How Student Loans Work: Your Complete Guide to Borrowing Smart

Student loans fall into two main categories: federal and private. Most students choose federal loans for good reason. Federal loans typically offer lower interest rates and more flexible repayment options. The differences extend beyond interest rates. Payment terms, eligibility requirements, and borrower protections vary significantly between federal and private loans.

You can use student loans to cover tuition, housing, and living expenses while you’re in school.

How To Get Federal Student Loans

Getting federal student loans starts with one form: the FAFSA. The Free Application for Federal Student Aid tells colleges how much financial aid you qualify for each year.

Your aid package typically includes two types of support:

• Scholarships, grants, and work-study programs that you don’t repay
• Student loans that you repay after graduation

Your school sends you an award letter detailing your financial aid options. The letter shows what the school and federal government will offer you.

How To Get Private Student Loans

Federal loans should be your first stop. Federal loans typically beat private loans on interest rates and repayment flexibility. After exhausting federal options, you might need to consider private loans. Private lenders include banks, credit unions, and online financial institutions.

The application process mirrors applying for a personal loan. You choose a lender and submit an application through them.

Every loan requires you to sign a promissory note. The promissory note is your legal agreement to repay the borrowed amount plus interest. You’ll find all loan terms in this document, including your interest rate and repayment period.

Types of Federal Student Loans

The U.S. Department of Education offers federal student loans. You or your parents can borrow these loans. Some loans target students directly while others are designed for parents.

Three main federal loan types exist:

• Direct Subsidized Loans
• Direct Unsubsidized Loans
• Direct PLUS Loans

What Are Direct Subsidized Loans?

Direct Subsidized Loans should be your first choice after free aid. Only undergraduate students qualify for these loans. You must demonstrate financial need. The government subsidizes these loans by offering rates lower than private lenders typically provide.

You must complete the FAFSA to access subsidized loans.

Interest doesn’t accumulate while you’re enrolled at least half-time. You also get a six-month grace period after leaving school. Your loan servicer doesn’t require you to request this grace period.

What Are Direct Unsubsidized Loans?

Interest accrues on unsubsidized loans while you’re in school. Over time, this makes unsubsidized loans more expensive than subsidized options.

Financial need doesn’t affect eligibility for unsubsidized loans. Undergraduate, graduate, and professional students can all qualify.

What Are Direct PLUS Loans?

Graduate students, professional students, and parents of undergraduates can access Direct PLUS Loans. Interest rates on PLUS loans exceed those on other federal loans.

Current rates stand at 7.54% for PLUS loans. Compare that to 4.99% for undergraduate Direct Loans and 6.54% for graduate unsubsidized loans.

PLUS loans carry special risks for borrowers. No borrowing limits exist for these loans. Parents can borrow their full offered amount. The combination of unlimited borrowing and higher interest rates creates debt traps. Families should carefully evaluate PLUS loans before accepting them.

Types of Private Student Loans

Any lender except the federal government offers private student loans. Banks, credit unions, colleges, state governments, and online lenders all provide private loans.

Federal Direct Subsidized and Unsubsidized loans ignore your credit score. Private lenders examine your credit history closely. Many also consider your GPA or college major.

Key Differences Between Federal and Private Loans

Federal loans dominate the student loan market for compelling reasons:

• Federal loans usually charge lower interest than private loans
• Income-driven repayment plans make federal loans more manageable
• Federal loans offer better protection if you lose income
• You can pause payments through deferment or forbearance
• Some federal loans qualify for forgiveness programs
• Borrowing limits prevent students from taking excessive debt
• Interest rates don’t depend on your credit score or career choice
• Federal loans discharge upon the borrower’s death

Parent PLUS loans also discharge if the parent borrower dies. Private loans handle death differently. Co-signers may become responsible for your debt. Lenders might pursue your spouse or estate even without a co-signer.

How Does Interest Work on Student Loans?

Student loans aren’t free money. You must repay every borrowed dollar plus interest. Interest compounds over years and significantly increases your total cost.

Understanding basic loan terminology helps you manage debt effectively:

• Principal: Your original borrowed amount, averaging $40,000 for most students
• Interest rate: The loan’s cost expressed as a percentage (fixed or variable rates exist)
  • Federal loan rates typically range from 4% to 8%
  • Private loans may offer fixed or variable rates
• Loan repayment term: Your payoff timeline, spanning 10-30 years for federal loans
• Loan balance: Your principal plus accumulated interest at any given time

Contact your loan servicer to check your current balance. You can also access the National Student Loan Data System online.

Can You Lower Your Interest Rate?

Reducing your rate lowers monthly payments and total repayment costs. Four strategies can help you achieve this goal:

• Enroll in autopay
• Refinance your loans
• Negotiate with your lender
• Pay extra toward principal

Enroll in Autopay

Many servicers discount your rate by 0.25% for automatic payments. Setting up autopay takes minutes and saves money immediately.

Refinance

Refinancing replaces old loans with a new private loan. Strong credit, stable income, or a creditworthy co-signer help you qualify for better rates.

Warning: Refinancing federal loans eliminates income-driven repayment and forgiveness options permanently.

Negotiate With Your Private Lender

Call your private lender if your credit has improved. Lenders may lower rates to retain customers facing refinancing options.

Pay Extra Toward Principal

Extra principal payments don’t reduce your rate. They do reduce total interest paid over time. Small additional payments accelerate payoff and save money long-term.

When Is Your First Payment Due?

Payment timing depends on your loan type.

Federal loans don’t require payments while you’re enrolled at least half-time. Half-time usually means six credit hours per semester. Private lenders often demand payments during school.

Federal loans include a six-month grace period after graduation or leaving school. Your first payment occurs six months after you stop attending. Parent PLUS loans don’t include grace periods.

How To Pay Back Your Student Loan

Federal loans get assigned to loan servicers like Navient, MOHELA, and FedLoan Servicing. Check your Federal Student Aid account if you’re unsure about your servicer.

Make payments directly to your servicer online, by phone, or by mail. Automatic payments from your checking account often earn you a discount.

Private loan repayment varies by lender. Contact your lender about payment methods. Payments typically occur monthly regardless of loan type.

Need help planning your repayment strategy? Our partner Cambridge Credit Counseling offers personalized guidance to make payments more manageable.

Federal Student Loan Repayment Options

Federal loans offer multiple payment plans. Each plan serves different financial situations and goals.

Standard Repayment Plan

The standard plan enrolls you automatically. You’ll repay everything within 10 years. Shorter terms mean higher monthly payments than other options.

Income-Based Repayment Plans

Income-driven plans calculate payments based on your earnings. Low income can reduce your monthly payment to zero.

Common income-based plans include:

• Income-Based Repayment (IBR) Plan
• Income-Contingent Repayment (ICR) Plan
• Pay-As-You-Earn (PAYE) Plan
• Saving on a Valuable Education (SAVE) Plan

Your payment amount changes with your income. You’ll pay for 20-25 years. Remaining balances get forgiven after that period.

Important Update: Many income-driven plans will close to new borrowers after July 1, 2026. Plans will completely phase out by July 1, 2028. Enroll before these deadlines if you want to use these options. A new Repayment Assistance Plan (RAP) will replace most current plans.

Student Loan Forgiveness Programs

Government and nonprofit employees may qualify for Public Service Loan Forgiveness (PSLF). PSLF forgives remaining debt after 10 years of qualifying payments. You typically need an income-based repayment plan to receive PSLF.

Private Student Loan Repayment Options

Private lenders rarely offer flexible payment plans. Some provide forbearance or hardship programs. Contact your lender directly about available options.

What if You Can’t Afford Your Payment?

Before COVID-19 pauses began, one-third of borrowers showed financial distress. Fifteen percent had defaulted. Another 15% used deferment or forbearance. You’re not alone if payments feel impossible.

Understanding consequences and acting quickly protects your finances. Several options exist when you can’t make payments:

• Pause payments temporarily through deferment or forbearance
• Consolidate multiple loans to simplify payments
• Apply for loan forgiveness programs if you qualify

Struggling for years after graduation? Consider whether bankruptcy might erase your student debt.

Understanding Deferment and Forbearance

Deferment and forbearance both pause federal loan payments temporarily. Most pauses last up to 12 months at a time. Interest handling creates the crucial difference:

• Deferment: Interest doesn’t accrue on subsidized loans during deferment periods
• Forbearance: Interest continues accumulating on all loan types during forbearance

Unpaid interest during forbearance gets added to your principal balance. Capitalized interest increases your total loan cost.

Apply through your loan servicer with supporting documentation. Common approval reasons include financial hardship, unemployment, medical expenses, military service, or returning to school.

How Student Loans Affect Your Credit Score

Student loans shape your credit history for years. Your payment behavior determines whether that impact helps or hurts you.

On-time payments build strong credit history. Regular payments prove you’re responsible to future lenders. Good payment history helps you qualify for mortgages, auto loans, and credit cards.

Late or missed payments damage your credit score. Defaults, late payments, and some deferment types appear on credit reports. Poor loan management makes qualifying for future credit harder. You’ll also face higher interest rates when approved.

Your total loan balance affects lending decisions indirectly. Lenders examine your debt-to-income ratio when evaluating applications. High student debt with low income raises red flags.

Do You Need Good Credit for Student Loans?

Credit requirements vary by loan type.

Federal Direct Subsidized and Unsubsidized loans don’t require credit checks. Eligibility depends on FAFSA information and financial need. Most students qualify without credit history or scores.

Direct PLUS Loans require basic credit screening. The government checks for serious credit problems like recent defaults or bankruptcies. You don’t need excellent credit to qualify.

Private lenders thoroughly review your credit. Banks, credit unions, and online lenders check credit scores and history before approval. Poor credit or limited history often requires a co-signer. Co-signers accept responsibility if you can’t repay the loan.

What Can You Use Student Loans For?

Student loans must cover education-related expenses:

• Tuition and school fees
• Rent (on or off campus)
• Utilities and groceries
• Textbooks and supplies
• Transportation costs
• Healthcare and medications
• Childcare during school attendance

You cannot use student loans for vacation travel, business ventures, credit card debt, luxury electronics, or frequent dining out. Limit spending to expenses supporting your education.

Can You Use Student Loans for Rent?

Yes, student loans can cover rent on or off campus. After your school deducts tuition and fees, remaining funds transfer to you. Use leftover money for living expenses including rent, groceries, utilities, and transportation.

Remember: Loans fund education-related costs only. Basic living expenses qualify. Luxury purchases and vacations don’t.

Can You Defer Loans for Grad School?

Yes, you can typically defer federal undergraduate loans during graduate school enrollment. In-school deferment applies when you’re enrolled at least half-time.

Schools usually report enrollment automatically, triggering deferment. Request deferment from your servicer if automatic processing doesn’t occur.

You won’t make monthly payments during deferment. Interest may still accumulate on unsubsidized loans. Paying interest during school prevents larger balances later.

Private loans don’t always offer in-school deferment. Contact your private lender about available options.

What’s the Difference Between Refinancing and Consolidation?

Refinancing and consolidation serve different purposes. Understanding the distinction helps you choose the right strategy.

Refinancing Student Loans

Refinancing creates a new private loan that pays off existing loans. Your new loan may offer lower interest rates, different repayment terms, or both.

You can refinance federal, private, or mixed loans. Refinanced federal loans become private loans permanently. You’ll lose income-driven repayment, forgiveness programs, and federal deferment options.

Refinancing works best with strong credit, steady income, and low debt-to-income ratios. Strong financial profiles qualify for better rates. Refinancing makes sense when you’re not using federal benefits and have high interest rates.

Consolidating Student Loans

Federal consolidation combines multiple federal loans into one Direct Consolidation Loan. The goal is simplified repayment, not lower rates.

You’ll make one monthly payment to one servicer. Income-driven plans and federal forgiveness programs remain available. Consolidation doesn’t require credit checks and preserves federal protections.

Extended loan terms lower monthly payments but increase total interest paid. Consolidation can reset Public Service Loan Forgiveness progress. Timing matters significantly.