Federal direct loans have become one of the most popular types of student loans in the United States for several reasons. They offer flexible repayment options, a convenient application method, and generous terms for both eligibility and allowable expenses. Despite these benefits, these loans have a few disadvantages, including a lack of subsidized options for graduate students, difficulty qualifying for bankruptcy, and funding limitations.
Key Takeaways
- Federal direct loans offer flexible repayment options, a convenient application method, and generous terms for both eligibility and allowable expenses.
- There are no subsidized federal direct loans for graduate students.
- Borrowers who default or become otherwise unable to repay their federal direct loans have to undergo additional steps to have debt cleared when declaring bankruptcy.
- Undergraduates who apply for direct unsubsidized loans and are claimed as dependents on a parent or guardian's tax return cannot borrow nearly as much as independents—undergraduates who file their own tax returns.
Understanding the Limitations of Federal Direct Loans
Graduate Students
There are no subsidized federal direct loans for graduate students. Although the federal government will cover the interest payments on loans for undergraduate students who meet the income qualifications for a direct subsidized loan, it doesn't offer this type of loan to grad students. Only unsubsidized loans are available past the undergraduate level.
Graduate students are also charged a higher rate of interest on their loans than undergraduates. The graduate-student rate for the 2023–2024 school year was 7.05%,compared to 5.50% for undergrads. Although both loan rates are now tied to the 10-year Treasury note, graduate rates are always higher than undergraduate rates. Current interest rates for federal direct loans can be found on the Federal Student Aid website.
Bankruptcy
Borrowers who default or become otherwise unable to repay their federal direct loans may find it difficult to escape them by declaring bankruptcy. Federal student loans are one of three types of debt (along with back taxes and divorce-related payment arrangements) that cannot be automatically discharged under either Chapter 13 or Chapter 7 bankruptcy. There is a small window of relief for those who fall into the category of “undue hardship,” but it can be tricky to qualify for this category. Borrowers seeking to establish undue hardship will have to file a separate legal action known as an advisory proceeding to establish the financial impact of continuing to repay their loans. If the court decides that no undue hardship exists, borrowers will have to find a payment plan that they can afford.
Loan Limits
Although the dollar limits for federal direct loans differ according to several criteria, borrowers whose financial needs exceed those limits will have to supplement their direct loans with other funding sources, such as private student loansthat may charge considerably higher interest.
Undergraduates who apply for direct unsubsidized loans and are claimed as dependents on a parent or guardian's tax return cannot borrow nearly as much as "independents," undergraduates who file their own tax returns, claiming themselves. The following table compares what students of each type can borrow:
| Direct Unsubsidized Loan Limits: Undergraduate Students | ||
|---|---|---|
| Annual Loan Limits | Dependent | Independent |
| First-Year (Freshman) | $5,500 | $9,500 |
| Second-Year (Sophom*ore) | $6,500 | $10,500 |
| Third-Year and Beyond (Junior, Senior) | $7,500 | $12,500 |
| Cumulative | $31,000 | $57,500 |
Loans in Default
Any applicant for a federal direct loan who is currently in default on any other federal loan will be automatically denied. The borrower will have to get all loans in default status back into current standing with the U.S. Department of Education before a federal direct loan will be granted. The Fresh Start program is currently available to help students that are in default become active on their loans again. Students may apply on the Federal Student Aid website. If you're not eligible, you may contact your loan servicer and make six consecutive months of payments on your defaulted loan. Once this is complete, you will be considered eligible for student aid again.
Loan Fees
All federal direct subsidized and unsubsidized loans now charge a 1.057% origination fee for each loan. This fee is assessed for both subsidized and unsubsidized loans.
Not Available for All Schools
Federal direct loans can only be used at educational institutions that distribute Title IV student aid funds; students planning to go to a schoolthat's not in this category will have to find some other type of financial aid, but you can easily learn whether your school qualifies by going to the Database of Accredited Postsecondary Institutions and Programs website.
Multiple Applications
Students must apply for a new federal direct loan every year. Approval for one loan doesn't guarantee approval for subsequent years.
Are Federal Direct Loans Eligible for PSLF or IDR Forgiveness?
Yes, all federal direct loans, both subsidized and unsubsidized, are eligible for current loan forgiveness and income-based repayment (IDR) plans.
Do Federal Direct Loans or Private Loans Have Lower Interest Rates?
Typically, federal direct loans offer a more attractive interest rate than private loans. The rate is tied to the 10-year Treasury Note, and it should be appropriate for the current state of the economy.
Is There a Grace Period Before Payments Start on Federal Direct Loans?
Federal direct loans offer a six-month grace period before payments are due, which is triggered by graduation, leaving school, or dropping below half-time enrollment.
The Bottom Line
Although federal direct loans have become the most popular type of student loan in use today because of their many benefits, they also come with some very real drawbacks. Graduate students aren't eligible for terms that are as favorable as those provided to some undergraduates, and students who are claimed as dependents on another’s tax return cannot borrow as much as those who claim themselves. For more information on the advantages and disadvantages of federal direct loans, consult your financial aid officer.
