What it means
Under the program, a student completes a federal aid application, and if eligible receives an offer of a loan through the college's financial aid office. The money is sent to the school to pay tuition and fees first, with any remainder passed to the student for living costs.
The loans are owned by the federal government, and private servicers collect payments and handle questions. There are several loan types, and the main split is between subsidised and unsubsidised.
Subsidised loans are for students with financial need, and the government pays the interest while the student is in school at least half time, but unsubsidised loans are not based on need and interest builds from the day the money is paid out. Parents and graduate students can borrow under a separate type known as PLUS loans, and borrowers can combine loans through consolidation.
Interest rates on new federal loans are set each year by a formula in law and then stay fixed for the life of that loan. Fees are usually deducted from each payment before the student receives the money, so the amount received is slightly less than the amount borrowed.
Borrowing limits apply by year and in total, depending on the type of student. Repayment normally starts after a grace period following graduation or leaving school.
Borrowers can choose standard fixed payments or income-driven plans that tie payments to earnings. Rules for forgiveness, deferment and plan features change with law and administrative decisions, so they should be checked at the time of borrowing.
For employers and finance teams, the programme matters because student debt affects employee finances, hiring and benefits. Some employers offer help with repayments as a benefit, and the tax treatment of that help depends on the law in force.
Understanding how interest builds on unsubsidised loans also helps in advising young staff.
In practice
Real-world examples.
Example
A first-year student at a state university needs $5,500 a year for tuition and books. She borrows a subsidised loan, so the government pays the interest while she is enrolled. Her balance is exactly what she borrowed when repayment begins. She plans to start repaying a small amount each month once she has a part-time job, so the total cost stays low.
Example
A graduate student in business takes an unsubsidised loan of $20,000 for a master's degree. Interest builds at 6% a year, or $1,200, during the first year. He pays $100 a month toward interest while studying so the balance does not grow.
Example
A parent borrows $15,000 to help a daughter attend a private college. The loan has a fee deducted from each payment, so the school receives slightly less than $15,000. The parent budgets the monthly repayment before signing and keeps a copy of the loan terms for the family records.
Formula
Calculation
Interest accrued during school (simple) = loan amount x annual rate x years
Balance after capitalisation = loan amount + accrued interest
Suppose a student takes an unsubsidised loan of $10,000 at an illustrative fixed rate of 6.0% and stays in school for 4 years without paying the interest. Accrued interest = 10,000 x 0.06 x 4 = $2,400. If that interest is added to the principal when repayment starts, the new balance = 10,000 + 2,400 = $12,400. Interest from then on is charged on $12,400, which is why paying interest while in school can save money.Case study
Seen in the real world.
Northfield Analytics is an illustrative, fictional data company that hires many recent graduates. Its human resources director notes that new hires often decline jobs with the lowest salaries because of student loan payments.
She works with the finance team on a modest benefit. The company contributes $100 a month toward each employee's federal loan, capped at $1,200 a year, for up to 40 employees. The annual cost is 40 x 1,200 = $48,000.
After a year, early resignations among graduates drop from 12 to 5, and the illustrative saving in recruiting and training is larger than the benefit cost. The lesson is that the employer treated loan repayment help as a retention investment and measured it against replacement cost. Before extending it, the finance team also confirmed how the benefit is treated for payroll tax, so that no surprises arise at the year end.
Watch out
Common mistakes.
- Ignoring interest that builds on unsubsidised loans while in school, which makes the balance at graduation much larger than the amount borrowed.
- Assuming the amount received equals the amount borrowed, when fees are usually deducted first.
- Assuming repayment rules and forgiveness options are fixed, when law and policy can change them.
Questions
People also ask.
What is the difference between subsidised and unsubsidised loans?
On subsidised loans the government pays the interest during certain periods, while on unsubsidised loans interest builds from the start.
Who lends the money?
The Department of Education lends directly, and private servicers manage the billing.
Can the interest rate change after borrowing?
New loans take the rate set for that year, and for federal loans it stays fixed for the life of that loan.
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