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How Do Student Loans Work? Your Questions, Answered

Student loans are a part of many Americans’ lives. 43.2 million people have student loan debt, according to EducationData.org. And with new students attending college each year, that number only continues to grow.

If you’re one of those millions with student loans, or if you’re thinking about taking out loans for college, then you need to understand how student loans work. The impact on your present and future finances is too significant to ignore.

To get you up to speed, we’ve put together this comprehensive guide to how student loans work. From the different types of loans to the nuts and bolts of interest and repayment, you’ll find answers to your student loan questions below.

Note: The federal government has paused payments and interest on eligible student loans until January 31, 2022. Learn more here.

What Are Student Loans?

Student loans are a type of financial aid to help you afford higher education costs. These costs include tuition, room and board, and other education-related expenses.

Student loans can come from either the federal government or a private lending institution. In exchange for the money to pay your education costs, you must repay the full amount of the loan plus interest.

Of course, it’s a bit more complicated than that in practice. Keep reading to learn about the different types of student loans available to you.

Federal vs. Private Student Loans

We can group student loans into two main categories: federal and private. Both can help you pay for college, but the details of how they work vary. Let’s take a closer look at each type of loan to understand the differences.

Types of Federal Student Loans

As the name implies, federal student loans come from the United States government. Specifically, they come from the U.S. Department of Education via the William D. Ford Federal Direct Loan Program.

Currently, there are four types of student loans available from the federal government:

  • Direct Subsidized Loans
  • Direct Unsubsidized Loans
  • Direct PLUS Loans
  • Direct Consolidation Loans

Only the first three types of loans are relevant here since they’re the ones you’ll get while you’re preparing for or attending college. See our guide to refinancing student loans to learn more about Direct Consolidation Loans.

So what about the other three loan types? Let’s look at the details of each:

Direct Subsidized Loans

First, we have Direct Subsidized Loans. These are only available to undergraduate students who demonstrate sufficient financial need (as determined by the FAFSA, which we’ll discuss later).

If you qualify for a subsidized loan, the federal government will pay the interest on your loan while you’re in school and for the six-month grace period after you leave school. This is ideal, as the final amount you have to repay will be lower.

Direct Unsubsidized Loans

Direct Unsubsidized Loans are available to not just undergraduates, but also to graduate and professional students. You don’t need to demonstrate financial need, making these loans available to a wider range of undergraduates overall.

Because they’re unsubsidized, however, interest will accrue on these loans while you’re in school and during your grace period after you’ve left school.

Direct PLUS Loans

Our final type of federal loan is the Direct PLUS program. Like Direct Unsubsidized loans, Direct PLUS loans are available to both graduate and undergraduate students. Parents of undergraduate students can also apply for these loans to help their children pay for college costs.

While there’s no financial need requirement for PLUS loans, you do have to pass a credit check to qualify. If you have an adverse credit history, then you may still be able to qualify if you meet certain additional requirements.

Federal Student Loan Advantages and Protections

Compared to the private student loans we’ll discuss in the next section, federal student loans have a variety of advantages and protections.

To start, the interest rates on federal student loans are fixed and (relatively) low. For loans that were paid out on or after July 1, 2021, and before July 1, 2022, the interest rates are as follows:

  • Direct Subsidized and Unsubsidized Loans to undergraduates – 3.73%
  • Direct Unsubsidized Loans to graduate and professional students – 5.28%
  • Direct PLUS Loans – 6.28%

These rates are lower than those on private student loans or credit cards, making them an appealing option.

It gets better, though. Besides low interest rates, federal student loans offer you a variety of legal protections to make repayment easier:

Six-Month Grace Period

Direct Subsidized and Unsubsidized Loans have a six-month grace period once you leave school. During this time, you aren’t required to make payments. This can ease your financial burden while you find a job.

Income-Driven Repayment Plans

You may be eligible for an income-driven repayment option if your federal student loan payments are high compared to your monthly income. With this plan, the government will lower your monthly loan payment to be more manageable.

Learn more about income-driven repayment plans here.

Deferment or Forbearance

If you’re experiencing life circumstances that make it difficult or impossible to repay your federal student loans, then you may be eligible for deferment or forbearance.

When your loan is in deferment, you temporarily postpone making payments. Possible reasons include:

  • Cancer treatment
  • Economic hardship
  • Receiving a graduate fellowship
  • Enrolling in an eligible college or career school
  • Active duty military service

The other type of protection available is forbearance. With forbearance, your payments will either be temporarily reduced or stopped completely. Learn more here.

Loan Forgiveness Programs

The final advantage of federal student loans is the possibility of loan forgiveness. Depending on the situation, this may also be called loan “cancellation” or “discharge.” All of these mean that you’re no longer required to repay some or all of your student loans.

Here are some possible reasons your loans could be forgiven, canceled, or discharged:

For further information, consult this page.

Private Student Loans

So far, we’ve discussed only federal student loans that come from the U.S. government. However, there is another category: private student loans.

Like federal student loans, private student loans exist to help you pay for your higher education costs. The main difference is that these loans come from private lenders such as banks or credit unions.

Because these loans are from a private institution, they don’t have the same protections available as federal student loans. In particular, they tend to lack grace periods, deferment/forbearance options, income-driven repayment plans, or the possibility of loan forgiveness.

Furthermore, private student loans usually have higher interest rates than their federal counterparts. And sometimes the interest rate will be variable, meaning it could increase (or decrease) depending on broader economic conditions.

Due to the higher interest rates and lack of protections, you should avoid private student loans like the plague! To learn more about the differences between federal and private student loans, check out this comparison table from Federal Student Aid.

How Do You Get Student Loans?

Now that you understand the main types of student loans available to you, we can move on to the process of getting them. The steps will differ depending on whether you’re applying for a federal or private student loan.

How to Get Federal Student Loans

For federal student loans, your first step will be to fill out the Free Application for Federal Student Aid (FAFSA). The FAFSA provides your college with the information they need to determine your financial need and the aid available to you. In addition to student loans, this aid could also include grants or federal work-study.

From there, you’ll receive an official aid offer from your college (or colleges, if you’re still trying to pick a school). Once you accept this offer, your college’s financial aid office will apply your aid to your college costs.

How to Get Private Student Loans

Getting a private student loan is much like applying for any other type of bank loan. The lender will review your (or your family’s) credit score and financial history to determine loan terms and eligibility. If you qualify, then the lender will send the needed amount to your school.

Since we strongly discourage you from taking private student loans, we have nothing further to say on the matter.

Just remember that there are other ways to pay for college besides loans, including scholarships and working while you’re in school.

When Do You Have to Repay Student Loans?

If you’ve taken student loans, hopefully they helped you get a well-paying, interesting job. But regardless, you still have to repay your student loans.

When you have to start repaying them depends on the type you have. Federal student loans are due once you graduate, drop below half-time enrollment, or leave school. As we mentioned above, some types of federal loans have a six-month grace period once you’re no longer in school. While you don’t have to make payments during this time, you certainly can.

With private student loans, the lender sets the repayment terms. You might have to start repaying some private loans while you’re still in school, while others will offer a grace period.

Regardless of the type of student loan you have, student loans do not “go away on their own” after a certain amount of time has passed. You must repay them, and failing to make payments can seriously harm your financial health.

If you’re having trouble making payments, be sure to contact your loan servicer ASAP. They can help you explore your options for easier repayment.

Want to pay off your student loans faster? Here’s how.

Student Loans: Know What You’re Getting Into

I hope this guide has cleared up some of the confusion surrounding how student loans work. While we hope that you don’t need to take out loans, they are a reality of attending college for many. Just be sure you understand what you’re signing up for!

For more tips on paying for college, check out our guides to applying for financial aid and getting scholarships.

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