits than dependants. Full details on student loan borrowing limits are available here.

Federal Student Loan Interest Rates

Congress sets the rates on federal student loans. Current interest rates are on the Department of Education’s Student Loan Page. Generally speaking, federal student loan rates are slightly higher than the best rates offered by those in the private sector. Graduate student loan interest rates will also be higher than undergraduate loan rates.

All federal student loan interest rates are fixed-rate loans. This means that the interest rate will not go up or down during the life of the loan.

However, each year interest rates on new loans are recalculated based upon market conditions. The loans borrowed in your first year of college may have a different interest rate than the loans borrowed in your third year.

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 if you borrow $5,000, your initial balance will be approximately $5,050. The fee for PLUS loans is much higher, currently starting at over 4%.

We hate to see fees associated with student loans. 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 can get their payments lowered to 10% of their monthly discretionary income. This perk is not offered by any private lender. 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 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 to 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 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 overwhelmed by student debt.  Additionally, borrowers who work in public service can have their loans forgiven after ten 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.

The benefits of fed loans go beyond the huge advantages of income-driven repayment and forgiveness. Federal loans have the most borrower-friendly terms. These terms include protections for borrowers who become disabled. The federal government has also offered excellent relief to borrowers during the Coronavirus pandemic. Private student loan lenders usually are not as borrower-friendly.

Federal Student Loan 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. However, there are protections in place to ensure that programs like Public Service Loan Forgiveness will not be eliminated.

Problem number two is the companies 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 in 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.

Federal Student Loan Review Final Thoughts

Even though there are genuine 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.

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About the Author

Student loan expert Michael Lux is a licensed attorney and the founder of The Student Loan Sherpa. He has helped borrowers navigate life with student debt since 2013.

Insight from Michael has been featured in US News & World Report, Forbes, The Wall Street Journal, and numerous other online and print publications.

Michael is available for speaking engagements and to respond to press inquiries.

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