Student loans are installment loans that cover educational costs like tuition, fees, books, and living expenses. There are two sorts of loans: federal and private, and the one you obtain determines your interest rate, repayment alternatives, and consumer rights.
Student loans, like other types of loans, are borrowed funds that must be repaid over time, together with any related interest and penalties. Discover how student loans work so you can borrow and repay them with confidence.
Types of Student Loans
Federal student loans are provided by the government, whereas private loans can be obtained from private companies like as banks, credit unions, and online lenders.
Federal Student Loans
These loans are accessible through the United States Department of Education. To access them, you must submit the Free Application for Federal Student Aid (FAFSA). Most federal student loans, except for PLUS loans, do not need a credit check. Their interest rates are similarly not credit-based; they are determined by federal law and are often lower than private loan rates.
Depending on your financial requirements, you may have many federal loan options:
- Direct subsidized loans. Available to undergraduate students with financial need. The amount you qualify for is based on your year of study and financial independence from parents. The government subsidizes these loans, so interest does not accrue while in school or during deferment. However, it starts collecting when you graduate or drop below half-time status.
- Direct unsubsidized loans. Available to all undergraduate, graduate, and professional students, regardless of financial need. Because these loans are unsubsidized, interest accrues at all times.
- Direct PLUS loans. Graduate and professional students, as well as parents of dependent undergraduate students, can use this money to pay expenses not covered by other forms of financial help. For example, if you have some subsidized or unsubsidized loans but need extra money to cover a financing gap, you could apply for a direct PLUS loan. A credit check is required when applying for a PLUS loan.
- Direct consolidation loans. This option allows you to consolidate several federal student loans into a single loan with a single servicer and interest rate. This can lengthen your repayment period, lowering your monthly bill, but it may result in paying more in interest over time.
Private Student Loans
These loans are accessible from banks, credit unions, and online lenders. Private student loans differ from federal loans as they do not have fixed interest rates or maximum loan amounts.
Lenders normally set their own borrower requirements, but in general, a strong or exceptional credit score—usually 670 or higher—will result in the most competitive rates and terms. Undergraduates have shorter credit records, making it difficult for them to seek private student loans independently. To be eligible for private loans, undergraduates must often have a co-signer. Some student loans do not require a co-signer.
Private student loans lack the same borrower protections as federal student loans. Borrowers of private loans are not eligible for income-driven repayment plans, forgiveness for public service jobs, or payment-postponement schemes in case of financial hardship. That is, it is often preferable to max out government loans before turning to private loans.
How Does Student Loan Interest Work?
Interest is a cost charged by the lender for borrowing money, which is commonly stated as a percentage of the amount borrowed. Student loans can have fixed interest rates, which remain constant throughout the loan’s term, or variable interest rates, which increase over time depending on economic conditions.
Most types of student loans begin charging interest as soon as you get the funds. That means the loan you took out freshman year will earn interest while you’re in school—and if you don’t make payments until you graduate, your balance will be higher than what you borrowed. Federal subsidized loans are an exception to this rule. If you qualify for these loans, the government will pay the interest while you’re in school or when you defer your debt.
When you make a student loan payment, the funds are initially applied to any interest that has accrued since your previous payment. Any remaining funds are then allocated to your loan balance. When you first start repaying your debts, interest costs will eat up a significant amount of your payments. However, as your loan gradually lowers and your repayment advances, more and more of your money will be applied straight to the loan balance.
Student loan interest is often charged on a daily basis. At some point, the interest you earn will be capitalized as well. Capitalizing interest adds accrued interest to your loan balance, resulting in interest accrual on top of existing interest. The timing of interest capitalization varies depending on the loan, but it typically occurs when you begin payments or after a temporary forbearance period finishes.
How to Apply for Student Loans
To apply for federal student loans, first fill out the FAFSA.
To complete the FAFSA, you must first obtain a Federal Student Aid ID (FSA ID). If the student is dependent, both parents and students must have an FSA ID. It functions as your electronic signature when you fill out the various federal student aid papers.
If you are a parent filling out the FAFSA for your child, visit FAFSA.gov to begin your application. You will provide personal information for both the student and the parent, such as names, Social Security numbers, and dates of birth. Before completing and submitting the form, you will also need to provide demographic and financial information.
Once admitted to a college, you will receive an award letter. Your award letter will specify the amount of student aid you receive, which may include grants, federal work-study monies, and federal student loans. You will be able to respond to your award letter and accept or reject the student loans you have been granted.
After exhausting federal student aid, private student loans are available for further funding. To apply, you must visit each lender individually. Some lenders may let you know if you prequalify for a loan based on your credit score and history. Others only let you know if you qualify after you have applied.
Private student loan applications differ per lender, but they often include financial and school information, as well as the amount of money needed, when you intend to graduate, and if you will apply with a co-signer.
What Can Student Loans Be Used For?
The total cost of attendance at your school includes tuition, fees, living expenses, and transportation for students pursuing a degree. If you intend to use student loans to cover these expenditures, your loan funds can be used for the following purposes:
- Tuition and fees
- Books
- Supplies and other equipment
- Meal plans and groceries
- Room and board (including an apartment and utilities)
- Technology expenses, like a computer
- Transportation costs, like gas or public transit passes
Most private student loans mimic federal student loan allowances, however certain lenders may impose restrictions on what you can and cannot use loans for.
How Much Do Student Loans Cost?
Congress determines federal student loan interest rates, which vary depending on the type of loan you take. For example, if you have a direct unsubsidized loan and a direct PLUS loan, the interest rates will change.
The following are the loan interest rates for the school year 2022-2023:
- 4.99% for direct subsidized and unsubsidized loans for undergraduates
- 6.54% for direct unsubsidized loans for graduate and professional students
- 7.54% for direct PLUS loans for graduate or professional students, and parents of dependent students
Your federal student loans are made up of the principal (the amount you borrowed) plus interest.
The interest rate on your federal loan will remain constant once you have taken it out. If you eventually combine your federal loans with a direct consolidation loan, the interest rate will be the average of the rates on your original loans, rounded up. Your interest rate will only alter if you refinance your student loans.
Private student lenders base your interest rate on your creditworthiness or that of your co-signer, if applicable. Some private student loans have costs, such as origination or late fees. While federal student loans have set interest rates that do not fluctuate over the course of the loan, private student loans frequently allow you to select between fixed and variable interest rates.
Remember that applicants with the best credit scores qualify for the lowest interest rates on private loans. The worse your credit score, the higher your interest rate will typically be.
Student Loan Repayment Options
Federal student loans offer some of the most favorable repayment conditions. Federal loans also have a six-month grace period, which means you don’t have to start repaying your loan until six months after graduation.
The normal repayment schedule for federal student loans predicts payback within ten years following graduation. You can, however, choose to enroll in an alternative repayment plan. Some of arrangements, known as income-driven repayment (IDR) plans, base your monthly bill on your discretionary income. There are four types.
- Income-based repayment (IBR). Your monthly contributions will range from 10% to 15% of your discretionary income. If you haven’t paid off your debt in 20 or 25 years, the outstanding balance will be forgiven. The year you originally borrowed determines whether you are eligible to pay 10% or 15% of your income and receive forgiveness after 20 or 25 years. Those who took out federal loans after July 1, 2014 are eligible for more favorable terms, including payments at 10% of income and forgiveness after 20 years.
- Income-contingent repayment (ICR). Your monthly payments will be 20% of your discretionary income, or the amount you would pay over the course of a 12-year fixed repayment plan. Any remaining balance is forgiven after 25 years.
- Pay As You Earn (PAYE). This plan restricts your monthly payments at 10% of your discretionary income and will never exceed what you would pay under the conventional repayment plan. The remaining sum will be forgiven after 20 years.
- Revised Pay As You Earn (REPAYE). Your monthly payment will be 10% of your discretionary income, but there is no assurance that you will pay less than under a conventional repayment plan. Any remaining balances after 20 or 25 years will be pardoned. REPAYE does not have an income criteria, unlike other IDR schemes, thus any borrower with federal loans, regardless of income, can sign up.
Federal student loans also provide deferment and forbearance options, which allow you to temporarily suspend payments without harming your credit score or defaulting on your loan.
Most private student loans have repayment terms of five to twenty years or more, with many including grace periods. However, keep in mind that interest often accrues while you are in school and when payments are postponed. Private lenders are also not required to provide the same period of forbearance if you are unable to make payments, with limits often set at 12 or 24 months for the duration of the loan term. Federal loans allow up to three years of forbearance or deferment, depending on the circumstances.
