Federal Direct Loans have become one of the most popular types of student loans in American for several reasons. They offer flexible repayment options, a convenient application method, and generous terms for both eligibility and allowable expenses.

Understand the Limitations

Despite these benefits, these loans have some limitations borrowers should understand before they start the application process. Here are the major drawbacks of Federal Direct Loans:

  • No subsidized Federal Direct Loans for graduate students – Although the federal government will cover the interest payments on loans for undergraduate students who meet the income qualifications for a Direct Subsidized Loan, it does not offer this type of loan to grad students. Only unsubsidized loans are available past the undergraduate level.
  • Higher interest rates for graduate students – Graduate students are charged a higher rate of interest on their loans than undergraduates. The graduate-student rate for the 2015-2016 school year was 5.84% compared to 4.29% for undergrads. Although both loan rates are now tied to the 10-year Treasury note, graduate rates are always higher than undergraduate rates. Click here to check current interest rates for Federal Direct Loans.
  • Inability to discharge in bankruptcy – Borrowers who default or become otherwise unable to repay their Federal Direct Loans will not be able to escape them by declaring bankruptcy. Federal student loans are one of three types of debt (along with back taxes and divorce-related payment arrangements) that cannot be discharged under either Chapter 13 or Chapter 7 bankruptcy. There is a small window of relief for those who fall into the category of “undue hardship,” but it is very difficult to qualify for this category.
  • Loan limits – Although the dollar limits for Federal Direct Loans differ according to several criteria (see next point), borrowers whose financial needs exceed those limits will have to supplement their direct loans with other funding sources, such as private student loans that may charge considerably higher interest.
  • Lower loan limits for dependents – Undergraduates who apply for Direct Unsubsidized Loans and are claimed as dependents on a parent or guardian's tax return cannot borrow nearly as much as "independents," undergraduates who file their own tax returns, claiming themselves. The following table compares what students of each type can borrow:

Unsubsidized Loan Limits

[Note: The Direct Unsubsidized Loan limits in the table below are overall Federal Direct Loan limits. The loan limits are reduced by the amount of any Direct Subsidized Loans received by the student.]

Direct Unsubsidized Loan – Undergraduate Students

Loan Limits Dependent Independent
First-Year (Freshman) $5,500 $9,500
Second-Year (Sophomore) $6,500 $10,500
Third-Year and Beyond (Junior, Senior) $7,500 $12,500
Cumulative $31,000 $57,500
  • Not available for those with loans in default – Any applicant for a Federal Direct Loan who is currently in default on any other federal loan will be automatically denied. The borrower will have to get all loans in default status back into current standing with the Department of Education before a Federal Direct Loan will be granted.
  • Loan fees – All Federal Direct Loans now charge a 1.068% origination fee for each loan. This fee is assessed for both subsidized and unsubsidized loans.
  • Not available for all schools – Federal Direct Loans can only be used at educational institutions that distribute Title IV student aid funds; students planning to go to a school not in this category will have to find some other type of financial aid, but you can easily learn whether your school qualifies.
  • Multiple applications – Students must apply for a new Federal Direct Loan every year. Approval for one loan does not guarantee approval for subsequent years.

The Bottom Line

Although Federal Direct Loans have become the most popular type of student loan in use today because of their many benefits, they do also come with some very real drawbacks. Graduate students are not eligible for terms that are as favorable as those provided to some undergraduates, and students who are claimed as dependents on another’s tax return cannot borrow as much as those who claim themselves. For more information on the advantages and disadvantages of Federal Direct Loans, consult your financial aid officer.