Federal Student Loan Myths

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Bethany McCamish

By Bethany McCamish

February 8, 2019

Federal student loans make it possible for you to pay for a college education, but like any debt, you should be smart about it. Here are a few of the myths about federal student loans and the facts that will help you make informed decisions about your student loans.

Myth: You will receive enough funding to cover tuition with federal student loans.

As a student, there is a limit to how much you can borrow in federal student loans. Loan limits prevent students from borrowing too much money. These loan limits, however, may be less than the college’s cost of attendance, so you may have to rely on your savings and other types of financial aid to cover the college costs.

Undergraduate students can borrow $5,500 to $12,500 in Federal Direct Stafford loans each year, depending on the student’s year in school and dependency status. Graduate and professional students can borrow up to $20,500 in Federal Direct Stafford loans each year ($40,500 for medical school students) and up to the remaining cost of attendance in Federal Direct PLUS loans.

If you need to borrow from private student loans or the Federal Direct PLUS loan program, you may be borrowing more than you can afford to repay.

Myth: All federal student loans are the same

Federal student loans are not all the same. The differences can affect the cost and amount of debt.

The most common type of federal loans for undergraduate students are the subsidized and unsubsidized Federal Direct Stafford loans.

  • The U.S. Department of Education pays the interest on subsidized loans while you are enrolled in college on at least a half-time basis, during the grace period before repayment begins, and during any period of authorized deferment.
  • In contrast, interest accrues on unsubsidized loans during the in-school and grace periods, and during any deferments and forbearances. Accrued but unpaid interest will be capitalized by adding it to the principal balance.

Federal Direct PLUS loans are unsubsidized federal student loans available to graduate students and to parents of dependent undergraduate students. These loans have higher loan limits than Federal Direct Stafford loans, but they also carry a higher interest rate and loan fees.

Myth: Federal student loans will always be available as long as you complete the FAFSA

Each type of federal loan has limits on availability. Federal student aid is subject to a maximum time-frame limitation that limits the availability of federal aid to no more than 150% of the normal time to complete a degree. For example, students who are enrolled in a 4-year program are eligible for federal student loans for only 6 years. There are also aggregate loan limits that restrict the total amount of outstanding student loan debt available to a borrower.

Myth: Federal student loans are always a smarter option that private student loans.

Generally, federal student loans are a better option than private student loans. Federal student loans are cheaper, more available and have better repayment terms.

The only time this may not be true is when you compare Federal Direct PLUS loans with private student loans or private parent loans. Borrowers who have excellent credit may be able to qualify for a lower interest rate on a private student loan. However, borrowers who choose a private loan over a federal student loan will be sacrificing the superior repayment options available on federal student loans, such as longer deferments and forbearances, death and disability discharges, income-driven repayment and loan forgiveness.

Myth: Interest rates on your federal student loans are determined by your credit score

Your credit score and credit history do not affect the interest rates on federal student loans. The interest rates vary based on the type of federal student loan, but they are fixed rates set by federal law.

Eligibility for the Federal Direct Stafford loan does not depend on your credit history in any way. The borrower of a Federal Direct PLUS loan must not have an adverse credit history, but eligibility does not depend on credit scores or debt-to-income ratios. Interest rates and fees on federal education loans do not depend on the borrower’s credit scores or debt-to-income ratios.

The interest rates on private student loans, on the other hand, do depend on your credit score (and the credit score of your cosigner, if any).

Myth: You only need to make the minimum payments on federal student loans

Borrowers of federal student loans can choose longer repayment terms to reduce the monthly payment. Although you won’t go into default if you make the required payment on time, making minimum payments will cost you. A longer repayment term will cause more interest to accrue over the life of the loan. This will be more expensive than the standard 10-year repayment term.

Moreover, with certain repayment plans, such as income-driven repayment plans, you may be negatively amortized. This means the monthly payment is less than the new interest that accrues. The excess interest may be capitalized by adding it to the loan balance, which causes the loan amount to grow larger. If your loan payment is small enough, you will not make progress in paying off your debt.

Instead, choose the repayment plan with the highest monthly payment you can afford. This will save you money and pay off your debt quicker.

Myth: The loan servicer owns your federal student loans

Federal student loans are made by the federal government to assist with your education. While your loan may be managed by a separate company, they are only the loan servicer and do not own the loan. The loan servicer handles billing and payments and provides customer service for your loans. They act as the middleman between you and your lender. But, they have only limited authority to make changes to your loans. They can’t, for example, change the interest rate on your federal student loans. The loan servicer does not control the interest rate on your federal student loans.

You can find out who your loan servicer is by going to the national student loan data system and logging in with your FSA ID. Your loan servicer is assigned to you by the U.S. Department of Education and may change during the life of the loan.

Myth: You don’t have to think about your federal student loans until it is time to pay them back

Misunderstanding loan amortization and interest accrual is common for many student loan borrowers. Except for the subsidized Federal Direct Stafford loan, interest accrues during the in school and grace periods. If you don’t pay the interest as it accrues, it will be added to the loan balance when you enter repayment.

Monthly payments are applied first to late fees and collection charges, second to interest and last to the loan principal. At the start of repayment, most of your loan payment will be applied to interest, not principal. This is true of mortgages too. Over time, as the principal balance is paid down, more and more of each payment will be applied to the principal balance of your loan.

To make more progress in paying down the debt, pay the interest as it accrues during the in-school and grace periods. This interest must be paid before the principal balance will decrease.


Myth: Your federal student loans stop accruing interest during a forbearance

Interest continues to accrue on all student loans during a forbearance. If you do not pay the interest as it accrues, it will be added to your loan balance at the end of the forbearance.

A forbearance is different than a deferment. During a deferment, the federal government pays the interest on subsidized loans. The federal government does not pay the interest on unsubsidized loans, however. This interest remains the responsibility of the borrower and will be capitalized if the borrower does not pay the interest as it accrues.

Myth: Refinancing your federal student loans into a private loan will simplify your payments and save you money.

Refinancing student loans means getting a new loan that pays off the old loans. The new loan will have different terms and conditions from the original loan. Thus, refinancing a federal student loan into a private student loan means you are giving away all the superior benefits associated with federal student loans.

Refinancing federal student loans means a loss in many benefits – income-driven repayment plans, any federal forgiveness programs, generous deferment options, and more.

While you may be willing to refinance and lose protections to save money, this is not a guaranteed result. In order to save money, the interest rate on the new loan would need to be lower than the weighted average of the interest rates on the loans included in the refinancing. But, federal student loans generally have lower fixed rates than most private student loans.

The repayment term would also need to be the same. Any alternative, like a longer repayment term, will mean you pay more money for the length of the loan.

You do not need to refinance in order to simplify your loan payments. Instead, consolidating your federal student loans may be the better option. You can consolidate through Studentaid.gov for free with a Federal Direct Consolidation loan. This will combine your federal loans into one loan resulting in a single monthly payment. You can still access the benefits of federal student loans like repayment plans and loan forgiveness.

Also ask the loan servicer about unified billing. With unified billing, all of your loan payments are listed on a single monthly statement and you will make a single loan payment.

Myth: Late payments on a federal student loan do not affect my credit score

Federal law requires the U.S. Department of Education to report federal student loans to the three major credit bureaus. (The specific legislative citation is 20 USC 1080a.) If you are late with a payment, miss a payment or default on your federal student loans, it will be reported to Equifax, Experian and TransUnion. The U.S. Department of Education will also report if you make your student loan payments on time. Thus, your federal student loan payments will affect your credit score.

Myth: A federal consolidation loan will reduce your interest rate

The interest rate on a Federal Direct Consolidation Loan is the weighted average of the interest rates on the loans that are consolidated, rounded up to the nearest 1/8th of a percentage point. This more or less preserves the cost of the loans and does not save you money.

Technically, it is true that the interest rate on the consolidation loan will be lower than the interest rate on the loan with the highest interest rate. But, it will also be higher than the interest rate on the loan with the lowest interest rate.

Myth: Federal student loans will be forgiven eventually

There are three main types of loan forgiveness programs for federal student loans:

  • Public Service Loan Forgiveness (PSLF)
  • Teacher Loan Forgiveness
  • Forgiveness from income-driven repayment plans

There are also a variety of loan discharges, such as the closed school discharge, death discharge and total and permanent disability discharge.

Teacher Loan Forgiveness is an up-front loan forgiveness program, where part of your debt is forgiven for each year of service. But, the amount of forgiveness is limited to $5,000 or $17,500. You may still have some debt left over after receiving Teacher Loan Forgiveness.

Public Service Loan Forgiveness and the forgiveness at the end of income-driven repayment are both back-end loan forgiveness, where the forgiveness occurs after a number of payments. For example, Public Service Loan Forgiveness occurs after 120 qualifying monthly payments (10 years), while the remaining debt on an income-driven repayment plan would normally occur after 20 or 25 years of payments (240 or 300 payments).

The federal government is not going to wave a magic wand and cancel the $1.5 trillion in outstanding student loan debt. Hoping for a government bailout is not a solid strategy for debt pay off. Instead, try to pay them off faster and be rid of the burden.

Incidentally, there is no such thing as Obama Student Loan Forgiveness. That’s a myth started by advanced fee loan scams that want to charge you an up-front fee to help you change repayment plans. You can easily do this yourself, for free, at Studentaid.gov.

Myth: You are not required to repay your federal student loans if you drop out of college

You are required to repay your federal student loans, in full, even if you don’t graduate, can’t get a job in your field of study after graduating, or are dissatisfied with the quality of the college’s educational program or other services. A notice to this effect appears on the loan promissory note you signed and as part of the entrance and exit loan counseling you received.

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