We can’t say this enough: Federal loans have far better interest rates and repayment terms than private loans. You should always exhaust these before turning to private loans. So why do so many people take out private loans? Well, federal loan amounts are capped; you can only borrow so much money each year (see below for amounts). Those amounts don’t necessarily cover all your costs. Meanwhile, private loans often don’t have caps and when they do, they are as high as $200,000-$300,000.

To apply for federal student loans you must first fill out the FAFSA and then wait for your school to send you your financial-aid award letter. If you’re eligible, then you choose a lender. Typically these loans are handled by third party lenders like Sallie Mae or Citibank, but some schools employ something called the Federal Direct Student Loan program, where students borrow directly from the government instead of a bank or other lenders. But, either way, you don’t make the choice if you want to borrow from a lender or directly from the government, your school does.

Lenders can’t charge more than a certain fixed interest rate on new federal loans, a rate that is set by the government—hence the “federal” in federal loans. This rate doesn’t change over the life of the loan.

Shopping Around
When choosing a lender for federal loans, don’t just shop the banks or use the lender your school tells you to. It’s also worth checking out state agencies that we talked about in the previous section, since they often offer special discounts.

Whichever lender you choose, pay attention to all of the discounts you might qualify for. Banks sometimes waive fees or offer rebates. Some of these will be immediate like a waived origination fee for the loan, while others will kick in later once you’re paying off the loan. Weigh your options and figure out which incentives will lower your costs the most. 

So read the fine print, ask a lot of questions and make yourself a chart comparing the costs. Be sure to talk to a lender. Some companies will only waive the origination fee on your loan if you ask. And remember, it is your right to shop around for loans. You are not bound to use a lender on the preferred lender list that most schools send you and may try to push on you. This list of lenders is a mere recommendation. However, don’t ignore these lenders either since your school may have worked out some sort of deals with these businesses.

Know Your Loans - Perkins Loans
This is the best federal loan available for two reasons. First, the interest rate is only 5%. Second, the Perkins is a “subsidized” loan, which means the government pays the interest on it while you’re in school. That, in turn, means the interest doesn’t start to build up and get added to your balance (think credit cards) until you graduate and start repaying the loan.

Perkins Loans are reserved mostly for undergraduate and graduate students with the greatest financial need. Perkins is the only loan of the three that can only be administered by your school—not a bank or any other lender—from a limited pool of funds that the government supplies. Therefore, you would pay the loan back directly to the school, not the lender.

Unfortunately, undergrads can only borrow up to $4,000 in Perkins loans per year. There’s also a total cap of $20,000 during your undergraduate studies. Graduate students can borrow $6,000 per year, with a cumulative cap of $40,000.

These types of loans require payback starting nine months after leaving school and have a 10-year repayment term.

Know Your Loans - Stafford Loans
These loans come in two forms, subsidized and unsubsidized.

As is with Perkins loans, if you have a subsidized Stafford, the government covers the interest while you’re in school. The more financial need you have, the better chance you’ll have of qualifying for this type of Stafford.

With an unsubsidized Stafford, the government doesn’t pay the interest. This leaves you with two choices. You can pay the interest while you’re still in school to keep the balance from piling up. Or you can defer the payments until after you graduate, in which case the interest will keep building up – and getting added to your balance – while you’re in school.

Both types of Staffords have the same fixed interest rate of 6.8% for the entire life of the loan. And there are caps on the amount you can get in Stafford loans. Undergraduates whose parents claim them as dependents (for definition of a dependent go here ) on their tax returns can’t borrow more than $23,000 during the whole time they’re in school. Students who are not dependants (or whose parents were denied a PLUS loan – see below for more on those) can borrow up to $46,000, with no more than $23,000 being subsidized. Graduate students can’t borrow more than $138,500, with no more than $65,500 being subsidized.

Mix and Match
There are annual limits too. For instance, dependent students can only borrow up to $3,500 as freshmen, $4,500 as sophomores and $5,500 as juniors and seniors. Independent students and students whose parents have been denied a PLUS loan can borrow an additional $4,000 in unsubsidized Stafford Loans as freshman and sophomores and an additional unsubsidized $5,000 as juniors and seniors. Graduate students can’t borrow more than $20,500 per year, with no more than $8,500 being subsidized.

You can qualify for a Perkins, a subsidized Stafford and an unsubsidized Stafford in the same year. In fact, you want this to happen. The object here is to max out on all of the best loans, if you do need to borrow.

So if you’re eligible for $2,000 in subsidized Stafford loans based on your need and the annual Stafford limit is $3,500, you can borrow $1,500 in an unsubsidized Stafford to make up the difference. Make sense?

If you are awarded a subsidized Stafford loan, you will see it as part of your aid package. Unsubsidized Stafford loans might appear in a number of ways depending on how your school structures its award letters. It might be listed as part of your EFC which is where it should go since it is a non-need based aid. It could be listed as part of your package if your school wants to mask the fact that it couldn’t give you enough aid. Or it could not be listed at all, in which case you have to know to apply for it. Either way, you need to fill out the FAFSA in order to later apply for an unsubsidized Stafford.

Repayment on Stafford loans begins six months after graduation or if the student drops below half-time enrollment. The repayment term on Stafford loans ranges between 10 and 25 years depending on the repayment plan you select.

For the Graduates
PLUS Loans: These loans are only available to graduate students or parents of undergraduates. They come with a fair bit of flexibility. First, you can borrow up to the total cost of attending school, minus other financial aid. Also, it doesn’t matter how much you make or what kind of savings you have. Lenders only look at your credit history—although it doesn’t have to be pristine—not your need.

Even if your credit is lousy, you may still be able to get a PLUS loan if you are able to explain to the lender extenuating circumstances that caused the problems. Some lenders may also let you have a friend or a family member cosign for the loan, whether you are a parent or a graduate student. If an undergraduate’s parent is denied a PLUS loan, the student can borrow more on their Stafford loan (see Stafford Loans above). The same does not apply for graduate students who are denied PLUS loans because unsubsidized Stafford loan caps for graduate students are already considerably higher than unsubsidized Stafford limits for undergraduates.

The interest-rate on PLUS loans is set at 8.5% and just like with the other federal loans, it cannot go above this percentage regardless of which lender you use. These loans are not considered part of your financial-aid package since financial aid only consists of need-based awards.

Just like with an unsubsidized Stafford loan, your school might list the PLUS as part of your aid in order to mask the fact that it’s not able to award you enough need-based aid. Other schools don’t even bother mentioning that you can use PLUS loans to cover part or all of your EFC. It is okay to use the PLUS loan this way.

Paying it Off
Theoretically, your search could stop here. If your parents are willing to use a PLUS loan or if you are a graduate student, you shouldn’t have to take out any private loans. If your parents can’t or won’t take out PLUS loans, however – or if you’re a graduate student with no savings and lots of expenses outside of tuition – you’ll need to resort to private loans too. See the next section for more on those.

Repayment on PLUS loans begins 60 days after the lender sends the money to your school. So if the bank hands out the money in August for a freshman starting school, the first payment will come due in October. However, as is the case with the unsubsidized Stafford loan, you can choose to defer the payments by allowing interest to pile up. PLUS loans typically have a 10 year repayment term.

If you are an undergraduate student whose parents took out a PLUS loan in order to avoid private loans, be sure to discuss in advance who will be paying off these loans. Technically, the parent is responsible for paying off this loan, but since these lower interest loans can prevent the student from having to take on expensive private loan debt, it may make sense to work out a system where the student pays off the loan or at least helps with the repayment. Just a thought.