How Do Student Loans Work?

Student loans are loans specifically intended to provide funds for school, and they’re issued either by the federal government or private lenders. You can borrow only for specific purposes, such as covering the costs of tuition, room, and board.

You should take out student loans only when you’ve exhausted other free sources of funding, such as scholarships and your personal savings.

This guide will provide resources on how student loans work, so you can make an educated choice when applying for student loans.

In this guide:

• Who offers student loans
• How student loan interest works
• How to get student loans
• How student loans work while in college
• How student loan repayment works after graduation

Who offers student loans

There are two types of student loans: federal and private.

The U.S. Department of Education offers federal student loans. For most borrowers, these loans are the best deal to finance their education. Federal loans from the Department of Education offer standardized rates, fees, and terms set by the government.

Private student loans are an alternative to federal loans and are offered by private lenders. They typically should be taken out only to fill the gap that federal loans can’t cover. That’s because private loans usually cost more due to higher interest rates, and they offer fewer protections for borrowers.

You can learn more in this guide to the differences between federal versus private student loans.

Federal student loan types

There are many different types of federal student loans available, most of which fall under either Stafford or PLUS loans.

Stafford Loans

Also called Direct Loans, Stafford Loans include Subsidized and Unsubsidized loans from the government.

Direct Subsidized Loans

Subsidized loans are a type of Stafford Loan that are available only to undergrads pursuing higher education who have demonstrated financial need when completing their Free Application for Federal Student Aid (FAFSA).

There are both annual and aggregate loan amount limits on Direct Subsidized Loans.

The major benefit of Direct Subsidized Loans is that the government will pay the interest while the borrower is in school, as well as during student loan deferment following graduation. This means you aren’t accruing interest and your loan balance isn’t growing while you finish your degree.

Direct Subsidized Loans also offer low fixed interest rates and a low standard origination fee—and you can qualify regardless of your credit or income.

Direct Unsubsidized Loans

Both undergrads and graduate or professional students can qualify for Direct Unsubsidized Loans. These loans also offer low fixed rates and low origination fees, and borrowers can qualify no matter what their credit or income history is.

However, unlike Subsidized Loans, these loans aren’t based on financial need, and the government will not subsidize interest. This means your loan balance will grow while you earn your degree—unless you start making loan payments immediately.

There are annual and aggregate limits on Direct Unsubsidized Loans as well—although the limits are higher for grad students than for undergrads.

PLUS Loans

PLUS Loans include both Parent PLUS Loans and Grad PLUS Loans.

Parent PLUS Loans

Parent PLUS Loans are a type of parent student loan that are available to parents of undergrads. While they offer standardized interest rates and origination fees, these are higher than with Direct Loans, and it’s sometimes possible for people with excellent credit to get a more affordable private loan.

You also cannot qualify for PLUS Loans with an adverse credit history. And for parents, payments are not automatically deferred while students are in school. Typically, repayment begins within 60 days of loan dispersal.

PLUS Loans are also not eligible for income-driven repayment plans unless the loan has been consolidated under an eligible Direct Consolidation Loan.

Grad Plus Loans

Grad PLUS Loans are a type of graduate student loan offered by the government. Like Parent PLUS loans, you can’t qualify with adverse credit and interest rates are usually higher than with Direct Loans.

Private student loans

Private student loans are offered by banks, credit unions, and online lenders.

Loan terms can vary considerably among private lenders. Most lenders allow borrowers to defer payments until around six months after graduation—this is called a grace period.

Interest rates vary among private lenders, especially if you have limited or poor credit or you get a loan without a cosigner. And while a repayment plan of 10 years is standard, private lenders also offer a variety of repayment terms including those lasting five years, 15 years, or 20 years.

You can learn more in our guides to getting student loans without a cosigner as well as our guide to private loan options for bad credit borrowers.

How student loan interest works

Lenders charge interest so they can make some money on the loan.

How interest is applied to your loan

Your interest rate is divided by the number of days in the year and the resulting percentage is multiplied by your loan balance (called the principal) and then added on top.

As you pay off more of your loan, the interest charges will be smaller and smaller because there is a smaller principal balance that the interest is calculated based off.

You can see how much a student loan would cost with interest, as well as what your monthly payments would be, by using our Student Loan Payment Calculator.

How lenders decide on interest rates

Federal loan programs offer the same interest rates to all borrowers, no matter their credit scores. Interest rates are set by Congress and rates differ depending upon the academic year and the particular loan program, as well as whether the borrower is in undergraduate school or graduate school.

Generally, undergraduate borrowers get the lowest rates, and higher rates are charged to graduate students and parents who borrow for their children through the PLUS loan program.

Private loan interest rates work differently. Private lenders can set their own rates, and these rates can vary based on your credit score, loan term, and other factors. Private lenders also offer both fixed and variable interest rates, while all federal student loans by the government have fixed rates.

You can learn more in our guide to student loan interest rates.

How to get student loans

To qualify for any federal student aid, students will need to complete the Free Application for Federal Student Aid (FAFSA). This can be completed online and will require details about personal and family income.

To get student loans from private lenders, you’ll need to apply with the lender directly. You can learn more in our guide to:

• How to apply for student loans
• How to get a student loan

Federal student loans

Federal student loans are available to undergrads and graduate students attending eligible schools.

• After completing the FAFSA, you will receive a financial aid package from each school you apply to. This will detail the loans that you’re eligible for.
• If you accept the financial aid package, you’ll sign a promissory note for federal student aid.
• Loan funds will be released to your school. Your school will deduct enough to cover your tuition, room, and board, and release the remainder (if any) to you. You can use this remaining balance to pay for other school-related expenses, such as purchasing textbooks, or living costs.

Private student loans

Applying for private student loans requires you to complete the application process with the lender of your choosing. The specific process can vary from one lender to the next. Most lenders require proof of income and good credit to qualify.

• You’ll need to fill out an application on the lender’s website.
• You will need to qualify for the loan. While there are student loan options for bad credit borrowers, most lenders require a good credit score.
• You may need to apply with a cosigner if you can’t qualify on your own. You can learn about the pros and cons of getting a cosigner as well as what options you have for finding a loan that doesn’t require a cosigner in our guides.

You can compare private student loan options for free using LendEDU’s free application. If you want to see our top rated companies, check out our Best Student Loans page.

Student loan limits

The federal government sets annual and aggregate limits on the amount of Subsidized and Unsubsidized Direct Loans you are eligible for. Most private lenders will allow you to borrow more, and you can also borrow more with federal Direct PLUS Loans.

Both federal and private loans, however, are generally capped at the school-certified cost of attendance. This includes not just tuition costs, but also other college costs, like textbooks and living expenses.

You can learn more about federal student loan limits.

How often do I need to apply for student loans?

Typically, you need to apply for student loans at the beginning of each academic year.

How student loans work while in college

While you’re in school, it’s important to keep tabs on how much you’re borrowing. Otherwise, you could be surprised with a large loan balance after graduation.

You also need to pay attention to whether your loans are accruing interest. Although you’re not generally required to make payments while in school, paying interest on at least some of your unsubsidized and private loans may be advisable to keep your balance from growing.

Repayment rules can differ between federal and private loans while in school, so you also need to understand how each loan type works.

Federal student loans

With federal student loans, repayment isn’t required while in school. However, interest keeps growing on Unsubsidized Loans. This interest could be compounded onto your principal balance, so you’ll end up paying interest on interest.

The good news is, interest doesn’t accrue on Subsidized Loans. This means the balance of your subsidized student loans won’t grow while you’re in school.

You can learn more in our guide to subsidized vs unsubsidized student loans.

Private student loans

With most private student loan lenders, you can select from among a few different repayment options while in school. These options could include:

• Deferring payments until after graduation
• Making a flat monthly payment
• Making interest-only payments

If you can afford to, it’s a good idea to pay at least the interest accruing so your loan balance doesn’t get bigger while you earn your degree.

And actually making full monthly payments on your loans could allow you to graduate with much less student loan debt since you’ll have already chipped away at the loan principal. Unfortunately, most students can’t afford this.

Student loan exit counseling

Student loan exit counseling is required for federal student loan borrowers. This process takes place near the end of your time at school, and it helps to prepare you to begin repaying your student loans.

You can learn more in our guide to student loan exit counseling.

How student loan repayment works after graduation

After graduation—or after you’re no longer enrolled at least half-time in school—you’ll need to begin student loan repayment on both federal and private student loans.

You need to understand when payments begin, who to send payments to, and what payment plan options are available to you.

Student loan servicers

If you have federal loans, you will be assigned a student loan servicer that works with the Department of Education.

This servicer is where you’ll send your monthly payments, as well as where you’ll enroll in a repayment plan and direct any questions you have about student loan repayment.

Grace periods

While repayment begins after graduation, it doesn’t typically begin the day you leave school.

There is a six-month grace period on most federal student loans. And many private lenders also offer a grace period as well, although the length can vary from lender to lender.

You can learn more in our guide to student loan grace periods.

Repayment

Federal repayment plans

The federal government provides flexible repayment plan options, including:

• Standard repayment: This plan allows you to repay loans over 10 years
• Income-driven plans: These plans cap payments at a percentage of your discretionary income
• Extended repayment plans: These plans allow you to repay your loans over a longer period of time, lowering monthly payments
• Graduated payment plans: Under these plans, payments go up over time—ideally as your income rises

You can learn more in our federal student loan repayment guide.

Private student loan repayment plans

When you take out loans from a private lender, you have a choice of repayment terms. But once you agree to a repayment plan, you can’t change it without refinancing.

Many lenders do provide the option to pause payments in times of financial hardship, though. You can learn more about what options are available for you if you are struggling in our Can’t Pay My Student Loans Guide.

How to save money on repayment

Student loan repayment can be a challenge, but there are ways to pay off your loans more quickly and to save on interest. You can find out more by checking out our guide to saving money on student loans.

How taxes work with student loans

When you’re repaying student loans, you may be able to deduct the interest paid on those loans from your federal taxes. This can save you hundreds each year. You can learn more in our guide to student loans and taxes.