A student loan isn't much different than a loan you take out for a car or a house. Once you're approved, you receive your money and pay for your education. After you graduate, you pay back the loan, with interest, until it has a zero balance. Federal student loans have lower interest rates than private loans.

Over 40 million Americans have student loans, and if you don’t have one, you probably know someone who does. But how do student loans work? A student loan is similar to any other loan you might take out for a car, a house or some other item.

If the lender approves you, you will be given a certain amount of time to pay off the loan, and interest will be assessed. Late fees and other fees may also be charged. You may have a set day to pay each month, or the lender may allow you to change the due date (as long as you make a payment each month). 

The rules for loan repayment varies, according to the lender and the servicer (such as American Education Services) that helps administer payback of the loan.

Loans pay for your tuition or part of your tuition, but unless you get a full ride scholarship, you will need to pay for housing, transportation, and supplies out of pocket.

Federal Student Loans

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Federal student loans are offered by the federal government and are the most popular loans. How do student loans work if you get them for the Federal government? Here’s a look at the types of loans and what you need to do once you’ve been approved for one.

You should fill out a Free Application for Federal Student Aid (FAFSA) during your junior or senior year of high school. The deadline changes each year, so check their website for details. Use your parents' financial information if you are a dependent, or your tax information, pay stubs or bank information if you are independent.

If you are approved for a federal student loan, you’ll need to go through financial counseling online or in-person. You will learn about how to act like a responsible borrower, and you’ll sign a Master Promissory Note or Promissory Note. Keep one or more copies of this document. It outlines the repayment conditions for your loan.

There are several student loans available from the federal government, and you should try getting one of them before looking at private loans.

Direct Subsidized and Unsubsidized Loans

Direct loans from the federal government are sometimes called Stafford Loans.

Subsidized Loans are given to undergraduates with significant financial needs. The government pays the interest while you are attending school or in deferment. The FAFSA determines the loan cap depending on your financial need.

You are responsible for interest on a direct unsubsidized loan. These loans are available to graduate and undergraduate students. The amount is determined by the cost of your tuition and the amount of other financial aid you receive.

Direct PLUS Loans

These loans require a credit check and are given to graduate and professional students. The amount covers expenses other aid doesn’t, and is administered by the U.S. Department of Education.

Direct Consolidation Loans

If you have more than one federal student loan, you can combine them into one loan with one company administering the repayments.  The combined loan is called a Direct Consolidation Loan.


Federal loans are less complicated than private loans because:

  • 1
    No cosigner is necessary for most loans
  • 2
    Interest rates are fixed
  • 3
    You can deduct interest on your taxes
  • 4
    No credit checks are needed, except for PLUS loan

Private Loans

A private loan comes from a credit union, state organization, bank, or school. The amount of the loan and repayment terms depend on the lender. Private loans should be a last resort, because you may need to pay them back while still in school. You may need a cosigner or credit check for some private loans.

The interest rate for a private loan may be 18 percent or higher, and most private loan companies won't let you know the interest rate until after you have completed an application. Interest on a private loan may not be tax-deductible.

Private loans are a good choice for you if you’ve already reached the maximum amount allowed on subsidized and unsubsidized federal loans. You should have excellent credit or a co-signer for a private loan.

SallieMae, Discover and SunTrust are reputable private lenders of student loans.

Interest Rates

The interest rate on your loan is determined by figuring a particular percentage of your principal (unpaid loan amount). Interest is the money the lender receives when borrowing a larger amount of money.  You must pay interest on all unsubsidized loans.

Federal loan rates are fixed. As of 2016, the interest on direct and subsidized and unsubsidized loans is 3.76 percent for undergraduates and 5.31 percent for professional and graduate students. Direct PLUS loans come with interest at 6.31 percent.

Depending on the lender, private student loans can stir up havoc with your finances for years after you’ve left school. When you hear about folks who are still paying off their student loans in their 30s, they probably took out a private loan.

Paying Back Loans

Most servicers let you change repayment options as your employment situation changes. If you can't pay back a loan for a certain amount of time, you can apply for a deferment or forbearance on federal and many private loans.

You will still garner interest during this time if you have an unsubsidized loan.

Learn all you can about paying back a private loan before you take one out. Some have flexible payment options and allow re-negotiation of the interest rate. Some private loan servicers will let you use deferments or forbearance.

Federal Loan Repayment

After you graduate, you won’t need to start repaying your loan for six months. You will need to choose how much you’ll pay each month. The more you pay monthly, the less you will pay – and you’ll finish paying much sooner.

You’ll make better progress paying the principal with larger monthly payments, and you won’t have as much accrued interest as you’ll get with smaller payments.  You will pay more money total if you make smaller monthly payments due to the accrued interest.

A standard repayment plan lets you pay off your loan in ten years or 30 years for a Direct Consolidation Loan.  You will pay more money per month with this choice, but pay your loan off sooner.

A graduated repayment plan has small payments initially, and the payments increase every two years. The loan has a ten-year payment window.

An extended repayment plan lets you pay every month on a graduated or fixed plan and pay off the loan in 25 years. This plan is open to people who owe $33,000 or more on their loan.

You pay 20 percent of your discretionary income or the amount of a monthly, 12-year fixed payment each month in an income-contingency repayment plan. (You'll choose the lesser of these two options.)

You’ll make payments every month based on your annual income in an income-sensitive repayment plan. This repayment option lasts for up to 15 years.

An income-based repayment plan has a limit of 10 percent of a borrower’s discretionary income. Discretionary income is defined as the difference between 150 percent of the poverty guidelines for your family size/state and your yearly income.

Ask your financial aid counselor which option will work best for you, or use the repayment estimator on the Federal Student Aid site.

Borrow Responsibly

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Always think about how you will repay your loans, as it can affect your credit rating ability to pay for a house, car or even get the job you want. Only borrow what you need for tuition, books and school-related expenses. You should be able to pay the loan back without sacrificing the income needed for rent, food, and other everyday expenses.

Look at the beginning salaries for people in your chosen field. Adjust your loan amount so that you will be able to pay back the money you’ve borrowed without struggling. Don’t borrow too much and assume you’ll be able to pay it back quickly.

Research your occupation using the U.S. Department of Labor's Occupational Outlook Handbook. Look at help wanted ads in the area(s) where you want to live to get an idea of what employers pay for starting workers in your profession.

Save copies of your loan papers. Remember that your signed promissory note means you agree to repay the loan even if you can’t get a job in your field of study or don’t complete your courses.

Repay your loan on time. Partial payment doesn't fulfill your obligation. You need to pay the whole amount, with interest and fees, by the time it's due or risk defaulting on the loan.

Let your loan servicer know if you transfer, withdraw from school, graduate or take classes part-time. If you can’t make a payment, let your servicer know as soon as possible. You may be able to work out a different payment plan or get a deferment or forbearance.

We hope you understand more about the answer to “How do student loans work?”, and will use the information to decide what loan is best for you and how you will pay it back.

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