How Do Student Loans Work? A Guide to Paying for College
Paying for college can be a challenge for most students, but that doesn’t have to stop you from reaching your goals. Student loans are a tool that can put higher education, and a better job, well within your reach, even if tuition costs are a concern. If you are looking for ways to pay for education costs, you might ask yourself: How do student loans work?
Luckily, we’ve got your back. This primer on student loans and how they work will help you understand the basics of this financial tool and help you make an informed choice about how to pay for college.
What are student loans and how do student loans work?
A loan is money that you borrow all at once and gradually pay back. Sounds like a good deal, but in most cases people who get loans also have to pay back interest. A student loan is given to pay for college expenses such as tuition, books, room and board, and student fees.
Often, students who are in financial need are given some help from their schools or the federal government through grants and scholarships. When these don’t cover all your expenses, student loans can help make up the difference.
What types of student loans are available?
Federal student loans
The federal government, through the US Department of Education, offers several ways you can borrow money to pay for a higher education. These federal loans offer fixed interest rates and (with one exception) don’t require a credit history, and interest payments are tax deductible. Types of federal loans1, often called Stafford loans, include:
- Direct Subsidized Loans2: These student loans are available only to undergraduate students who demonstrate financial need, and students do not need to pay accrued interest until six months after graduation—the government covers the interest until then to “subsidize” your education.
- Direct Unsubsidized Loans3: These loans have no financial need requirement, and students are responsible for paying all of the interest, including while they are in school. Both graduate and undergraduate students can apply, and the amount is based on your tuition and other financial aid you’ve qualified for.
- Direct PLUS Loans4: Professional and graduate students can apply for these student loans, along with the parents of dependent undergraduate students who need help paying for education costs. Financial need is not required, but borrowers need to pass a credit check.
- Direct Consolidation Loans5: If you have several federal loans at once, you can consolidate them into a single student loan.
Private student loans
The federal government isn’t the only lender that offers student loans. You can also apply for loans from organizations including banks, credit unions, your college, or state to help pay for educational expenses. Details such as interest rates, credit checks, repayment schedules, and how much you can borrow depend on the loan and the lender.
Before taking out a private loan to pay for school, make sure you read the fine print and know exactly what terms you are agreeing to. Some loans may charge interest and require payments while you’re still in school, and have variable (rather than fixed) interest rates.
To find a private student loan opportunity, inquire at your bank or search online at websites such as Credible.6
How does interest work on student loans?
Interest is basically the fee you pay for the right to borrow someone’s money. It is how lenders make money from offering loans. Interest is not a one-time fee, but is usually charged once per month as a percentage of the unpaid balance. The great thing about student loans is that typically interest rates are lower and fixed—so they won’t change along with the market. The percent of interest charged depends on what kind of loan you recieve. Here are the current interest rates for federal student loans7:
- Direct Subsidized: 5.05%
- Direct Unsubsidized for undergraduate students: 5.04%
- Direct Unsubsidized for graduate students: 6%
- Direct PLUS: 7.6%
How much money can I borrow?
How much you can borrow for a federal student loan is based on how much it costs to attend your chosen college. This amount is determined by your school and takes tuition and other expenses into consideration, along with the amount of aid you’ve received from other sources, including scholarships and grants. The maximum amounts8 you can borrow are:
- Direct Subsidized and Unsubsidized Loans9 for undergraduates: Between $5,500 and $12,500 per year.
- Direct Unsubsidized Loans for graduate students: Up to $20,500
- Direct PLUS: Cost of attendance minus any other financial aid
Private lenders set their own maximum loan limits.
While student loans are a good type of debt that helps you build credit and invest in your future earning potential, take care to borrow only what you need to get through school.
How do I apply for a student loan?
Applying for federal student loans
When you apply for college, you should also fill out a government financial aid application known as the FAFSA10 (Free Application for Student Aid) in the fall before you plan to attend college. This application determines your financial need and eligibility for government student aid programs, including loans and grants, and results will be sent to your school. Once you are accepted to a college, you will be sent a financial aid offer, which includes information about which loans you qualify for and how much money you can borrow. For more information about the financial aid process, contact your school.
Applying for private student loans
Your school, state, and other lenders and organizations may also use your FAFSA to determine eligibility for needs-based loans and scholarships. Banks, credit unions, and others may have a separate application process, and they may or may not require a good credit history or a cosigner.
How do I pay back my student loan?
After you graduate, it’s time to start paying back your student loans. Private loans generally give you a short grace period, perhaps up to six months, and then start requiring monthly payments. To repay federal loans, you have several options:
- Standard repayment: Pay a fixed monthly rate calculated to pay it all off in ten years. You’ll pay less in interest, but individual payments will be higher.
- Graduated repayment: Start out with smaller payments that increase every two years, with the goal of paying it all off in 10 years.
- Extended repayment: Those with $33,000 or more in loan debt can pay monthly on a graduated or standard plan that will be paid off in 25 years.
- Income-based repayment: Monthly payments are set at 10% of your discretionary income, which is the difference between your income and 150% of the poverty guidelines for your family size and location.
- Income-contingent repayment: Monthly payments amount to either 20% of your discretionary income or how much you’d pay monthly to pay off the loan in 12 years, whichever is less.
- Income-sensitive repayment: Make monthly payments for up to 15 years that are based on your income.
Not sure which method works for you? The Federal Student Aid website has a repayment calculator11 to help you decide which is best based on your loan amount, income, and interest rates.
The cost of college shouldn’t have to hold you back from qualifying for a job you would love. Student loans are an important tool that can help you get to graduation day while covering all your expenses. If you are interested in preparing for your future now, request more information about our degree programs at Stevens-Henager College.