Federal Student Loans Made Through the William D. Ford ...

Federal Student Loans Made Through the William D. Ford Federal Direct Loan Program: Terms and Conditions for Borrowers

Updated June 26, 2023

Congressional Research Service R45931

SUMMARY

Federal Student Loans Made Through the William D. Ford Federal Direct Loan Program: Terms and Conditions for Borrowers

R45931

June 26, 2023

Alexandra Hegji Analyst in Social Policy

The William D. Ford Federal Direct Loan (Direct Loan) program is the single largest source of federal financial assistance to support students' postsecondary educational pursuits. The U.S. Department of Education estimates that in FY2024, $85.8 billion in new loans will be made through the program. As of the end of the first quarter of FY2023, $1.4 trillion in principal and interest on Direct Loan program loans, borrowed by or on behalf of 38.3 million individuals, remained outstanding.

For many individuals, borrowing a federal student loan through the Direct Loan program may be among their first experiences in incurring a major financial obligation. Upon obtaining a loan, a borrower assumes a contractual obligation to repay the debt over a period that may span a decade or more.

Loans were first made through the Direct Loan program in 1994. Since then, Congress has periodically made changes to the program and the terms and conditions of loans. Changes have impacted program aspects such as the availability of loan types, interest rates, loan repayment, loan discharge and forgiveness, and the consequences of default. Over time, the accumulation of changes--many of which are differentially applicable to borrowers or loan types--has resulted in a set of loan terms and conditions that are voluminous and complex. Congress may contemplate making future changes to loan terms and conditions.

This report has been prepared to provide Congress with a comprehensive description of the terms and conditions and borrower benefits that are applicable to loans made through the Direct Loan program. Emphasis is placed on discussing loan types, provisions related to borrower eligibility, amounts that may be borrowed, interest and fees, loan repayment, repayment relief, loan forgiveness benefits, the consequences of default, and the methods used to ensure borrowers are informed about the terms and conditions of their loans and their obligation to repay them.

Direct Loan Types

Four types of loans are available through the Direct Loan program. Direct Subsidized Loans are available only to undergraduate students with financial need. Direct Unsubsidized Loans are available both to undergraduate students and graduate students. Direct PLUS Loans may be borrowed by graduate students and by the parents of undergraduate students dependent upon them for financial support. Direct Consolidation Loans allow borrowers to combine debt from multiple existing federal student loans into a single new loan.

Eligibility and Amounts That May Be Borrowed

Whether an individual may borrow a loan, and the amount they may borrow, are determined by the interaction of many factors. Eligibility to borrow varies by loan type, borrower characteristics, program level, and class level. The amount an individual may borrow is subject to annual and aggregate borrowing limits, and federal need analysis and packaging procedures. Loans are made available in amounts constrained by program rules, but--with the exception of Direct PLUS Loans--without consideration of a borrower's ability to repay. Eligibility to borrow a Direct PLUS Loan depends on an individual's creditworthiness.

Interest on Direct Loan Program Loans

Procedures for calculating interest vary by loan type, repayment status, and the period during which a loan was made. In limited circumstances, the federal government subsidizes, or does not charge, interest that would otherwise accrue. Interest subsidies are mostly limited to Direct Subsidized Loans; however, certain interest subsidies may be provided on all loan

types.

Loan Repayment Plans

Numerous repayment plans, each with different payment structures and maximum durations, are available. Among the various plans, income-driven repayment (IDR) plans cap monthly payments at a specific percentage of a borrower's

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Federal Student Loans Made Through the William D. Ford Federal Direct Loan Program

discretionary income. For most repayment plans, monthly payments must cover the interest that accrues; however, the IDR plans allow for negative amortization, in which case monthly payments may be for less than the interest that accrues.

Deferment and Forbearance

Periods of deferment and forbearance offer a borrower temporary relief from the obligation to make monthly payments. In certain instances, interest subsidies may be provided during periods of deferment; however, with limited exceptions, interest subsidies are not available during periods of forbearance.

Loan Discharge and Loan Forgiveness

A borrower may be relieved of the obligation to repay their loans in certain circumstances. Student loan debt may be discharged on the basis of borrower hardship (e.g., death, total and permanent disability, school closure) or may be forgiven following an extended period of repayment according to an IDR plan or completion of a period of public service.

Loan Default, Its Consequences, and Resolution

If a borrower defaults, the loan becomes due in full and the borrower loses eligibility for many benefits, as well as access to other forms of federal student aid. The government also uses numerous means to collect on defaulted student loan debt. A limited set of options is available for a borrower to bring a defaulted loan back into good standing.

Loan Counseling and Disclosures

Student borrowers are required to undergo financial counseling, which is designed to provide them with comprehensive information on the terms and conditions of their loans as well as their rights and the responsibilities they assume as borrowers. Loan terms and conditions are specified in a promissory note, which is a contract that establishes the borrower's obligation to repay the loan, and in a plain language disclosure document that uses simplified terms to explain a loan's terms and conditions and the borrower's rights and responsibilities.

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Federal Student Loans Made Through the William D. Ford Federal Direct Loan Program

Contents

Introduction ..................................................................................................................................... 1 Background on the Direct Loan Program........................................................................................ 2 Direct Loan Types ........................................................................................................................... 4 Eligibility and Amounts That May Be Borrowed............................................................................ 6

Factors Affecting Eligibility to Borrow..................................................................................... 6 General Student-Based Eligibility Criteria ......................................................................... 6 Student Dependency Status................................................................................................. 7 Program Level..................................................................................................................... 8 Undergraduate Class Level ................................................................................................. 9 Financial Need .................................................................................................................... 9 Eligibility Requirements for Direct PLUS Loans ............................................................. 10 Eligibility Requirements for Direct Consolidation Loans .................................................11

Amounts That May Be Borrowed ........................................................................................... 13 Annual Loan Limits .......................................................................................................... 13 Aggregate Loan Limits ..................................................................................................... 14 Limits on Borrowing Determined by Need Analysis and Packaging ............................... 16

Interest on Direct Loan Program Loans ........................................................................................ 19 Interest Rates ........................................................................................................................... 19 Procedures for Setting Student Loan Interest Rates.......................................................... 19 Interest Accrual ....................................................................................................................... 22 Subsidized Interest .................................................................................................................. 23 Interest Subsidy on Direct Subsidized Loans ................................................................... 23 Interest Rate Reduction for Automatic Debit Repayment................................................. 24 Interest Subsidies on Eligible Loans Repaid According to Certain Income-Driven Repayment (IDR) Plans During Negative Amortization ............................................... 24 No Accrual of Interest on Loans of Certain Active Duty Servicemembers ...................... 25 SCRA 6% Interest Rate Cap on Loans of Borrowers Who Enter Military Service .......... 25 Interest Subsidy on All Loan Types During Cancer Treatment Deferment ...................... 26 Deferred Payment of Accrued Interest .................................................................................... 26 Negative Amortization ...................................................................................................... 26 Interest Capitalization ............................................................................................................. 26 Limit on Interest Capitalization in the IDR and Alternative Repayment Plans ................ 28

Loan Origination Fees ................................................................................................................... 29 Loan Repayment............................................................................................................................ 30

Grace Period............................................................................................................................ 30 Loan Repayment Period .......................................................................................................... 30 Loan Repayment Plans............................................................................................................ 31

Standard Repayment Plans ............................................................................................... 38 Extended Repayment Plans............................................................................................... 39 Graduated Repayment Plans ............................................................................................. 40 Income-Driven Repayment (IDR) Plans........................................................................... 41 Alternative Repayment Plans............................................................................................ 56 Prepayment.............................................................................................................................. 57 Application of Payments on Delinquent Loans....................................................................... 58 Deferment and Forbearance .......................................................................................................... 59

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Federal Student Loans Made Through the William D. Ford Federal Direct Loan Program

Deferments .............................................................................................................................. 59 In-School Deferment......................................................................................................... 60 Graduate Fellowship Deferment ....................................................................................... 60 Rehabilitation Training Program Deferment..................................................................... 61 Unemployment Deferment................................................................................................ 61 Economic Hardship Deferment......................................................................................... 61 Military Service Deferment .............................................................................................. 62 Post-Active Duty Student Deferment ............................................................................... 62 Cancer Treatment Deferment ............................................................................................ 63

Forbearance ............................................................................................................................. 63 General (Discretionary) Forbearance................................................................................ 64 Administrative Forbearance .............................................................................................. 64 Medical or Dental Internship or Residency Forbearance.................................................. 65 AmeriCorps National Service Forbearance ...................................................................... 65 Teacher Loan Forgiveness Program Forbearance ............................................................. 65 Student Loan Debt Burden Forbearance ........................................................................... 66 National Guard Duty Forbearance .................................................................................... 66 Department of Defense Student Loan Repayment Program Forbearance ........................ 66

Loan Discharge and Loan Forgiveness.......................................................................................... 66 Loan Discharge for Borrower Hardship .................................................................................. 67 Discharge Due to Death .................................................................................................... 67 Total and Permanent Disability Discharge........................................................................ 67 Closed School Discharge .................................................................................................. 70 False Certification and Unauthorized Payment Discharges.............................................. 72 Unpaid Refund Discharge................................................................................................. 72 Borrower Defense to Repayment Discharge..................................................................... 72 Bankruptcy Discharge....................................................................................................... 74 Loan Forgiveness Following IDR Plan Repayment................................................................ 75 Loan Forgiveness for Public Service....................................................................................... 75 Teacher Loan Forgiveness Program.................................................................................. 75 Public Service Loan Forgiveness (PSLF) Program .......................................................... 76 Tax Treatment of Discharged and Forgiven Debt ................................................................... 80

Loan Default, Its Consequences, and Resolution .......................................................................... 81 Consequences of Default for Borrowers ................................................................................. 82 Resolution of Default .............................................................................................................. 84 Loan Rehabilitation........................................................................................................... 85 Loan Consolidation........................................................................................................... 86

Loan Counseling and Disclosures ................................................................................................. 86 Entrance Counseling ............................................................................................................... 87 PLUS Loan Credit Counseling For Borrowers with Adverse Credit ...................................... 88 Master Promissory Note and Plain Language Disclosure ....................................................... 89 Exit Counseling ....................................................................................................................... 90 Additional Information on Loan Terms and Conditions ......................................................... 91

Tables

Table 1. Annual and Aggregate Loan Limits, by Borrower Type and Program Level: July 1, 2012, to Present ...................................................................................................................... 15

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