The term “Student Loan” is shorthand for ANY loan for college. The reality: loans to pay for college are taken by:
- Students,
- Parents, and
- Students and parents, jointly
This is a not a trivial nuance. Understanding who is legally obligated to pay the loan is critical. It’s not complicated, but can be confusing:
- All undergraduate students are eligible to borrow for college using the government’s Federal Direct Loan Program. Some students may also qualify for a private credit student loan, but for most, the Direct Loan Program is the best deal in town.
- Parents may also borrow from the federal government through the Direct PLUS Loan Program. However, many parents find private credit loans more favorable than the PLUS loan: lower interest rates and no Loan Origination Fee.
- Banks, credit unions, states and others make private loans to students, parents, or both. Many times, the student applies for a private loan and needs a creditworthy co-signer (often a parent) to get the loan. With co-signed loans, both the student and the parent are equally obligated to make a payment if the other is unable to pay, and the co-signer can be released from the obligation to pay when the student establishes their own good credit.
Once you know who is legally obligated to pay, it’s important to know if the borrower will be able to repay the loan. This free Student and Parent Loan Navigator:
- Estimates loan payments and shows how much can be saved by making relatively small interest payments while a student is in school.
- Offers a Loan Manageability Index to indicate how burdensome the debt might be for a student and parent based on their income.
- Answers frequently asked questions about Federal Direct and private loans.
What’s the Difference between Federal Direct 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 Direct Loans.
- Private loans are made by others: banks, credit unions, credit card companies, colleges and universities, agencies created by states, specialty finance companies, etc.
In 1965, Congress passed the Higher Education Act to set up a way for students to borrow money for college. The goal was to provide access to higher education to any student who wanted to go to college – regardless of income or assets. Over time, a separate program was established for parents to help their children.
The Federal Direct Loan Programs
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”) after October 1st for the academic year that begins the following year.
Subsidized vs. Unsubsidized Direct Loans
As we said above, all undergraduates are eligible for a Federal Direct Loan. The only question is whether the loan is Subsidized or Unsubsidized by the government.
ED uses the FAFSA® form to capture information about family and student income and assets to determine a student’s eligibility for a Direct Subsidized Loan. Subsidized Loans are need-based. Students who are eligible for a Subsidized Loan are not responsible for paying the interest that accrues on the loan during the in-school, grace, and deferment periods.
Unsubsidized Loans require students to either pay the interest during those periods or to capitalize the interest. Students who capitalize interest choose not to pay the interest due on the loan each month. Instead, they elect to add the unpaid amount each month to the principal amount of the original loan. The Student and Parent Loan Navigator shows the benefit (i.e., reduced total cost) of paying interest on Unsubsidized Loans while a student is in-school.
The federal government caps the maximum amount of Subsidized and Unsubsidized Direct Loans that a student may borrow based on their year of study. Students who are eligible for a Subsidized Loan may also receive an Unsubsidized Loan. 1st year students may receive up to $3,500 of Subsidized Loans and $2,000 of Unsubsidized Loans.
- 1st Year students: $5,500 (no more than $3,500 subsidized)
- 2nd Year students: $6,500 (no more than $4,500 subsidized)
- 3rd and 4th year students: $7,500/year (no more than $5,500/yr subsidized)
Loan Terms and Conditions
The process for applying for a Federal Direct Loan starts with filing the FAFSA®. ED then provides aid eligibility information to the student’s college, which offers the student financial aid, including Federal Direct Loans, via a Financial Aid Award Letter. The Financial Aid Award Letter will detail a student’s eligibility for Direct Subsidized and Direct Unsubsidized Loans.
Direct Loans:
- Are made at a fixed rate of interest, which will not change over the life of the loan. The current interest rate for Federal Direct Loans made through June 30, 2026 is 6.39%.
- Require students to pay a Loan Origination Fee of 1.057%.
- Offer a standard repayment plan and more flexible ones for borrowers who have trouble paying.
- Require borrowers to go through Entrance and Exit Counseling.
- Do not require students to undergo a credit check before getting a loan.
Student loans, like other financial instruments, require borrowers to enter into a binding contract that discloses the requirements of the loan and outlines the borrower’s responsibility for repaying the loan. ED uses a Master Promissory Note (MPN) to obligate the students to repay the loan.
Direct PLUS Loans (a.k.a. Parent PLUS Loans) are issued to parents of dependent undergraduate students. 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.
Direct PLUS Loans:
- Offer a fixed interest rate: 8.94% for PLUS Loans made on or after July 1, 2025.
- Require parents to pay a Loan Origination Fee of 4.228%.
- Have a cap on the amount that may be borrowed. Parents who have not previously taken a PLUS Loan before July 1, 2026 can borrow up to $20,000/yr with a lifetime cap of $65,000 per student. Parents who have previously borrowed under the PLUS Loan program may continue to borrow up to the college’s cost of attendance (minus other financial aid) with no lifetime cap.
Under the Parent PLUS program, the parent is the sole borrower. Parents are unable to transfer the loan to the student in the future.
Private Credit 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 credit track record to pass a lender’s credit test, but they may still get a Private Credit Loan. Nearly all Private Credit lenders permit a co-signer to join the student as an obligor on a loan. In this way, the lenders consider the parent’s credit history and may approve the loan based on the parent being a co-signer for the student.
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 tests established by the lender.
Private Loans:
- Require students to pass a credit test – often requiring undergraduates to apply with a co-signer.
- Often permit the co-signer to be released from the loan when certain conditions are met.
- 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 7 and 15 years.
- Have a maximum borrowing amount equal to the cost of attendance (minus other financial aid).
- 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. For most families, the Federal Direct Program offers the combination that works the best.
The Student and Parent Loan Navigator is a free tool that requires very few user inputs to provide information about loan payments on federal and private loans, a Loan Manageability Index, and answers to frequently asked questions.