How do Federal College Loans Work?

If you file financial aid paperwork for the colleges in which you have applied, you will receive an award letter. The financial aid award letter tells you how much financial support the school is willing to give you for the coming year.  Financial aid can come in a variety of forms, including grants, scholarships and loans.  Schools tend to have financial aid policies through which they pledge to find ways to meet some or all of your financial need.  The statistic schools get measured by when providing this additional help is called % of need met.

In understanding a family's real cost in their child attending school, it is important to understand that the sticker price of a school (Cost of Attendance) and their ultimate price are two different numbers altogether.  Some students will apply to $40,000/yr COA schools and end up having a net cost (or out-of-pocket cost) of $20,000/yr, and get award letters from colleges with a COA of $60,000 that may be able to offer you a OOP cost of only $15,000 per year.  We will leave the reasons behind this math for another day; right now, let's focus on some of the line items you might see on the award letter - the loans which comprise a portion of the family need being met.

A student's eligibility for loans is interpreted by each individual school, as a result of information provided by the family on the Free Application for Federal Student Aid (FAFSA) form, and/or information provided by the family on the PROFILE form, as required by the school.  Imagine a pot of money available to each school to dole out each year as they decide.  This decision is made annually by schools for incoming freshmen and any active qualifying students at the school who provide timely information each year.  It never hurts a family to provide this information, even if they received no federal need-based aid the year before.  The students who submit these forms the soonest in the process (earliest date for submitting FAFSA is January 1 of each year) get in line early for consideration for limited federal aid funds.

Here are the questions we will answer:

• What are Stafford Loans, and how do they work?
• What are PLUS Loans, and how do they work?
• What are Perkins Loans, and how do they work?

Stafford Loans
Stafford loans are federal government-funded monies given to schools for use as they see fit. Stafford loans can be offered two ways - as subsidized loans, or as unsubsidized loans.  The U.S. Department of Education pays the interest on subsidized loans until the first payment is due, generally six months after the student leaves the school (including graduation), or becomes considered a less than half-time student.  Unsubsidized loan payments are due on the same schedule as subsidized loans, but the interest accrues from the time the first payment is made to the school.  According to College Board, of all federal loans, 35% are subsidized Stafford loans and 40% are unsubsidized Stafford loans.  Stafford loans are in the student's name.

Currently, subsidized Stafford loans have a fixed interest rate of 3.4%, and unsubsidized Stafford loans have a fixed rate of 6.8%.  In awarding subsidized loans (clearly the preferred loan), 67% of loan recipients' parents had an adjusted gross income (AGI) of less than $50,000 per year, 25% had an AGI between $50,000 and $100,000, and the remainder had an AGI in excess of $100,000 per year.  It is not uncommon for a school to offer a combination of both types of loans, depending on a student's need.  this delineation is made on the award letter.  Stafford loans have a 4% fee, with 3% being an origination fee, and 1% being a default fee.  Generally, there is a maximum loan amount (between both types of Stafford loans) of $5,500 per year.  See Stafford Loan Site for more details.

PLUS Loans
PLUS loans are the second-most popular type of federal education loans offered.  PLUS loans are most often made to the parents of the students, and like the Stafford loan, are contemplated by each individual school as a result of information provided by families on the FAFSA or PROFILE form, as required by each school.  The loans are decided upon each year for incoming freshmen as well as active students who have at least half-time status.  Of all federal education loans, 10% are PLUS loans.

Currently, PLUS loans have a fixed interest rate of 7.9%.  The limit on the amount of the loan is the difference between the cost of attendance and any other financial aid received.  The loans have a 4% origination fee, and payments on the loan start immediately after the first loan payout.  On occasion, parents can qualify for a deferment of payments, with payments starting six months after the child leaves school (including graduation), or goes to less than half-time status.  See PLUS Loan Site for more details.

Perkins Loans
Of all federal education loans to undergraduate students, Perkins loans are the least used.  Of all loans offered, 1% are Perkins loans, and are offered to students.  Schools use the FAFSA and/or PROFILE form that families file each year.

Perkins loans have a 9-month grace period to start making payments after the student leaves school (including graduation) or goes to less than half-time status, have a 10-year repayment period, and are always subsidized, meaning that interest is paid by the Department of Education on the loan until payments begin by the student after the grace period..  Currently, Perkins loans have a fixed 5% interest rate and no origination fees.  Limits are $5,500 per year for undergraduates, with a cumulative limit of $27,000.  For more info, see the Perkins Loan Site.