Federal Student Loans

Federal student loans are offered through the U.S. Department of Education and are designed to give easy and inexpensive access to loans for school. You don’t have to make payments on the loans while you are in school, and the interest on the loans is tax deductible for most people. Direct Loans, also called Federal Stafford Loans, have a competitive fixed interest rate and don’t require a credit check or cosigner.

Direct Subsidized Loans

Direct Subsidized Loans are federal student loans on which the government pays the interest while you are in school. Direct Subsidized Loans are made based on financial need as calculated from the information you provide in your application. Qualifying students can get up to $3,500 in subsidized loans in their first year, $4,500 in their second year, and $5,500 in later years of their college education.

Direct Unsubsidized Loans

Direct Unsubsidized Loans are federal loans on which you are charged interest while you are in school. If you don’t make interest payments while in school, the interest will be added to the loan amount each year and will result in a larger student loan balance when you graduate. The amount you can borrow each year depends on numerous factors, with a maximum of $12,500 annually for undergraduates and $20,500 annually for professional or graduate students. There are also aggregate loan limits that put a maximum cap on the total amount you can borrow for student loans.

Direct PLUS Loans

Direct PLUS Loans are additional loans a parent, grandparent, or graduate student can take out to help pay for additional costs of college. PLUS loans require a credit check and have higher interest rates, but the interest is still tax deductible. The maximum PLUS loan you can receive is the remaining cost of attending the school.

Parents and other family members should be careful when taking out PLUS loans on behalf of a child. Whoever signs the loan is responsible for the loan forever, and the loan generally cannot be forgiven in bankruptcy. The government can also take Social Security benefits should the loan not be repaid.

Private Loans

Private loans are also available for students who need them from banks, credit unions, private investors, and even predatory lenders. But with all the other resources for paying for college, a private loan is generally unnecessary and unwise. Private loans will require a credit check and potentially a cosigner, they will likely have higher interest rates, and the interest is not tax deductible. As a general rule, you should be wary of private student loans or avoid them altogether.

Using a Loan Calculator

Students need to remember that they are consumers when it comes to taking on loans for college. Not thinking about what the debt means after college only compounds the issues. It is important to think about how much you could afford to pay monthly on a student loan once you have completed college. It’s easy to do the math on loan costs. The Smart Student’s Guide to Financial Aid has a free loan calculator that will do the work for you. All you have to do is plug in the numbers. The loan calculator will also give you an estimate of what your annual salary will need to be to be able to repay the loan. Of course, the loan calculator will not know your other financial commitments, so be sure to look at the monthly payment and decide if you can afford that additional expense.

Repayment Strategies

Payments on student loans will begin shortly after you graduate. While many websites, financial gurus, and talking heads in the media will encourage you to pay off your student loans as quickly as possible, you should give careful consideration to your repayment options and how they may impact your financial plans. Quickly paying off your student loans or refinancing your student loans into a private loan may be the worst option available to you.

Payment Plans

The federal government has eight separate loan repayment programs, each with their own way of calculating the payment you owe. Five of the programs tie loan payments to your income, which can make it easier to afford your student loans when you are just starting off in your career. The programs are described briefly below, but you should seek the help of a licensed fiduciary financial adviser familiar with student loans when making decisions related to student loan payment plans.

The standard repayment plan, also called the graduated plan, sets a consistent monthly payment to pay off your loan within ten years (or up to thirty years for consolidated loans). You can also choose a graduated repayment plan, which will begin with lower payments and then increase the payment every two years. A third option is the extended repayment plan, which provides a fixed or graduated payment for up to twenty-five years. However, none of these programs are ideal for individuals planning to seek loan forgiveness options, which are discussed below.

Beyond the normal repayment options, the government offers five income-based repayment options: (1) the Pay As You Earn (PAYE) repayment plan, (2) the Revised Pay As You Earn (REPAYE) repayment plan, (3) the Income-Based Repayment (IBR) plan, (4) the Income-Contingent Repayment (ICR) plan, and (5) the Income-Sensitive Repayment (ISR) plan. Each program has its own method of calculating payments, along with specific requirements for eligibility and rules for staying eligible in the program. Many income-based repayment plans are also eligible for loan forgiveness after a set period of time, assuming you follow all the rules and remain eligible.

Loan Forgiveness Programs

Many income-based repayment options also have a loan forgiveness feature built into the repayment plan. If you make 100 percent of your payments on time and follow all the other plan rules, any remaining loan balance at the end of the plan repayment term (typically twenty to thirty years) will be forgiven. This means you will not have to pay the remainder on your student loans.

This loan forgiveness, however, comes with a catch: taxes. Any forgiven balance will be counted and taxed as income during that year. So if you have a $100,000 loan forgiven, you could be looking at an additional $20,000 tax bill that year (assuming you were in the twenty percent marginal tax rate).

Another option is the Public Service Loan Forgiveness (PSLF) program for students who go on to work for a nonprofit or government organization. If eligible, you can have your loans forgiven after working for ten years in a qualifying public service job and making 120 on-time payments on your loans. A major advantage of PSLF is that the loan forgiveness may not be taxed as income in the year the loan is forgiven.

Consider Professional Advice

The complexity of the payment and forgiveness programs makes it difficult for nonexperts to choose the best strategy to minimize costs. Additionally, the strict rules and potential tax implications create a minefield of potential financial problems. In 2017, the first year graduates were eligible for the PSLF program, ninety-nine percent of applicants were denied due to misunderstanding the programs or having broken one of the many requirements for eligibility.^[1]

Your Rights as a Loan Recipient

As a recipient of a federal student loan, you have the same rights and protections as you would for any other loan, including the right to know the terms and conditions for any loan before signing the paperwork. You also have the right to know information on your credit report and to dispute any loan or information on your credit file.

If you end up in collections, you also have several rights, even though you have missed loan payments. Debt collectors can only call you between 8:00 a.m. and 9:00 p.m. They also cannot harass you, threaten you, or call you at work once you’ve told them to stop. The United States doesn’t have debtors’ prisons, so anyone threatening you with arrest or jail time is automatically breaking the law.

Federal student loans also come with many other rights, including the right to put your loan in deferment or forbearance (pushing pause on making payments) under qualifying circumstances. Deferment or forbearance can be granted if you lose your job, go back to school, or have an economic hardship. If you have a life event that makes it difficult to make your payments, immediately contact the student loan servicing company on your loan statements to see if you can pause your student loan payments.

The Consumer Financial Protection Bureau (CFPB) has created a series of sample letters you can use to respond to a debt collector. You can also file a complaint with the CFPB if you believe your rights have been violated.