How Do Student Loans Work? Here's What You Need to Know

So you've been accepted into your college of choice...congratulations! Now, how are you possibly going to afford the tuition?

With student loan balances at near record highs and university tuition having tripled since 1978, college students across the country are turning to student loans to help finance the enormous cost of higher education. And since this cost will ultimately be one of the largest you incur of your lifetime, we think it makes sense that you have a firm grasp on how student loans work and you understand the terminology surrounding their usage.

Where Should I Start?

If you've determined that you definitely need to take our student loans to cover the cost of your annual tuition, room/board, etc., then it's important to note that there are two broad categories of student loans: federal and private. Below we'll explain the pros and cons of both.

Federal Student Loans

You'll want to explore your federal student loan options first. Why? There are a couple of reasons. First, federal loans have fixed interest rates and also offer a number of different repayment plan options. This is something that private lenders don't normally offer their borrowers. Second, federal student loan rates are fixed for a given year. Private student loan lenders typically offer both fixed or variable interest rate products, but those rates will all depend on how creditworthy you (or your cosigner) are.

Private Student Loans

Looking at private student loan lenders makes the most sense once you've exhausted your ability to borrow more from the federal government. Like most things, the government does have a limit on how much they are willing to lend each student and that number will vary depending on a number of factors from what university you're attending to your current financial situation. You'll have to do some research to determine who the best lenders are for you.

How Do I Apply for My Student Loans?

Now that you understand the difference between federal and private loans, let's discuss how you're going to start applying for your financial aid. You'll first want to go to the FAFSA (Free Application for Federal Student Aid) website and login as a new student.

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Before you start the process, there are a few things you'll need to make sure you have at the ready. Also, plan on the FAFSA application taking about 60 minutes to fill out in its entirety.

FAFSA Checklist

Here's what you'll need to fil out your application:

  • Your Social Security Number or Alien Registration Number
  • Your (or your parents) federal income tax returns and W2s
  • Your (or your parents) bank statements
  • An FSA ID

Once you've completed the FAFSA application, the schools that you are applying to will review the information and send you a financial aid packet with details of their proposal. This is where you'll see how much money your eligible to borrow for each University. Of course if the federal student loan number is well short of the total you need to attend the school (and you can't afford the whole balance of difference) this is where you should explore private lenders or additional scholarship opportunities.

How Do Student Loans Work When I'm In School?

Since students who need loans to attend school aren't typically paying back that loan while still taking classes, what happens to your loan during the 4 years you are studying? Fortunately, lenders don't expect you to make payments while you're studying for your degree.

That being said, the interest on your student loans will accrue each year unless you have Perkins loans (for those in exceptional financial need) or federal subsidized loans. So while there's no one forcing you to make loan payments while in school, there's nothing prohibiting you from doing so either! This table below gives you a quick peek at how this works across different types of student loans:

Loan TypeInterest Accrues While in School?Loan Payments Due When in School?
Federal Subsidized LoansNoNo
Perkins LoansNoNo
Federal Unsubsidized LoansYesNo
Federal PLUS LoansYesNo
Private Student LoansPossiblyPossibly

What Happens to My Student Loans After I Graduate or Leave School?

For federal loans (with the exception of PLUS loans), the government allows students a waiting period called a "grace period" for 6 months after you've graduated. During that time you won't need to worry about making payments towards your student loan balance but interest will still accrue. However, this number can be longer if your situation is one of the following:

  • You are active military
  • You return to school before the grace period ends
  • You consolidate your loans

In the event of military duty or returning to school, your grace period essentially resets and will restart once you leave the military or stop attending school. In the event you consolidated your loans, the grace period is effectively waived and you will begin repayment in 2 months (after your consolidated loan is paid out).

And After My Grace Period Expires What Do I Do?

After your grace period expires, you'll need to choose a repayment plan. If you forget to do this, you'll be enrolled in the governments standard repayment plan which is 10 years.

However, if you're looking to pay the lowest possible amount each month, then it's going to make sense to discuss your options with them. The standard repayment plan won't always give you the lowest monthly payments. If your income is on the lower side, then opting for the income-driven repayment plan may be your best option.

Here's a full list of your repayment options for federal student loans:

Repayment Plan TypeWho Qualifies?Years to RepayMonthly Payment
StandardEveryone10Same throughout repayment
GraduatedEveryone10Increases every 2 years
ExtendedDirect and FFEL loans after Oct. 7, 1998, greater than $30k balance2510% or 15% of discretionary income. Changes with income
Income-Based RepaymentAll who have a partial financial hardship20 or 2510% or 15% of discretionary income. Changes with income. Will never be more than under Standard plan
Pay As You EarnDirect loans from after Oct. 1, 2007. Must have a partial financial hardship2010% or 15% of discretionary income. Changes with income. Will never be more than under Standard plan
Revised Pay As You EarnAll Direct Loans20 or 2510% of discretionary income. Changes with income
Income-Contingent RepaymentAll Direct Loans25The lesser of 20% of income or what you'd pay on a 12 year fixed payment plan. Changes with income.
Income-Sensitive RepaymentFFEL Loans10Based on annual income. Each lender's formula for determining amount varies.

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