How student loans work

Federal and private student loans are available to help cover the costs of earning a college degree, but there’s a lot you need to know before applying.

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Student loans can help fund your college education. Learn more about how student loans work in this guide. (iStock)

Navigating the world of student loans can be tricky, but many students use student loans to help fund their education every year. While student loans are a helpful tool, there are also important details you need to know before applying for a loan. 

This guide will go over how student loans work and help you navigate your student loan journey.

What types of student loans can I get?

Student loans fall into two categories — federal loans and private loans. The type of loan you should get depends on your situation and whether or not you qualify.

Federal loans

Federal loans are the most common type of student loan because they come with access to benefits and protections unavailable with private loans. Generally, it’s also easier to qualify for a federal student loan. It’s typically better to exhaust federal student aid before turning to private student loans. 

The Department of Education has several different loan types available, each with its own criteria:

  • Direct Subsidized Loans — Subsidized Loans are for eligible undergraduate students and are based on financial need. The Department of Education pays interest on these loans for students while they’re attending school (at least half-time), during the first six months after they leave school, and in periods of deferment.
  • Direct Unsubsidized Loans — Unsubsidized Loans aren't need-based and are available to eligible undergraduate, graduate and professional students. Students are responsible for paying the interest on Unsubsidized Loans.
  • Direct PLUS Loans — PLUS Loans are available to graduate and professional students, as well as parents of undergraduate students. These loans are the only federal student loans that require a credit check.
  • Direct Consolidation Loans — A Direct Consolidation Loan allows students to combine multiple federal student loans into one loan with one loan servicer and one monthly payment.

Private loans

Private student loans are secured through a private lender, like a bank or other financial institution. Your credit score, credit history and income typically determine whether you’ll qualify for a private student loan. Private student loans are a way to cover remaining educational costs that federal loans can't cover.  

Qualifying for a private student loan usually requires a hard credit inquiry, which can temporarily drop your credit score. Some private lenders allow you to use a cosigner to secure a loan if you don't qualify for a private loan on your own. Private student loans can come with fixed or variable interest rates. 

Credible lets you compare rates on private student loans from various lenders in minutes.

Pros and cons of federal student loans

Federal student loans have helped many students pay for college expenses, but they have both benefits and drawbacks. 

Pros

  • No credit check needed There are no credit history requirements to qualify for a federal student loan, except for PLUS Loans.
  • No cosigner required Unlike many private loans, a cosigner isn't required to secure a federal student loan.
  • Income-driven repayment plans Federal loans offer several payment plan options, including plans based on your income and family size. If you're just launching your career, your payments are likely to be lower in the beginning.
  • Government protections Federal loans come with access to loan deferment and forbearance options if you have trouble making payments. You can also qualify for loan forgiveness through programs like Public Service Loan Forgiveness (PSLF) and Teacher Loan Forgiveness.

Cons

  • Borrowing limits Most federal student loans have a maximum annual and total loan limit. The amount received through federal loans may not be enough to cover all your education expenses.
  • Origination fees Federal student loans have origination fees. These fees are a percentage of the loan total, so you'll receive less money to pay for school expenses than you borrow.
  • Loan default If you default on your loan, the government could garnish wages from your paycheck. The government could also garnish your tax return and Social Security benefits in some cases.

Pros and cons of private student loans

Private student loans also have pluses and minuses. 

Pros

  • Not need-based Private loans are based on your or your cosigner’s credit, so there's no need to prove financial need to qualify for a loan.
  • Higher borrowing limits Private lenders often let you borrow up to the cost of attendance, while most federal loans have stricter borrowing limits.
  • Potentially lower interest rates You can potentially score a lower interest rate if you have excellent credit and meet the lender's other underwriting requirements.

Cons

  • May require a cosigner Unless you've established good credit, you'll probably need the help of a cosigner with good to excellent credit to qualify for a private student loan.
  • Variable interest rates Some private student loans have variable rates, so there's a chance your interest rate could increase during payoff.
  • Don’t offer the same benefits and protections Private loans aren't eligible for federal loan forgiveness programs or income-driven repayment plans. They’re often less flexible if you face hardship.

How much can I borrow?

When borrowing money for school, you should only borrow enough to pay for school and other educational expenses. The amount you can borrow depends on the type of loan you take out. 

How much can I borrow in federal student loans?

  • Direct Subsidized and Unsubsidized Loans $5,500 to $12,500 annually. Dependent students can borrow up to $31,000 total, with no more than $23,000 from Subsidized Loans. Independent undergraduate students can borrow up to $57,000 total ($23,000 max in Subsidized Loans), while independent graduate and professional students can borrow up to $138,500 total with no more than $65,500 from Subsidized Loans.
  • Direct PLUS Loans Up to the cost of attendance minus any other aid received. Schools determine the cost of attendance. Dependent students whose parents don't qualify for a Parent PLUS Loan may qualify for extra funding.

How much can I borrow in private student loans?

Private student loan amounts vary by lender but maximums are typically the cost of attendance. In some cases, lenders may set minimum lending requirements on student loans. 

Credible makes it easy to compare private student loan rates from multiple lenders.

How much will I have to pay in interest on a student loan?

The amount of interest you pay on a student loan varies depending on whether you have a federal or private loan, along with other factors. Federal student loans have fixed interest rates, set by Congress, that won't change for the life of the loan. 

The interest rate on Direct Subsidized and Unsubsidized Loans (disbursed on or after July 1, 2021, and before July 1, 2022) is 3.73% for undergraduates and 5.28% for graduate or professional students. The interest rate on Direct PLUS Loans (disbursed on or after July 1, 2021, and before July 1, 2022) is 6.28%.

Interest rates on private student loans vary depending on the lender and your credit. Some private student loans come with variable interest rates, so the amount paid each month could change over time. Other factors that affect interest include: 

  • Loan amount The higher your loan amount, the more interest you’ll pay each month.
  • Repayment term The length of your loan term can affect how much interest you'll pay — the longer your loan term, the higher your interest rate. Most federal loans begin on the standard 10-year repayment plan, but other federal payment plans can stretch payments up to 30 years. Private student loans generally have repayment terms from five to 20 years.

When do I repay my loans?

At some point, you're required to start repaying your student loans. The exact timing of when repayment begins depends on the type of loan you took out.

Repaying federal student loans

You aren't required to start repaying federal student loans until after you graduate or fall below half-time. But that doesn't mean your loan won't accrue interest while attending school. During periods where payment isn't required, interest still accumulates on PLUS Loans and Unsubsidized Loans. If you choose not to pay the interest during this time, it will accrue and eventually capitalize, meaning the interest is added to your principal balance. 

The Department of Education offers several repayment plans based on your needs and the type of loans you have: 

  • Standard Repayment Plan This is the default repayment plan for federal loans. It comes with set monthly payments for 10 years, or up to 30 years for Consolidation Loans.
  • Graduated Repayment Plan Payments on this plan start lower and increase every two years for up to 10 years, or up to 30 years for Consolidation Loans.
  • Extended Repayment Plan Loan payments are extended up to 25 years. Payments can either be fixed or graduated, and you must have more than $30,000 in Direct Loans to qualify.
  • Revised Pay As You Earn Repayment Plan Loan payments are the equivalent of 10% of your discretionary income. Loan terms last between 20 and 25 years. Any balance left after the loan term is forgiven, though you may be required to pay income tax on the forgiven amount.
  • Pay As You Earn Repayment Plan Monthly payments are the equivalent of 10% of your discretionary income, but never more than you’d pay with a Standard Repayment Plan. Any balance left on the loan after 20 years is forgiven. You may be required to pay income tax on the forgiven amount.
  • Income-Based Repayment Plan Monthly payments are either 10% or 15% of your discretionary income, but never more than you’d pay with a Standard Repayment Plan. Any balance left on the loan after 20 or 25 years is forgiven, but you may be required to pay income tax on the forgiven amount.
  • Income-Contingent Repayment Plan Monthly payments are the lesser of either 20% of your discretionary income or the amount you’d pay on a 12-year fixed payment term (adjusted according to your income). Any balance left on the loan after 25 years is forgiven. You may be required to pay income tax on the forgiven amount.
  • Income-Sensitive Repayment Plan Monthly loan payments are based on your annual income, and the balance must be paid in full within 15 years.

Repaying private student loans

Private lenders set their own repayment terms. Depending on the lender, you may have the option to choose your repayment term, opting to start payment immediately or defer payments. 

Interest begins to accrue immediately on private student loans. Common payment plans for private student loans include: 

  • Deferred repayment With this plan, you defer all your principal and interest payments until after graduating or leaving school.
  • Interest-only repayment You can choose to pay interest charges while in school to keep them from accruing and capitalizing on your loan balance.
  • Fixed repayment Borrowers can pay a fixed amount each month until they graduate or leave school.

If you’re ready to find the private student loan for you, check out Credible and compare rates from different lenders.