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How Student Loans Work

Federal Student Loans

college loan officer with family
Direct PLUS loans are federal student loans borrowed by a student's parents, or loans taken out by graduate or professional students. SDI Productions/Getty Images

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As student loans go in the United States, those issued by the federal government are about as good as they come. Federal student loans offer low, fixed interest rates. This typically makes them much more attractive than private loans from commercial lenders.

There are three types of student loans a person can get from the U.S. government: Direct subsidized, direct unsubsidized and direct PLUS.

  • Direct subsidized loans are backed by the federal government and the U.S. Department of Education, which is the lender. The department of education will cover the interest if the student borrower is in school at least part time; during the first six months after the student leaves school (with or without a diploma); or when the loans are in deferment. Direct subsidized loans are awarded only to undergraduates and are based on financial need, and the school sets the limit on how much a student can borrow. There is also a limit to how much the total loan can be subsidized. For example, a first-year, dependent undergrad can have no more than $3,500 of their maximum $5,500 direct loans subsidized.
  • Direct unsubsidized loans are available to both undergraduate and graduate students. Unlike the direct subsidized loans, unsubsidized loans are not based on financial need, however, schools still determine still how much students can borrow. Students cannot take out loans that exceed the cost of attendance, and other financial awards like scholarships and assistantships are taken into consideration. The interest rate on an unsubsidized loan may be low, but interest is still an important fact to consider. Unsubsidized loans accrue interest all the time. The Department of Education explains it like this: "You are responsible for paying the interest on a direct unsubsidized Loan during all periods." That means if students don't pay interest on their unsubsidized loans while they're in school, they'll graduate with a (much) larger balance than what they actually borrowed. For example, a $5,000 unsubsidized loan with a 4.53 percent interest rate accrues about 62 cents per day. After four years of in-school deferment, that can tack on roughly $906 to that loan from freshman year.
  • Direct PLUS loans are federal student loans borrowed by a student's parents, or loans taken out by graduate or professional students. Out of all the types of federal loans, these most resemble a traditional commercial loan. Whether parents are eligible for a PLUS loan is based on their credit worthiness, and interest rates are higher than direct student loans. The cost of attendance at the university where the student is enrolled sets the limit for what a parent or grad student can borrow. PLUS loans are all unsubsidized, so interest begins to accrue immediately.

The process of obtaining one of these three federal student loans starts with filling out the Free Application for Federal Student Aid (FAFSA). If you are considered a dependent by the department of education, you will need to include your parents' financial information. Tip: Even if you aren't sure that you want to take out loans, the FAFSA can be your gateway to other types of aid like the Pell Grant. The FAFSA is relatively easy and can pull your financial information directly from the IRS.

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