Federal Student Loans – An Introduction

The first step in erasing your student loans is understanding what you’ve borrowed. This is not as easy as it should be, but the process is getting better. Once you know what type of loans you hold, you can begin to understand your options.

There are two types of student loans:

Private loans are made by private institutions and are not backed by the federal government. Private lenders might be a bank, a commercial lender (e.g. Sallie Mae), a state agency or a nonprofit organization. Private student loans do not have the same management options as federal loans and can therefore be more difficult to manage.

Federal loans are loans made directly by the federal government. Federal loans provide a range of repayment and loan management options, making them generally easier to manage than private loans. As an example, federal loans offer: (1) repayment plans (including plans tied to your income); (2) the option to postpone payment in certain situations via deferment and forbearance; and (3) the possibility of loan forgiveness.

While federal loans offer more flexibility in repayment, they generally have severe consequences upon default. There are no statute of limitations on federal loans which means the federal government can pursue repayment indefinitely.

National student loan data system

The National Student Loan Data System (NLDS) lists all federal student loans you’ve borrowed. The information at the NLDS is specific to you. If you’ve taken out a loan that is not listed on NLDS, it’s probably a private loan.

If you don’t have an FSA ID, you will need to create one by providing your social security number along with other personal information. I didn’t have one – so in the spirit of journalism I went through the process of creating one. Like a lot of government systems, it’s a taxing process of bizarre security prompts and verification screens.

The effort is worth it. After you jump through the final hurdle, you’ll be be presented with a list of all your federal student loans, the amount disbursed and the amount outstanding. It’s a helpful tool to see everything in one place.

There are two types of federal student loans: FFEL loans guaranteed by the federal government and Direct federal loans issued by the federal government.

Federal family education loan (FFEL) program

The FFEL program was the second largest U.S. higher education loan program before it was eliminated in March 2010. If all of your loans originated after March 2010, you can skip to the Direct section below. If you originated any loans prior to March 2010, you may have FFEL loans.

In the FFEL Program, private lenders made federally guaranteed student loans to parents and students. This had two major benefits for the private lenders: (1) the federal government guaranteed the loans, insuring private lenders against default and (2) the federal government partially subsidized the loans by paying fees to the private lenders associated with the loans.

As you can imagine, the FFEL program was a huge benefit for the private lenders. Private lenders could charge higher interest rates and fees (paid by the government) but took nearly zero risk of loan default. If a borrower defaulted on his loans, the government stepped in as a guarantor, paid the private lender, and then pursued repayment itself against the borrower.

The system of having taxpayers pay banks a premium to act as middlemen is a large part of the reason the government shut down the program.

It’s important to know if you have FFEL loans, because FFEL loans are not eligible for all of the federal loan repayment programs currently available to borrowers. In order to make FFEL loans eligible, you will need to consolidate them with a Direct Consolidation Loan so that in essence your FFEL loans are converted into Direct loans.

Federal direct student loan program (Direct)

The Direct student loan program provides loans directly from the government. Most loans issued after 2010 are Direct loans. If you have Direct loans, you owe money to the Federal government. In 2015, the Government Accountability Office estimated the total portfolio at $1 trillion dollars.

Where it gets confusing is that the government hires loan servicing companies to handle the day-to-day operations of collecting and processing Direct student loans. The are many different loan servicing companies, but the four main ones are: Navient (formerly Sallie Mae), Great Lakes Higher Education Corporation, Pennsylvania Higher Education Assistance Agency (PHEAA) and Nelnet.

So, although you owe the money directly to the federal government, you make payments on the loan to the loan servicing company. If you click on a Direct loan in your NSLDS profile, the database will show you the current servicer. The loan servicing companies are also available to “assist” you in changing repayment plans or other questions you may have regarding your student loans. Unfortunately, the loan servicing companies are often as confused by the federal regulation as are the borrowers themselves, meaning you need to double-check any information they provide.

There are several subsets of federal student loans. The types of loans discussed below can either be Direct or FFEL student loans (except Perkins loans).

Federal Perkins Loans. Federal Perkins Loans are neither Direct nor FFEL loans. In a Perkins Loan, your school is the lender and the loan is guaranteed by the government. Perkins loans carry a fixed 5 percent interest rate, subsidized by the government so that interest does not begin to accrue until the borrower begins to repay the loan. Perkins loans are available to undergraduate and graduate students but only in small amounts. Perkins loans have the added benefit of being eligible for Federal Loan Cancellation for individuals working in certain situations.

Federal Subsidized Stafford Loans. As of July 1, 2012, Federal Subsidized Stafford Loans are only available for undergraduate students. However, prior to 2012 they were available to undergraduate, graduate and professional students. If you borrowed money for law school prior to 2012, you may have Federal Subsidized Stafford Loans. The benefit of these loans is that the government “subsidizes” the loans by paying interest on the loans while you are in school and during authorized deferment. This is a significant benefit that is unfortunately no longer available to law students.

Federal Unsubsidized Stafford Loans. Beginning in 2012, Federal Unsubsidized Stafford Loans are the only type of Stafford loans available to law students. The loans are “unsubsidized” because they begin to incur interest the moment the loan is disbursed. Every year on July 1 interest rates on Stafford loans are reset. The graduate student loan interest rate is based on the interest rate of the 10-year Treasury Note plus 3.6 percent. A Federal Unsubsidized Stafford Loan issued to a 1L before July 1, 2016 will immediately begin accruing interest at a rate of 5.84 percent.

Federal Graduate PLUS Loans. Federal Graduate PLUS Loans are loans available to graduate and professional students. They are issued by the Federal government through the Direct program up to an amount equal to the cost of attendance as determined by your school minus any other financial aid received.

The original meaning of the acronym – now irrelevant – was “Parent Loan for Undergraduate Students”. Since 2006, graduates and professionals have been able to borrow under the PLUS program to finance their own education. The interest rate for Graduate PLUS loans are set in July of each year and are typically higher than Stafford loans. Additionally, Graduate PLUS loans may have an origination fee which is added to the balance of the loan upon disbursement.

Because Graduate PLUS Loans allow for a high balance, high interest and do not offer subsidies, they are the most costly loans for law students. Despite their cost, because Stafford loans are capped at a fixed amount while Graduate PLUS loans are available up to the cost of attendance, many law students rely on Graduate PLUS loans to finance their education.

Federal Parent PLUS Loans. Federal Parent PLUS loans are the worst type of loan, made directly to the parent on behalf of the student. They are similar to Graduate PLUS Loans, but command a higher interest rate, typically include origination fees and the parent is the only party legally responsible for paying the loan. They are generally not available for income-based repayment options.

What about private loans? I’ll tackle that in a future post.

Joshua Holt is a former private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He is always negotiating better student loan refinancing bonuses for readers of the site.