How Do Federal Student Loans Work?

By Kassondra Cloos | Published on March 2, 2026

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The rising cost of college has made it increasingly challenging for students and their families to finance higher education. If this sounds like you, you might be considering federal student loans as a way to help cover the cost of college.

So how do they work? How much should you borrow? And what will you owe when you finally graduate? Today we answer these questions and more.

What are federal student loans?

Federal student loans are loans provided by the U.S. Department of Education to help students pay for qualified educational expenses like tuition, fees, books, and housing. They’re offered to both undergraduate and graduate students alike, and you won’t need a cosigner or credit score for most of them. You can borrow up to the full cost of attendance set by your university.

When you borrow a federal student loan, you are accepting funds from the federal government with the understanding that you will pay them back, plus interest, over a set loan repayment term after you graduate. All federal loans have fixed interest rates.

Types of federal student loans

The government offers various types of federal student loans, including Direct Subsidized Loans, Direct Unsubsidized Loans, and Direct PLUS Loans, each with its own eligibility criteria and terms.

• Direct Subsidized Loans are available to undergraduate students who demonstrate financial need. The interest on these loans is paid by the government while the borrower is in school, during the grace period, and during deferment periods. This makes Direct Subsidized Loans an attractive choice for students looking for low-cost borrowing options.

• Direct Unsubsidized Loans are available to both undergraduate and graduate students regardless of financial need. Generally, the borrower is responsible for paying the interest on these loans during all periods.

• Direct PLUS Loans, also known as Parent PLUS Loans, are federal loans available to parents of dependent undergraduate students and graduate/professional students. These loans are not based on financial need but may require a credit check. Interest rates on Direct PLUS Loans are generally higher than those on subsidized and unsubsidized loans. PLUS Loans offer parents the flexibility to finance their child’s education expenses.

What happens to my federal student loan while I’m in school?

As long as you’re enrolled at least half-time at an accredited educational institute, you won’t have to make student loan payments until after you graduate, thanks to in-school deferment. Once you’ve graduated from your program, you’ll be granted a six-month grace period, so that ideally you’ll have a job before you enter repayment.

It’s important to note that while college students don’t have to make payments in school, interest may still accrue on the loan balance. Whether it does depend on whether you have a Direct Subsidized Loan or a Direct Unsubsidized Loan.

The Department of Education covers the cost of interest on subsidized loans while you’re in school and for your six-month grace period, which means that the amount you borrowed will be the amount you owe upon graduation. However, unsubsidized loans start accruing interest immediately, even when you don’t owe payments.

If you’re able to make payments on your loans while you’re in school, doing so can help you save a lot of money over the life of the loan. None of your payments will go toward the principal of your balance—the amount you borrowed—until you pay all of the outstanding interest on the account, which could add up to thousands of dollars over the course of multiple school years.

You can contact your loan servicer directly to set up automatic payments of interest—and a little extra, if possible—so that your balance is more manageable once you’re a new grad.

How do you borrow a federal student loan?

To borrow a federal student loan, you’ll have to follow these steps:

1. Fill out the Free Application for Federal Student Aid (FAFSA): Complete the FAFSA form every academic year. This application is used to determine your eligibility for federal student loans and other forms of financial aid.

2. Review your financial aid award letter: After submitting your FAFSA, you’ll receive a financial aid award letter from your school. This letter will detail the types and amounts of financial aid, including federal student loans, that you are eligible for.

3. Accept or decline the federal student loans: Once you receive your financial aid award letter, you can choose to accept or decline the federal student loans offered to you. It is important to carefully consider the amount you need to borrow and only accept what is necessary to cover your education expenses.

4. Complete the required steps for loan disbursement: If you accept federal student loans, you will need to complete additional steps before the funds are disbursed to your school. This may include signing a Master Promissory Note (MPN) and completing online entrance counseling sessions to understand your rights and responsibilities as a borrower.

5. Repay the loan after graduation: Remember that federal student loans have to be repaid after you graduate or leave school. Familiarize yourself with repayment options and develop a plan to manage your student loan debt responsibly.

How do you repay a federal student loan?

After you graduate, you’ll have a grace period of six months before you have to start repaying your student loan. During this period, your unsubsidized loans will continue to accrue interest, but your subsidized loans will not.

When it comes to how you repay your federal loans, typically you’ll be enrolled in the Standard Repayment Plan, but you’ll have many other student loan repayment options to choose from:

1. Standard Repayment Plan: Under this plan, you make fixed monthly payments over a 10-year period. The amount you repay each month will depend on the total amount you borrowed and the interest rate.

2. Graduated Repayment Plan: This plan starts with lower monthly payments that gradually increase over time. The repayment period is typically 10 years, but it can be extended up to 30 years for consolidated loans.

3. Income-Driven Repayment (IDR) Plans: These plans base your monthly payments on your income and family size. These include Income-Based Repayment (IBR), Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), and Income-Contingent Repayment (ICR).

4. Extended Repayment Plan: This plan stretches your repayment term up to 25 years, which can result in lower monthly payments. It is available for certain loan types and requires a minimum loan amount.

Will my loans be eligible for forgiveness?

There are lots of different forgiveness programs available to borrowers. Some focus on borrowers experiencing hardship, while others are for people in public service careers. Here are a few of the most common:

1. Public Service Loan Forgiveness (PSLF): This program is available to borrowers who work full-time for a qualifying employer, such as a government or non-profit organization, while making 120 qualifying monthly payments. After meeting the requirements, the remaining balance on the borrower’s Direct Loans may be forgiven.

2. Teacher Loan Forgiveness: This program is designed for teachers who work in low-income schools or educational service agencies. Depending on the subject taught and the number of years of service, teachers may be eligible for forgiveness of up to $17,500 on their Direct Subsidized and Unsubsidized Loans or their Subsidized and Unsubsidized Federal Stafford Loans.

3. Income-Driven Repayment (IDR) Forgiveness: Under income-driven repayment plans, borrowers may be eligible for forgiveness after making a certain number of qualifying payments. The specific requirements and timeframes vary depending on the chosen payment plan (such as Income-Based Repayment, Pay As You Earn, Saving on a Valuable Education, or Income-Contingent Repayment).

Keep in mind that these are just a few examples of the student loan forgiveness programs available, and more are expected to be added. Do your research and consult with your loan servicer to determine your eligibility for any loan forgiveness programs.

What if I have trouble repaying my federal student loan?

The federal government offers many protections to students to help prevent them from going into default. If you’re struggling to repay your federal student loan, there are several hardship options available. Here are a few of the most common:

1. Deferment

If you are facing financial hardship or are unable to make your student loan payments, you may be eligible for a deferment. A deferment allows student loan borrowers to temporarily stop making payments or reduce the amount you are required to pay for a specified period. During this time, interest may not accrue on certain types of loans, such as subsidized federal loans.

2. Forbearance

Forbearance is another option for borrowers facing financial difficulties. It allows you to temporarily pause or reduce your student loan payments for a specific period. Unlike deferment, interest continues to accrue on all types of loans.

3. Income-Driven Repayment (IDR) Plans

If your monthly loan payments are high compared to your income, you may qualify for an IDR plan. These plans adjust your monthly payments based on your discretionary income and family size, potentially making them more affordable.

Depending on your income and loan balance, your monthly payments could be as low as $0 under certain IDR plans. After a certain number of payments (typically 20 or 25 years), any remaining loan balance may be forgiven.

4. Student loan consolidation

You can simplify and lower your monthly payments with a Direct Consolidation Loan from the federal government. This is known as “student loan consolidation.” Consolidating combines your federal loans into one loan with a new repayment term, so you may be able to spread out your payments over a longer period of time. There is no origination fee for a consolidation loan, but you may pay a slightly higher interest rate, as your new fixed rate will be a weighted average of the rates on all your loans rounded up to the nearest eighth percent.

5. Student loan refinancing

You may be able to lower your interest rate and/or your monthly payments by refinancing your loans with a private lender. When you refinance, you replace your existing loan(s) with a new one, and if you’re in a better financial situation than when you borrowed your original loans, you may be able to qualify for a lower interest rate.

Refinancing for a longer loan term can lower your monthly payments, but it may increase the amount you pay in interest over the life of the loan. On the other hand, refinancing for a shorter repayment term can save you significant money over time and help you pay off your loans sooner, but it may result in higher monthly payments.

It’s important to note that once you refinance federal loans, they become private, and the process is irreversible. That means you’ll lose eligibility for federal hardship protections, student loan forgiveness, income-driven repayment, and any other programs for federal borrowers. Private lenders may offer hardship protections or even student loan forgiveness in some extreme cases, but they are not obligated to.

How much can I borrow in federal student loans?

Each type of federal loan has its own limits, which can also vary based on your year in school and whether you’re an independent student. The financial aid offer letter you receive from your university should explain what you’re eligible for. You can always call the financial aid office with any questions.

Limits for the Federal Direct Loan Program are as follows:

For undergraduate students

• Direct Subsidized Loans: $3,500 to $5,5000 per year

• Direct Unsubsidized Loans: $5,550 to $12,500 per year

For graduate and professional students

• Direct Unsubsidized Loans: $20,500 per year

• Direct PLUS Loans: Up to the full cost of attendance, as set by your university

For parents of dependent undergraduate students

• Direct PLUS Loans: Up to the full cost of attendance, as set by your university

If you don’t get enough in federal loans, scholarships, or grants to cover your education, you can also look into work-study programs and private student loans.

How are federal student loans different from private student loans?

Federal student loans and private student loans differ in several key aspects:

• Loan Source: Federal student loans are provided by the U.S. Department of Education, while private student loans are offered by banks, credit unions, and other private lenders.

• Interest Rates: Federal student loan interest rates are fixed and set by the government. Private student loans, on the other hand, may be fixed or variable interest rates and are determined by the lender’s evaluation of the borrower’s creditworthiness.

• Credit Requirements: Federal student loans do not require a credit check for most loans, except for PLUS loans. Private student loans do require a credit check, and the interest rates are influenced by the borrower’s credit history.

• Repayment Terms: Federal student loans offer a variety of flexible repayment options, including income-driven plans that base monthly payments on the borrower’s income and family size. Private student loans have repayment terms set by the lender, which vary and may not include income-driven options.

• Loan Limits: Federal student loans have specific annual and aggregate loan limits based on the borrower’s grade level and dependency status. Private student loan limits vary depending on the lender and usually have higher borrowing limits compared to federal loans.

• Loan Forgiveness and Benefits: While federal student loans offer several different forgiveness options, private student loans generally don’t offer forgiveness outside of extreme circumstances. Federal loans also provide certain borrower benefits, such as deferment and forbearance, that may not be available to borrowers of private student loans.

Learn more about Earnest private student loans

Federal student loans are a flexible source of funding when you don’t get enough financial aid or scholarships to pay for school. But federal loans have limits. And if you still can’t cover the cost of college after what you’re awarded from the federal government, it may make sense to consider private lenders like Earnest.

Earnest offers low rates, no origination fees, and up to a 9-month grace period. Find out what you could be eligible for by using our rate calculator. It’s fast, free, and it won’t affect your credit score.

About the Author

Kassondra Cloos

Kassondra Cloos is a writer, editor, and former Earnest client. She refinanced her own student loans with Earnest after graduating and has first-hand experience with the refinancing process. She has been writing about personal finance and student loans since 2017. She also writes about sustainable travel and adventure for The Guardian, Outside, Backpacker, and many other publications. You can find more of her work via her travel newsletter, Out of Office.

Disclaimer

Disclaimer: This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.