We hear many news stories about students graduating from college with massive student loan debt. It’s enough to scare many of us away from student loans entirely.
But many students and families may not be able to pay the full cost of college from their existing savings and income.
This is why it’s important to understand your student loan options before you make any assumptions or rule out borrowing money.
In this article, we’ll take a look at one of the best student loan options: Direct Loans. These loans can help your student pay for college at a relatively low borrowing cost.
In this article, I’ll show you how they work and provide an overview of everything you need to know about federal direct student loans, so you can decide if they’re right for you.
Knowing the facts will hopefully put your mind at ease, so let’s get started!
The following are some key points to introduce you to Direct Loans:
- Federal Direct Loans are student loans from the U.S. government.
- The loan is awarded to the student and paid by the student. Parents are not involved.
- Virtually any full time student can receive this type of loan.
- Direct Loans are available at most two- and four-year colleges.
- To apply for student loans as part of financial aid, you must complete a Free Application for Federal Student Aid (FAFSA) for each school year you’re enrolled.
- For the 2019-2020 school year, the maximum amount a freshman can borrow is $5500. Always check the maximum borrowing amounts for the year when you’ll be taking out a loan. These can change from year to year. Unfortunately, the maximum amount probably won’t be enough to cover full college expenses, so parents may need to help if more money is needed.
Now that you’re familiar with some of the basics, we’ll jump into the 11 things you should know about Direct Loans.
1. The Two Types of Direct Loans
All students qualify for unsubsidized federal direct student loans. When the loan is unsubsidized, interest is applied immediately and accrues while you’re enrolled in college. Students don’t have to start repaying the loan until they graduate or are no longer enrolled, but interest will still accrue while they’re in school.
A portion of a Direct Loan may be subsidized, which means the government pays the loan interest while the student is in college.
To qualify for a subsidized loan portion, you must show a financial need based on your FAFSA (Free Application for Federal Student Aid).
When you’re offered a Direct Loan, there is always an unsubsidized portion because there is a limit to the amount of subsidized loan money you may receive.
Students have the option to accept only the subsidized portion of the loan and refuse the unsubsidized portion. It’s entirely up to you, and you’ll make this decision for each school year, so you can choose to do it differently from year to year.
Amounts Allowed for Each Type of Loan
As of the 2019-20 school year, the total of unsubsidized and subsidized loans must not exceed $5500 for expenses during your freshman year.
For qualifying students, $3500 of this amount may be subsidized.
Students may not exceed the annual as well as total subsidized and aggregate loan limits shown here in Table A:
Direct Loan Limits for Dependent Students
|Total Aggregate Limit||$31,000*||$23,000*|
* You can potentially borrow Direct Loans for more than four years, but there is an aggregate limit of $31,000 overall and $23,000 for subsidized loans specifically.
Subsidized vs. Unsubsidized Loans: Comparing Two Families
Next we’ll take a look at the difference between subsidized and unsubsidized loans when it comes to how much you save by borrowing subsidized vs. unsubsidized.
Let’s consider the example of two families: Family 1 and Family 2, shown in Tables B and C respectively.
Each family has one student going off to college, and each student is going to borrow the maximum of $27,000 in Direct Loans over four years of college. The maximum borrowing limit is $27,000 for students taking the typical four-year college path.
While it’s possible to borrow up to $31,000 if you attend college for an extra year, as shown in Table A above, the annual borrowing limits for the first four years total $27,000. And you cap out at $31,000 if you attend school for a fifth year, regardless of the year-by-year limits.
We’ll assume an interest rate of 5% for both cases, and they won’t have to make any payments until after graduation, since Direct Loan repayments are deferred until six months after graduating from college.
Let’s start by looking at Family 1, whose student qualifies for the maximum amount in subsidized loans, which is $19,000 over four years. The student also borrows the maximum of $8,000 in unsubsidized loans.
Table B – Family 1
Assumes interest rate of 5%
|College Year||Subsidized||Unsubsidized||Grand Total|
|Total Amount Borrowed||$19,000||$8,000||$27,000|
|Total Loan Balance||$19,000||$9,051||$28,051|
|10-yr. Monthly Repayment||$202||$96||$298|
In Table B, we see the total amount borrowed at $19,000 for subsidized loans and $8,000 for the unsubsidized loans.
We also see the interest that accrues while Family 1’s student is in college, along with the total loan balance after four years of college, and the monthly payments that will be due on a 10-year payment plan.
No interest accrues on the subsidized loans because they’re interest-free. But $1,051 in interest accrues on the unsubsidized loans. This is why the total loan balance after four years is $9,051 for the unsubsidized loans and still only $19,000 for the subsidized loans.
As a grand total, Family 1’s student will have a total loan balance of $28,051 after graduation.
A 10-year repayment plan shows that the student will owe $96 per month for the unsubsidized loans and $202 per month for the subsidized loans. In total, that’s $298 per month in loan payments over the next 10 years.
Now let’s take a look at our other example, Family 2 in Table C.
Table C – Family 2
Assumes interest rate of 5%
|College Year||Subsidized||Unsubsidized||Grand Total|
|Total Amount Borrowed||$0||$27,000||$27,000|
|Total Loan Balance||$0||$30,354||$30,354|
|10-yr. Monthly Repayment||$0||$322||$322|
In Table C, we see that Family 2’s student doesn’t qualify for subsidized loans and ends up borrowing the Direct Loan maximum of $27,000, all in unsubsidized loans.
Since interest accrues for unsubsidized loans while you’re in college, the student in Family 2 accrues $3,354 in interest over four years. That leaves a total loan balance of $30,354 after graduation, with $322 per month due in loan payments for 10 years.
The Not-So-Big Difference: Subsidized vs. Unsubsidized Loans
Let’s do a quick review and look at the difference between Family 1 and Family 2.
They both borrowed the same money. They both won’t have to make payments until after graduation.
But the difference is that interest accrues while you’re in school when you have unsubsidized loans, so Family 2 will owe $2,303 more after graduation ($30,354 vs. $28,051), and it will have to pay $24 more per month ($322 vs. $298) for 10 years.
Of course, it would be nice to get all your loans subsidized. But the difference compared to taking out all unsubsidized loans isn’t all that big.
It only costs you a couple thousand dollars overall and only $24 per month if you don’t qualify for subsidized loans. And you’re still going to take the loans if you need them. It’s not horrible.
Even if you move your assets around to help maximize subsidized loan eligibility, it can cost you more in the long run than just taking unsubsidized loans.
Is it worth it to turn your life upside down and shift all your assets around for a $2,000 benefit over a 10-year period? Sometimes it can cost you as much as $2,000 in taxes and fees to make all those changes anyway.
Also, if you do things such as move more of your assets into a retirement plan to hide them, your assets might not be accessible to help make your loan payments.
If you can move your assets at minimal cost, then, by all means, take advantage of getting better loan terms. But don’t take a big hit in taxes or fees or create other problems just to save $2,000 on your student loans.
Special Rule for Students of Parents with Poor Credit
Please note the following special rule for students borrowing money and whose parents have poor credit:
A student may qualify for an additional $4,000 each year if their parents do not qualify for a PLUS loan (see below), which is a federal loan for parents only. This additional $4,000 is unsubsidized, so interest will accrue while your student is enrolled and once repayments begin.
2. Interest Rates
Interest rates for Direct Loans are hard to beat. As of the 2020-2021 school year, the interest rate for a Federal Direct Student Loan is 2.75%, but this is much lower than normal. Rates dropped dramatically in 2020 due to the COVID-19 pandemic, and they’re projected to start rising again for 2021-22, although they probably won’t be back to normal for another year or two.
Keep in mind that this rate changes each year, and the new rate for new loans is determined during the summer before each school year. However, the interest rate is fixed for the life of each loan.
What this means is that a student will take out a separate loan for each year of college. The interest rate will be based on the current rate for that school year, and it will not change for the life of that loan for that amount.
However, in subsequent years, when the rate changes and a student takes out another loan for another year, there will be a different interest rate.
The example in Table D shows the interest rates were for a student that started college in 2016 and took out a Federal Direct Student Loan in each year.
|Freshman year – 2016-17||3.76%|
|Sophomore year – 2017-18||4.45%|
|Junior year – 2018-19||5.05%|
|Senior year – 2019-20||4.53%|
3. Benefits of Direct Student Loans
The first benefit of a student Direct Loan is that almost every student is eligible to receive one. This makes it possible to get a federal Direct Loan at all the schools you might be considering. It’s unlikely that one school will offer a loan and another will not.
This loan is the first type of aid offered to fill your need, and colleges like it because it doesn’t cost them anything.
Even if you don’t qualify for any other federal financial aid, a student will likely be offered a Direct Loan each year. It is common at state schools, where Direct Loans are often the only federal aid offered when parents are middle-to-upper income. And parents can potentially supplement Direct Loans by taking out a PLUS Loan or private loan.
Table E shows how a Direct unsubsidized loan would be applied to a freshman at a state school for a family earning $100,000.
|Family Income: $100,000|
|Cost of Attendence|
|Room and Board||$10,000|
|Direct Unsubsidized Loan||$5,500|
|Balance to Pay||$18,800|
No Co-Signer Required
Students can take out a Federal Direct Student Loan without any cosigners. This is the only student-borrowed non-cosigner loan available to a student with no credit history or income (the typical 18 year-old going to college after high school).
Students may delay payments until after college graduation and pay with their future earnings.
Direct Loans also provide disability and death benefits.
All of these benefits are not offered in many other non-federal student loans.
4. Requirements for Receiving a Direct Student Loan
There are only three items needed to receive your loan:
- The student must be enrolled or planning to enroll at least half-time at a participating school.
- The FAFSA must be completed and submitted.
- The student must meet eligibility as determined from the FAFSA submission.
5. Receiving and Accepting a Loan Offer
Your first Federal Direct Student Loan is finalized after you graduate from high school. If you’re familiar with it early in your high school years, you’re ahead of the game.
First, you’ll start the process during your senior year of high school. You’ll complete and submit the FAFSA (Free Application for Federal Student Aid) during that time. Some high schools offer sessions to help students and parents complete this form.
Next, any loans are offered in the financial aid offer letter that you receive from each college where you applied for aid.
The letter typically comes in March of your senior year.
The loans will be listed along with other aid (if you qualify). Other aid might include scholarships, grants and work-study, and it can come from federal or state sources, or directly from the college.
Once you select a college to attend, you’ll begin working with the financial aid office at that school for the remainder of the process.
If you’ve been offered a loan and decide to accept it, the following steps will be completed in the summer before college begins:
- You will fill out paperwork for the loan for your school of choice, most likely on an online portal.
- You must sign a promissory note.
- Your college will require some type of counseling to make sure the student understands that they’re responsible for the loan even if they drop out of school. This counseling could include videos and/or meetings.
- The government directly pays the college, and the college deducts the amount from your tuition and fees bill.
- You may manage and track your loans at studentaid.gov.
6. Receiving Your Money
Federal Direct Student Loan money is sent directly to the college. It is not sent to the student or family. The college will generally apply the money with one-half applied to each semester or one-third to each trimester.
If there is money left over after applying money to the student’s bills at the college, the student can request a check. You can use this money to pay other expenses such as books or rent.
However, some students spend this extra money on spring break or foolish purchases. It’s their money, and they will have to live with the consequences. College is more than academics: it’s also learning how to deal with everyday issues and make life decisions.
7. Academic Progress
Satisfactory academic progress is necessary to continue to receive federal student aid or loans.
Each school has its own policy for satisfactory academic progress. This policy may be found on the school’s website, or you may speak to someone in the school’s financial aid office to learn more.
Schools generally look at the following criteria when determining academic progress:
- A minimum GPA must be maintained.
- You must successfully complete a minimum number of credits by the end of the academic year.
Your school can inform you about how often it evaluates your progress and what will happen if you fail to meet its satisfactory academic progress requirements.
Some schools may allow you to appeal a decision regarding your academic progress, if you had a circumstance such as a student illness or a death in the family.
8. Making Your Payments
Here are a few points for you to know about repaying your loan:
- The most important thing to know is that payments can be deferred until after graduation. Yes, that’s good news. Your son or daughter can focus on their studies and will not have to think about payments until their degree is in their hands.
- Payments will begin six months after graduation, which allows the student a little time to find employment and start to get on their feet before starting loan repayment.
- If the student continues with full-time student status after graduation and pursues a second major or attends grad school, law school, or medical school, payments can be further deferred.
- Please note that payments will begin immediately if a student leaves school or drops below half-time student status.
- Parents may assist students with their payments, but this loan is ultimately in the student’s name and is the student’s responsibility.
9. Loan Consolidation
All of a student’s direct subsidized and unsubsidized loans can be consolidated, and the interest rate is then averaged. Consolidation is usually done just prior or during repayment and typically after graduation.
Consolidation is common because it combines multiple smaller loans into one big loan that’s easier to manage and will often bring down your minimum payment.
Your consolidated loans may be combined with your repayment plan. There are several different repayment plans to choose from, which we’ll review in the next section.
10. Repayment Plans
Federal Direct Student Loan repayment plan options are as follows:
- Standard repayment – Payments are a fixed amount, and loans are paid off within 10 – 30 years.
- Graduated repayment – Payments are lower at first, and then increase, usually every two years. Amounts are determined to make certain loans are paid off within ten years. (10 – 30 years for consolidated loans.)
- Extended repayment – Payments can be fixed or graduated and are paid off within 25 years.
- Income-based repayment plans – There are four different options under this plan in which your payment is recalculated each year and is determined by how your income and family size change each year. Outstanding balances will be forgiven if these loans are not repaid in full after 20 – 25 years.
It may not be helpful to worry too much about repayment options and decisions until you get there and have all the facts and options in front of you.
You may decide which payment is right for you, based on your current situation, when repayment begins.
Borrowers can often change their repayment plan choice if the need arises.
The worst case is the default 10-year repayment option if circumstances change a lot.
The current fee for a Direct Student loan is 1.062%. This one-time amount is deducted from what is sent to the college.
For example, the fee for a $5500 loan would be $58.41. $5500 – $58.41 = $5441.59, which is credited at the college. $5441.59/2 = $2720.79, which is credited each semester.
This fee is small and is far outweighed by the many other benefits of federal direct student loans that we’ve discussed.
Check Out My Direct Loans Q&A
Still have questions or need a quick review? Read my Direct Student Loans Q&A for answers to some of the most common questions on this topic, plus a great review of the core details we covered here.
You can also find other helpful college planning articles and resources by checking out the following links and recommendations:
Statistics and details from this article can be found at https://studentaid.ed.gov