Navigating Federal Student Loans: A Comprehensive Guide

About 20 million Americans currently attend a college or university, and almost two-thirds of them borrow money to pay tuition and other expenses. The total amount of student loan debt in the United States is now estimated to exceed $1 trillion. The average debt for all borrowers is somewhere around $30,000, and that number continues to grow as tuition and other costs keep going up. Student loan programs offer some forms of relief to borrowers that are not usually available for other types of loans, such as payment deferrals and various repayment plans. Unlike many other types of loans, however, student loans are not subject to discharge in bankruptcy, except in extraordinary circumstances. Consumers should consider their options very carefully when considering borrowing money for education. Student loans fit into two broad categories: federal loans and private loans.

Understanding Federal Student Loans

Federal student loans are provided by the government, specifically through the Department of Education (DOE). Until 2010, the DOE also guaranteed loans by private investors. Federal student loan programs include Federal Perkins Loans, Stafford Loans, the Federal Direct Student Loan Program (FDLP), and consolidation of existing federal loans under a new FDLP loan. These loan programs limit the amount students may borrow at any one time and in the aggregate.

Types of Federal Student Loans

Within the federal loan system, there are subsidized and unsubsidized loans. Subsidized loans, in which the DOE pays some or all of the interest, are available based on financial need. Borrowers pay both principal and interest in unsubsidized loans. Repayment is typically deferred as long as the borrower remains enrolled in school at least half-time.

Applying for Federal Student Loans

To apply for federal student loans, the first thing you need to do is complete the Free Application for Federal Student Aid (FAFSA®). In addition to federal student loans, the FAFSA® also determines your eligibility for other federal student aid like grants and work-study. If you think you might need to borrow both federal and private student loans, always submit your FAFSA® first. You’ll receive a financial aid offer from the colleges you’ve been accepted to. All student loans-federal and private-include terms and conditions.

Private Student Loans

Private student loans are available from banks, finance companies, nonprofit organizations, and other entities. Lenders like Sallie Mae used to provide guaranteed federal student loans through the DOE and now offer private loans. These loans are not eligible for federal subsidies, and they are usually more expensive than federal student loans. Federal income-based repayment plans are not available for private loans. Borrowers often turn to private lenders when they hit their federal borrowing limits. Private student loans usually offer the choice of a fixed or variable interest rate. Fixed rates stay the same, giving you predictable monthly payments. Private student loans offer different repayment plans-including options that allow you to make interest-only or fixed payments while you're in school. Private student loans offer flexibility, since they can be taken out by a student (often with a cosigner), parent, or creditworthy individual. Private student loan funds are usually disbursed (sent) directly to your school’s financial aid office.

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Federal Loans vs. Private Loans

When comparing federal loans vs private loans, the key difference is that federal loans are provided by the government and private loans are provided by banks, credit unions, and other financial institutions. Whether you choose federal student loans or private student loans, you have to pay back the money you borrow, plus interest-whether you graduate or not. Student loans are legal agreements, so be sure you understand what you're signing. Is there a cosigner on the loan? Be sure to understand the difference between private student loans and personal loans. Private student loans are for education, while personal loans can be used for things like consolidating credit card debt, making home improvements, or paying for a wedding. In general, private student loans have lower interest rates than personal loans. They can also offer the choice of a fixed or variable interest rate.

Repayment Strategies for Federal Student Loans

Now that you understand the ins and outs of your loans, let’s go over some strategies for getting them paid off as quickly and smoothly as possible.

Knowing Your Loans

Make a list of your student loans. Include whether they’re private or federal, monthly payment and due date, the current and principal balances, the interest rates, and servicer. If you’re not sure, start by checking your free credit report. For federal loans, it will also help to know what type of loan it is (such as PLUS, subsidized, or unsubsidized) and the name of your repayment plan. You can look up your federal loans at studentaid.gov.

Budgeting and Payment Scheduling

See if your loans fit into your budget and pay schedule. Make a budget and explore strategies for reducing debt to help you see how your student loans fit into your finances. Request a different due date if that would make it easier for you to make your payments on time and in full.

Choosing the Right Repayment Plan

Make sure your federal repayment plan is the best one for you. You can use Education Department’s Loan Simulator to compare plans by monthly payment, total interest, and more.

Saving Time and Money

Set up direct debit (aka autopay) for 0.25% off your interest rate. With direct debt, your payment is taken automatically from your bank account each month. All federal direct loans and many private lenders offer this discount.

Extra Payments

Extra payments can get you out of debt faster and save you money on interest-if you can afford them. To get the full benefit, tell your servicer to apply extra payments to your highest interest rate loan(s) first.

Staying in Touch with Your Servicer

Stay in touch with your servicer. Take notes when you talk on the phone with them: jot down the date, the name of the person you’re talking to, what you asked, and how they answered.

Claiming Student Loan Interest on Taxes

Claim your student loan interest on your tax return. Depending on your income and tax filing status, you may be able to claim up to $2,500 of the student loan interest you paid in a given year.

Income-Driven Repayment (IDR) Plans

If your payment is too high, seek income-driven repayment rather than a pause on payments. Pauses, known as deferment and forbearance, are not long-term solutions. An income-driven repayment (IDR) plan can reduce your monthly payment to as low as $0. Use ED’s Loan Simulator to choose the right plan for you.

The SAVE Plan

Learn about SAVE, the newest IDR plan, and how to enroll. The SAVE plan is the most affordable student loan repayment plan in history. It may provide you with the lowest monthly payments and reduced times to getting loan forgiveness if you borrowed a small loan. Also, under the SAVE plan, if your monthly payment doesn’t cover the accrued interest, that interest will not be charged to you. Instead, it will be forgiven, meaning your loan balance will not grow. Call your servicer to understand how the SAVE plan can help you reduce the cost of repaying your federal student loans.

Recertifying Your Income

Borrowers enrolled in IDR plans must annually recertify their income and household size. As part of the FUTURE Act, you can provide consent to ED to automatically recertify your IDR payment based on information from the Internal Revenue Service (IRS). By consenting, you allow ED to receive your tax return information and your monthly payment will be automatically adjusted without you having to recertify each subsequent year. If your income has changed from your most-recent tax return, you can always submit additional documentation to have your monthly payment reviewed. Set a reminder to renew your paperwork. If you don’t consent to the automatic recertification, you will need to confirm your income annually in order to keep your payment based on your income. Failure to recertify will likely result in a significant increase in your monthly payment amount. It can also result in interest capitalization. Renew your IDR income recertification early if your income goes down or your household grows. Your monthly payment will be recalculated. These plans allow repayment flexibility based on your income (or lack thereof) you may be eligible for a lower monthly payment, possibly as low as $0, through an income-driven repayment (IDR) plan.

Capitalization

Beware of capitalization. For federal student loans, interest will be capitalized - or added to your principal - under two circumstances: when you exit a period of deferment on an unsubsidized loan or when you are repaying a loan under the income-based repayment (IBR) plan and you no longer need financial assistance as determined by the regulations. In other instances, interest may accrue but not be added to the principal. Keep in mind that a monthly payment will be applied against outstanding interest before it will be applied to your loan principal. In the new SAVE plan, any interest that remains after a monthly payment is applied will be forgiven by ED and your balance will not grow.

Lowering Payments Through Retirement Savings

Lower your payment by saving for retirement. Your IDR payment is based on your adjusted gross income (AGI). Contributing to a tax-deferred retirement account, like a 401(k) or 403(b), decreases your AGI and your IDR payment too. This could increase the amount forgiven if you are pursuing loan forgiveness through PSLF or IDR.

Parent PLUS Loans and IDR

Income-Contingent Repayment (ICR) is the only income-driven repayment plan available to Parent PLUS borrowers. Getting on ICR is also the best way to pursue Public Service Loan Forgiveness (PSLF) for your Parent PLUS loans. On ICR, your loan balance will also be forgiven after 25 years.

Consolidation

Consolidation is the first step. Parent PLUS loans are not directly eligible for ICR. You must convert them into a Direct Consolidation loan, starting with this free application. The Education Department offers help before and during the consolidation process. Do not consolidate other federal student loans with Parent PLUS loans. If you do, you will lose other benefits on those other loans, like access to other income-driven plans. Once you have a consolidation loan, you can request ICR. You can submit your request online or by calling your servicer. Set a reminder to renew your enrollment next year. If you fail to recertify your income and household size, your monthly payment will revert to a payment based on the standard, 10-year payment schedule. Parent Plus borrowers recertify by logging in to your federal student aid account. Your total loan balance can grow on ICR. If your monthly payment does not cover the accrued interest, your loan balance will go up, even though you’re making payments. Unpaid interest will also capitalize each year until your total balance is 10% higher than the original balance. This means you will pay interest on your interest.

Servicemember Benefits

Exercise your rights as a servicemember.

Public Service Loan Forgiveness (PSLF)

Your service counts towards public service loan forgiveness (PSLF). After you make 120 qualifying monthly payments under the PSLF program, you can apply to have your remaining loan balance forgiven, tax free. Learn more about your next steps from the PSLF Help Tool.

Interest Rate Cap

Get your interest rate capped. The Servicemembers Civil Relief Act (SCRA) entitles you to have your interest rate reduced to 6% on all debts taken out before your service began, including both federal and private student loans. Federal student loans can be reduced to 0% when you are serving in a hostile area. Reductions in federal student loan interest should happen automatically; check your statements to make sure. Contact your private student loan servicer to request a rate cap. There are other benefits for active-duty servicemembers with Direct Loans.

Avoiding Scams and Financial Pitfalls

Avoid scams and wasting money.

Credit Cards and Home Equity

Don’t use credit cards or home equity to pay off student loans. Credit cards will cost you way more in interest. If you refinance your loans using home equity and run into trouble paying your mortgage, you could lose your house. Either way, you will lose the flexible repayment options and borrower protections offered by federal student loans.

Returning to School

Don’t go back to school just to avoid loan payments. Even during in-school deferment, your unsubsidized loans will accrue interest. Carefully compare the costs and benefits of more education.

Protecting Your Information

Never share your loan or bank information, or your studentaid.gov login. Learn the other warning signs of student loan scams.

Paying for Help

Don’t pay for help with your student loans. Many companies sell support services, including filling out forms. These services, however, will charge you a fee for something you can do for free. Free, qualified help is available. Credit counseling nonprofits, which are different from credit repair companies, can help you make a plan to get out of debt. You can look for one near you by searching “credit counseling nonprofit” with the name of your city or town.

Defaulting on Federal Student Loans

When does default occur? If you continue to miss payments, your loan will eventually enter default. For most federal loans, this occurs after 270 days, or approximately 9 months, although loans are not reported to be in default until they reach the 360th day of delinquency and are sent to collections. Banks and other private lenders typically charge-off private education loans when they become 120 days past due, but charge-off rules vary by lender. A default note will go on your credit report, which can have a negative impact on your credit score. Once your loan is in default, the lender can file a lawsuit against you to collect on the debt. This is because student loans are unsecured debt, which means there is no collateral to repossess, such as a car or house. Defaulting on a federal student loan can have additional consequences. You could lose your eligibility for all federal student aid and face garnishment of your federal tax returns, wages, and Social Security payments. However, typically there are other options for getting out of default. If you are struggling to afford your student loan payments, reach out to your servicer immediately to ask about your options. Contact your private loan lender to determine what option is best for you. Borrowers who expect to be incarcerated for at least 10 years should inform their loan servicer.

Student Loans and Bankruptcy

Personal bankruptcy under Chapter 7 or Chapter 13 of the Bankruptcy Code offers a way for consumers to pay off some or all of their debts when they do not have enough income to continue making their required debt payments. Both types of bankruptcy may result in a discharge of certain debts at the end of the case, meaning that the debtor is no longer obligated to pay. Section 523(a)(8) of the federal Bankruptcy Code specifically excludes student loans from discharge. The only way a bankruptcy court may discharge student loan debt is if debtors can prove “undue hardship” to themselves and their dependents. Many courts have adopted a three-part test, known as the “Brunner test” after Brunner v. N.Y. State Higher Educ. Servs. Corp., 831 F.2d 395 (2d Cir. 1987), to establish undue hardship. This involves asking whether the debtor and the debtor’s dependents can maintain a “minimal standard of living” if the debtor is required to repay the student loan, whether the debtor’s circumstances are likely to persist for a substantial part of the loan’s repayment period, and whether the debtor has made a “good-faith effort” to repay the loan. If the court finds that the answers are “no,” “yes,” and “yes,” it may discharge the student loan debt.

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