Good news: starting July 1st the interest rate for Federal Loans is lower than the borrowing rate for Academic Year 2024-25. This year, students will be charged 6.39% and parents will pay 8.94% for Federal Direct and Federal Direct Plus Loans respectively. The Origination Fees are unchanged for each: 1.057% for Direct Loans and 4.228% for Plus Loans.
Students and parents will pay less interest than last year. But the question remains: are Federal Direct Loans the right choice for students and parents?
Short Answer: It depends.
- For students, yes.
- For parents, maybe.
Huh? The term “student loan” can be a misnomer because it is often used as a catchall of any loan made for college. But sometimes the borrower is the student, while other times it’s the parent. And sometimes parents and students co-sign the loans.
It’s not as complicated as it might initially seem. You simply need to know the difference between the Federal Loan program, which makes more than 90% of college loans each year, and the Private Loan programs.
What’s the Difference between Federal and Private Loans?
The fundamental difference is the lender.
- The federal government, specifically the U.S. Department of Education, is the lender for all Federal Loans to students and parents.
- Private Loans are made by others: banks, credit unions, credit card companies, colleges and universities, agencies created by states, specialty finance companies, etc.
The Federal Student Loan Program
The U.S. Department of Education (ED) loans money to families under the William D. Ford Federal Direct Loan Program, a.k.a. Direct Loans. There are four Direct Loan types:
- Direct Subsidized: for students
- Direct Unsubsidized: for students
- Direct PLUS: for parents
- Direct Consolidation: for students or parents
To be eligible for a Direct Loan, borrowers must file a FAFSA form (“Free Application for Federal Student Aid”). Students seeking a Federal Loan for the academic year 2025-26 have likely already filed the FAFSA and received their Financial Aid Award Letter detailing how much they may borrow from ED.
The federal government caps the amount a student may borrow per year:
- 1st Year students: $5,500
- 2nd Year students: $6,500
- 3rd and 4th year students: $7,500/year
Federal Direct Loans are the best deal in town for student borrowers.
- They are made at a fixed rate so budgeting for the monthly payment is easy.
- Repayment does not start until six months after a student separates from the school.
- There are flexible repayment plans to help students make affordable payments.
- Students with the most financial need get some portion of Subsidized Loans which do not accrue interest paid by the student until six months after they separate from the school. The Unsubsidized Loans accrue interest immediately, but that interest can be paid monthly while the student is in school – thereby substantially reducing the total amount of interest paid.
After exhausting their Federal Loan eligibility, some students will still have more to pay. This is where parents often enter the picture and subsequently will borrow to help students attend the college of their dreams. This is also where the more complicated decision needs to be made between the Federal Plus Loan and Private Loans.
Federal Direct PLUS loans
Direct Plus Loans (also referred to as Parent Plus Loans) are issued to parents of dependent undergraduate students. Parents may borrow an amount equal to the college’s cost of attendance less the amount of financial aid the student receives.
Unlike other Direct Loans, Parent Plus Loans are credit-tested. Borrowers cannot have an Adverse Credit History as defined by ED. Borrowers can be denied a Plus Loan for several reasons, including a prior student loan default or having balances greater than $2,085 that are at least 90 days past due, among other knock-out criteria.
Under the Parent Plus program, the parent is the sole borrower. Parents are unable to transfer the loan to the student in the future.
For parents with lower credit who are unable to borrow in the private credit market, the Plus Loan program may be their only opportunity to borrow in an effort to help students pay for college. Parents with good credit scores may be able to borrow from a private lender at interest rates below the Federal Plus Loan rate.
Private Credit Student Loans
Banks, credit unions, and others make Private Credit Loans to those who pass the lender’s credit tests. These credit tests are often very similar to requirements that lenders impose on borrowers for mortgages, personal loans, and automobile loans.
Often, dependent undergraduate students do not have the necessary established credit track record to pass a lender’s credit test, but they may still get a Private Credit Loan. Nearly all Private Credit Loan lenders permit a co-signer to join the student as an obligor on a loan. In this way, the lenders consider the co-signer’s history and may extend a loan to the student and co-signer.
Important note: Both the student and the creditworthy co-signer are contractually obligated under the terms of the loan. If a student is unable to make payments, the co-signer needs to make the payment or they, too, will be reported as delinquent to the credit bureaus.
Many lenders also offer a co-signer release feature that permits the non-student co-signer to be removed from the loan once a student meets credit tests established by the lender.
Additionally, Private Credit Loans:
- May offer fixed or variable rate loans with an interest rate that is dependent on the creditworthy borrower’s credit profile.
- Rarely charge an Origination Fee.
- Offer varying repayment periods, often between 5 and 15 years.
- Have a maximum borrowing amount equal to the cost of attendance (minus other financial aid).
- Often DO NOT offer the same flexible repayment terms offered under the Federal Direct Loan Program.
Conclusion
Undergraduate students have several options from which to choose the best loan to help them pay for college. The Federal Direct Program is designed to give students a limited amount of money to pay for college at a fixed rate of interest with favorable repayment terms. Other lenders offer Private Credit Student Loans which may supplement or be a substitute for Federal Direct Loans.
Families should understand the terms and conditions for each loan option and choose the loan which offers an optimal combination of terms and conditions for the student or parent borrower.