How Do Student Loans Work? 7 Important Things You Need to Know

BY The Lenders Network

how do student loans work

5 minute read

Many students end up borrowing money to pay for college, but how do student loans work? This simple guide will explain the 6 most important things to know.

Americans hold $1.5 trillion of student debt. That averages out to around $37,000 per student.Â

That’s a lot of student loan debt.

Odds are, after you graduate from college you’ll be making a hefty student loan payment for years down the road. Many students end up borrowing money to pay for college, but how do student loans work?

This simple guide will explain the six most important things to know.

1. What Types of Loans Are Available?

The first thing to learn is what are student loans. Student loans are loans specifically used for funding college. These loans can apply toward tuition, housing, or book rentals and other fees.

There are two main types of student loans to choose from, federal and personal.

Federal Loans

Wonder how federal student loans work? Federal student loans are funded by the government and their rates and repayment terms are set by law. To receive federal loans, you must apply for financial aid through your school.

Once you apply for financial aid, there are four main types of federal loans.

These include:

  • Direct subsidized loans – these loans get awarded based on financial need.
  • Direct unsubsidized loans – financial need is not a consideration of these loans.
  • Direct PLUS loans – loans that parents co-sign for. Credit checks are necessary but financial need is not.
  • Direct parent PLUS loans – parents are fully responsible for these loans even though they are for the student’s expenses.
  • Each of these loans come with varying interest rates and qualifications. Sometimes, a student won’t qualify for enough loans to fund their schooling. In that case, they can use personal loans to bridge the gap.

Personal Loans

Personal loans do not go through your school and financial aid. Instead, personal loans are through a private lender.

The money from personal loans is often available immediately, but payments also start as soon as you receive the loan. You should always aim to receive federal loans first and then use personal loans to cover any remaining expenses.

Another way people use personal loans is to consolidate student loans with high interest rates. By doing this, you can achieve a more desirable interest rate which saves you money in the long run.

Get Approved for a Personal Loan

2. How Much Can You Borrow?

When entering the student loan process, one of your main concerns is probably, “how much can I borrow?”

There is no set answer to this question. Each loan will have a different maximum amount.

The first step is to figure out your exact expenses for the year. Then apply for your federal loans first before looking into personal loans. By using a mixture of loans, you’ll be able to borrow enough to cover your expenses.

No matter how much you qualify for, you should never take out more loans that you need to cover your schooling costs.

3. What are The Interest Rates?

Do student loans have interest? The simple answer is yes. But each loan comes with a different interest rate.

Interest rates for federal student loans are set by law. Interest rates of direct subsidized and unsubsidized loans are 5.05 percent. Direct PLUS loans are 7.6 percent.

Subsidized student loans offer the best deal when it comes to interest. The government pays the interest on these loans while you are in school. For all other federal loans, you owe all interest accumulated throughout your schooling and beyond.

Interest rates of personal loans vary by lender and your qualifications.

4. How Do You Apply?

Government Loans

To apply for federal student loans, you must first file your FAFSA. This determines your eligibility for financial aid based on your family’s financial situation.

After completing your FAFSA, you will receive a Student Aid Report. This report shows your family’s expected contribution and what federal loans if any, you qualify for.

If you have specific questions, your school’s financial aid department can help you with your government student loan.

Applying for Private Loans

Private banks and credit unions also offer student loans, if you’re a member of a credit union you may have a better chance of getting approved for a student loan through them.

You will need to complete a student loan application, either online or in person. The lender will pull a copy of your credit report and have you sign a promissory note, which is a legally binding contract stating the terms of the loan and a promise to repay it.

Personal Loans

If you are having trouble getting a student loan for any reason, you have an option to use a personal loan. To apply for personal loans, you need to find a private lender. These include banks, online lenders, or credit unions. Each lender has their own application and qualification process.

To qualify for a personal loan you typically need a credit score of at least 580.

Get Approved for a Personal Loan

5. How Does Repayment Work?

Repayment on your student loans depends on which loans you choose.

For federal student loans, repayment begins six months after you graduate or you drop below half-time enrollment. The traditional repayment option is a 10-year term with equal monthly payments. You can also opt for extended repayment or income-driven payments.

Repayment on personal loans begins as soon as you take out the loan. Their repayment terms typically range between two to five years with equal monthly payments.

Standard repayment plan

The standard repayment plan is a fixed monthly payment with a loan term of 10 years. Your monthly payment will not change over time and you will know when your loan will be paid off.

Extended Repayment Plan

For loan holders with at least a $33,000 loan amount you can choose to repay the loan over a period of 25 years.

Income-Sensitive or Income-Based Repayment Plan

Payments are based on your monthly gross income, or 10% of your discretionary income and the loan term is 15 years.

Graduated Repayment Plan

This repayment plan is set up so you pay less money upfront and more every 2 years. This allows you to pay the majority of your loan off after graduation and in 10 years.

6. What if You Can’t Make Payments?

Sometimes the unexpected happens and you can’t make your payments on time.

There are a few options for federal student loans if you can’t make your payments. You can apply for deferment and forbearance, which pauses your payments for a period of time if you qualify. Some lenders, primarily for personal loans, hardship programs which similarly pause repayment.

If you don’t qualify for these programs and don’t make payments, you’ll rack up late and penalty fees. If none payment continues for a length of time, your loans become delinquent. Delinquent loans greatly impact your credit score and end up costing you much more in the long run.

7. Apply for a Government Grant

FAFSA is a Government program designed to help students who lack funds the ability to go to college. There are income requirements for FASFA but the guidelines allow for income as high as $180,000, so it’s worth applying for even if you think your parents make too much. For students living on their own parents income is not used, making it much easier to qualify for.

These grants do not need to be repaid, it’s free money for school. Recently, the U.S. Department of Education launched a new program called Stafford loans, which is an unsubsidized loan available to students regardless of income.

Stop Asking How Do Student Loans Work

Now that you’ve read this article, you should no longer be wondering, “How do student loans work?”

Remember to apply for federal student loans first and use personal loans to bridge any gaps. Take advantage of various repayment options and avoid missing payments. If you know the basics of student loans, you’ll successfully fund your education with little to no hassle.