Federal Student Loan Programs

Federal Student Loans - an Overview

In the United States, financial institutions issue financial aid to students who need assistance with their tuition, learning materials, and living expenses. Student loans differ from other forms of financial aid, such as scholarships and grants, in that they require the borrower to repay back the loan at an agreed upon interest rate. In contrast to most of the developed world, the United States educational system relies on student loans to assist prospective graduates in obtaining their post-secondary education. The vast majority of the U.S. population views a higher education as a worthwhile investment as opposed to a basic human right. As a result, graduates typically complete their course of study with high debt levels; however, employers generally pay higher wages to college graduates. Financial institutions distribute several types of student loans, including federal student loans, parent PLUS student loans, graduate PLUS loans, federal Perkins loan, and private loans.

What are Federal Student Loans?

During the 1950's, the United States government issued the first student loans under the National Defense Education Act (NDEA) to prospective graduates of engineering, science, and education majors. The U.S. government established the federal student loan program in the face countries that criticized the United States for lacking the education and technology during the Cold War. The U.S. government further extended their efforts by signing the Higher Education Act in the 1960s. The Higher Education Act promoted greater social mobility and opportunity for the less fortunate.

The United States Department of Education issues direct loans to college and university students, which help supplement established college funds, scholarships, grants, and work-study programs. The United States government only allows the student to use the funds towards educational expenses, such as tuition, room and board, books, supplies, equipment, fees, computer rentals, transportation expenses, and childcare. The federal government may issue subsidized or unsubsidized student loans, depending on the type of loan issued to the student. The United States Congress determines the pricing and loan limits; however, undergraduates typically receiver lower interest rates than their counterparts. Critics of the federal student loan process believe that the U.S. government should assess the pricing and loan limits on an individual basis to assess the risk of each case.

The federal government issues a six month grace period, which means the graduate must start making payments six months after graduation. If the student becomes less than half-time or fails to graduate at all, then he or she must start repaying towards the principle of the loan six months after the initial dropout. The annual limits of each federal loan type varies according to the student's educational progression and dependency. The federal government offers subsidized loans for students with financial need. This means that the federal government will pay the accruing interest while the student continues his coursework. Unsubsidized federal student loans simply means that the student must start to repay the interest upon graduation. Students have the option of repaying towards the interest of the loan while in school; however, not many students choose to take this route.

Federal Stafford Loans

The Higher Education Act of 1965 defines federal Stafford loans as funds issued with the guarantee that the principle of the loan will be repaid to the lender if the student defaults. The United States Congress renamed the Federal Guaranteed Student Loan program in honor of Robert T. Stafford for his contributions on higher education. Financial institutions offer lower rates for Stafford loans, mainly because they have the confidence that the federal government will repay back the loan if the student defaults. Prospective students must pass strict eligibility requirements before obtaining a Stafford loan. As of July 1 st, 2012, graduate and professional students do not qualify for subsidized Stafford loans; however, they may qualify for unsubsidized loans. Students who obtain Stafford loans must not exceed the aggregate limits for subsidized and unsubsidized loans. For instance, dependent undergraduate students must not exceed the maximum limit of $57,500 for the combined subsidized and unsubsidized loans. Students with subsidized loans must not exceed the maximum aggregate limit of $23,000. Graduates who have exceeded the total amount of subsidized loans may apply for comparable loans at less than or equal to the amount they would have received from a subsidized Stafford loan. The student may not qualify for an additional Stafford loan upon meeting the maximum aggregate levels until the student has repaid a portion of the funds.

Parent PLUS Student Loans

Financial institutions issue student loans to parents of undergraduate students (PLUS), usually with higher loan limits than those issued directly to the student. Parent PLUS student loans usually cover the gaps in the student's educational expenses. The lender holds the parent responsible for the repayment of these loans, not the student. In addition, parents must sign the master promissory note to repay the loan, which means they do not act as cosigners. Parents who fail to repay back the loan will suffer the same consequences as student's who default on their federal student loans; therefore, parents should opt for the “year 4” payment plan, instead of the “year 1.” Parent PLUS student loans can be expensive for the borrower with interest rates of 7.21% for the 2014-2015 year.

Federal Perkins Loan

The United States Department of Education distributes federal Perkins loans on an as needed basis. The Federal Perkins loan carries a fixed 5% interest rate for the duration of a ten-year repayment plan. The Perkins loan has a nine-month grace period that allows borrowers to start making payments on the tenth month after completing graduation. The federal government subsidizes the Perkins loan, which means that the interest does not begin to accrue until after the borrower starts to repay the loan. Teachers and Peace Corps volunteers may qualify for federal loan cancellation, a process that usually occurs on a graduating scale.

Graduate PLUS Student Loans

Financial institutions issue student loans to graduates at the same interest rates as Parent PLUS student loans. The Graduate PLUS loans are unsubsidized, government-backed educational loans with no limits. The Graduate PLUS loan program offers the same deferment options as the Stafford loans. Therefore, graduate students can delay repayment by opting for in-school deferment if attending at least part-time in a degree or its equivalent course of study. However, the lender can capitalize the interest off a deferment, making the interest rates higher than if it were repaid at the start. Prospective graduate students who wish to obtain a PLUS loan must be a U.S. citizen, pass a credit review, and not posses a prior default record on any federal student loan.

Federal Student Loan Consolidation

In the United States, the federal government offers debt consolidation for struggling students on the verge of default. The U.S. Department of Education purchases the existing loans and issues a fixed interest rate based on the current interest rate at the time it was purchased. The U.S. Department of Education does not change the fixed rate if the student decides to re-consolidate the loan in the future. If the student decides to enroll several loans into one debt consolidation, then the U.S. Department of Education will issue a calculated average appropriate to the then-current interest rates. Contrary to the principle of refinancing, federal student loan consolidation secures a fixed interest rate, which makes it entirely different than the debt consolidation offered by private lenders. In addition, student loan consolidation does not incur any fees to the borrower.

Start Building Credit

Student loans help build an individual's credit history. If an individual accrues outstanding debts, then he is liable to repaying back the principle and interest of a loan. If the person defaults or fails to repay back the loan, then that individual's credit history will ultimately have a bad track record. To avoid building a negative credit rating, students should never be late on a payment to their creditor. In addition, students should not take more out more student loans than they can afford repaying back. An individual's credit score can have a severe impact on their lives, which may prevent the student from getting an apartment, buying a house, or leasing equipment. Likewise, a small percentage of employers weigh an individual's credit score as a condition for employment.

Building a good credit rating can help you secure lower interest rates for private school loans, if your federal student loans do not cover all of your expenses. Opening a student credit card with small credit limit is a great way to start building credit history.