How Do Student Loans Work?

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If other forms of financial aid and personal funds don't cover your educational costs, you could turn to various student loan options to fill the gap. Available through both the U.S. Department of Education and private lenders, student loans allow borrowers to pay back the loan balance for their education plus interest over several years. Some student loan options offer more flexibility for student loan payments than others, and loan terms, student loan interest rates and qualifications vary as well.


Here's what you should know if you're wondering, "How do student loans work?"

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Basics of Student Loans

Students – and sometimes their parents – can take out student loans to cover the cost of attendance at a specific school for the school year. Federal Student Aid mentions that this cost not only includes tuition, books, fees and supplies for college students, but also many living expenses such as housing, meals, transportation and care for dependent children too. Misusing student loan funds for non-related expenses can result in penalties for borrowers with government loans.


The borrowed money usually goes directly from the lender to the school. There may be some money left over after covering the total cost of billed expenses and accounting for other financial aid like scholarships, grants and work-study wages. In that case, Columbia University says the financial aid office either sends the remainder to you to use for other qualified expenses or holds the credit balance for a future term.


How Federal Student Loans Work

With multiple options available for undergrad and grad students, federal student loans come from the federal government's funds and offer fixed interest rates and various repayment plans ranging from ​10 to 30 years​. They require at least half-time enrollment at a qualified school and in a qualified program. For example, if you only take one course a semester or enroll in an unaccredited program, you likely won't qualify for federal loans.


Federal Student Aid notes that two popular types of federal student loans include Direct Subsidized Loans, which require financial need and provide an interest subsidy, and Direct Unsubsidized Loans, which don't require need or offer a subsidy. These loans don't require a credit check or in-school payments. Your yearly loan amount depends on your dependency status and year in school, and lifetime limits also apply.


Requiring a credit check, Direct PLUS Loans exist for professional and grad students who need more than what the other loans offer. Parents can also take out these loans for dependent undergraduate students. These loans have a higher interest rate and origination fee than the other Direct Loans. While immediate payments after disbursement technically apply, Direct PLUS Borrowers can usually get a deferment as long as the student's studying half-time.


Available through both the U.S. Department of Education and private lenders, student loans allow borrowers to pay back the borrowed amount for their education plus interest over several years.

How Private Student Loans Work

If your college costs exceed the federal aid you're offered or your program doesn't qualify, you can look into student loans through private lenders like credit unions and banks. Sallie Mae mentions you can get these loans without half-time enrollment or demonstrated financial need. In addition, they can cover additional education options such as professional certifications or study abroad experiences.


Private student loans require a credit check unlike most federal options, so you could find qualifying harder or need a cosigner if you have a lower credit score. The Consumer Financial Protection Bureau (CFPB) notes that you could pay higher interest rates with private loans, or you could encounter variable interest rates. This can either make borrowing more expensive or lead to less predictable payments.


You may end up needing to make in-school payments with private loans, and you won't be able to take advantage of any interest subsidy like with certain federal loans either. Your payments usually aren't based on your income or lead to any eventual loan forgiveness. Often, the repayment term is ​10 years​.


Choosing the Right Student Loans

When deciding how to move forward with student loans, keep the pros and cons of federal versus private loans in mind. Federal Student Aid says it's recommended to stick with federal loans due to the flexible repayment terms, usually lower interest rates and possible subsidies over less flexible private loans that can be more costly, offer limited repayment options and can be harder to qualify for. However, you'll need to keep your eligibility in mind since federal loans aren't always an option.


Once you know which student loans you want, be careful with the loan amount so that you don't borrow more than you need after considering other financial resources. You should also keep the loan term and interest rate in mind since these will also affect the affordability of your future payments. It helps to consult a student loan calculator that lets you estimate your monthly payment amount, see the total interest accrued over the life of the loan and experiment with different repayment plans.

Getting Student Loans

The Federal Student Aid website provides the Free Application for Federal Student Aid (FAFSA) that you'll fill out to determine eligibility for federal grants and loans. You'll need your school's FAFSA code handy along with personal and financial information like your assets, tax return data and parents' information (if dependent).

After the FAFSA gets processed and you receive your school's financial aid package, borrowers need to complete online loan counseling and sign a Master Promissory Note agreeing to federal loan terms. The loan amount minus origination fees will go to the school.

The application process for private loans requires filling out a form with personal and financial details through the chosen lender. Sallie Mae says you'll have to disclose other aid sources, your school's information, contact info for references and income details. After undergoing a credit check and selecting any final loan terms, your school has to complete a certification step before final approval and any disbursement.

Repaying Student Loans

You usually get a ​six-month​ grace period after you graduate with federal student loans, explains Federal Student Aid. After that time, you'd make monthly payments based on the plan chosen.

For example, you'd pay ​120​ equal payments with the standard repayment plan, while you'd make ​20 to 25 years​ of varying payments and possibly receive loan forgiveness with an income-based repayment option. There's also the Public Service Loan Forgiveness option with ​120​ monthly income-based payments and student loan forgiveness after that point.

Private student loan repayment plans vary widely so that you may pay regular payments or interest payments in school, or you may not have to start repayment until after graduation. In any case, your payment amount will depend on your term length, interest rate and amount borrowed. Sallie Mae notes that private loans might allow for smaller payments immediately after graduation, but you won't have the more flexible government repayment plan options.

Handling Repayment Issues

Whether you've got federal or private loans, contact your loan servicer if you have repayment issues so you can avoid late fees and delinquency. Unpaid student loans can lead to issues such as immediate full repayment requests, wage garnishment, liens, credit damage and the inability to get more federal student loans.

You may get a deferment or forbearance for your student loan debt in situations where you have a verifiable financial hardship or meet other criteria. Your lender can let you know how long you'd qualify to pause payments and which form you should fill out. In most cases, the interest usually continues accruing while you have loans in either status. However, you shouldn't see negative effects on your credit score like you would if you become delinquent.

You might look into consolidation or refinance options to alter your payment, term or interest rate. However, you'll want to be careful when doing this with any federal student loans. For example, the CFPB warns that using a private lender to refinance Direct Loans means giving up income-based payments or any potential loan forgiveness. However, refinancing private loans to get a lower rate would be desirable.