How Do Federal Student Loans Work?

Student loans offered by the US Department of Education come in different types under the William D. Ford Federal Direct Loan Program, and it’s important to understand what sets them apart from each other. 

Undergrads are eligible for different loans than graduate students, professional students, or parents. Students with financial needs may qualify for subsidized loans. No matter which loan type fits your needs and circumstances, you need to know how it works.

Direct Subsidized and Unsubsidized Loans

Direct Loans are the number one choice of college students, largely because of their low fixed interest rates, the fact that you don’t need a credit history or a cosigner to get one, and you have the option of waiting until you’re done with school to start paying them back. 

The catch: The maximum loan amount is limited. The caps run between $5,500 and $12,500 based on your dependency status and class year.

Subsidized Loans

Undergrad students who need financial help to cover their college costs may qualify for Direct Subsidized Loans. With this loan program, the government pays all of the interest on your loans until it’s time for you to start making payments. The maximum amount you can borrow under this program depends on what year of school you’re in:

  • $3,500 for the first year of undergrad
  • $4,500 for the second year
  • $5,500 for the third year and beyond

Subsidized loans also come with a total combined cap of $23,000. To learn more about subsidized loan guidelines and requirements, visit

Unsubsidized Loans

Direct Unsubsidized Loans are available to both undergrad and graduate students, regardless of need, as long as they’re enrolled in degree programs and attend school at least half-time. 

With these loans, the borrower is responsible for all of the interest that accrues on the loan from the moment it’s disbursed. If you don’t make interest payments while you’re in school or during your six-month grace period, the accumulated interest will be added to your loan balance.

Direct Plus Loans

Sometimes, Direct Subsidized and Unsubsidized Loans just don’t cover the whole cost of school—particularly grad school. When that happens, students or their parents can apply for PLUS loans. 

Like other federal loans, PLUS loans require a currently completed FAFSA. These loans do require credit checks, and people with not-great credit histories may have to take extra steps to qualify. PLUS loans cost more in both interest and fees, and require quicker payments (often sixty days after disbursement); they look more like private loans than federal loans in many respects.

PLUS versus Private

If you’ve borrowed the maximum in Direct Subsidized and Unsubsidized Loans but still need more money to cover your college costs, you’ll have to choose between PLUS loans and private loans. 

If you have excellent credit and the ability to easily make monthly payments, private loans may be the better option, because you’ll almost always get a more competitive (lower) interest rate. However, there are several circumstances where PLUS loans may be more beneficial:

  • You think you’ll need the more flexible repayment options offered only by federal loans (though not all are available for parent PLUS loans)
  • You don’t have good enough credit to get a low rate on a private loan
  • You expect to qualify for Public Service Loan Forgiveness (find out more about this program at

Parent PLUS

Parents of dependent undergrads can take out loans to cover the balance of their children’s college costs, but parents don’t get all of the same protections and options as their children would. 

Parent PLUS loans come with some standard features, like fixed interest rates, loan fees (charged as a percentage of the loan), and the ability to defer payments until your child leaves school. Interest begins accumulating as soon as the money changes hands, so if you decide to defer payments, that interest will be added to the loan balance. 

Generally, the school will direct you to apply for the parent PLUS loan on the website (some schools have different procedures). 

If you’re eligible, you’ll have to sign a Direct PLUS Loan master promissory note (MPN). Next, funds will be disbursed directly to the school. If the loan proceeds are greater than the costs, the school will either return the money to you or your student (if you authorize that).

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