How Do Student Loans Work?

How Do Student Loans Work?

Kerry Vetter
by Kerry Vetter
Published: September 20, 2022

It is hard to deny the need for higher education in the modern world. People with grades get a better job, and earn more money. Such people are listened to and sometimes seem to be more respected. Actually, a university education opens more doors for you. Moreover, there are people who really love to study, who can know more.

But sometimes, you just see the prices and fall into despair because college costs are far from cheap. So here comes the rescue of student loans.

Nevertheless, before you decide and take a student loan to become a professional student, you should know more about it, right? How do student loans work in real life? So let’s see.

Table of Contents

What are student loans?
Types of student loans
How to take out a student loan?
What can you use your student loan for?
Federal student loan
Options to repay federal student loans
Types of loans The U.S. Department of Education offers
Private student loans
How do private student loans work?
The interest rate on a private loan vs. interest rate on a federal loan
What if you can’t pay your monthly payments?
Alternatives
FAQ

What are student loans?

Student loans are a type of loan that can help students pay for education and the associated fees.

The interest rate may be lower than for the other loans and the repayment schedule may be more flexible.

Types of student loans

types of student loans

The first thing to know is that there are two types of student loans – federal student loans and private student loans. In short, a federal loan is an aid that the government pays to you, it has a lower interest rate. And private student loans are paid by private lenders and have a higher interest rate.

But this is not the only difference between them, so read further and find out more details.

How to take out a student loan?

Federal:

  • File Free Application for Federal Student Aid
  • Review your aid offer

Private:

  • Carefully choose a lender
  • Choose the most favorable conditions
  • Submit the application and all necessary documents that the lender will require.

What can you use your student loan for?

Fortunately, there is no strict control over where to spend student loans. However, there are some guidelines on how best to spend your financial aid.

  • Pay tuition and fees.
  • Pay for housing if it is on campus.
  • Pay for housing and utilities if it is off campus.
  • Pay for meals on campus or groceries off campus.
  • Pay for transportation, including gasoline, tolls, trains, and buses.
  • Buy textbooks, books, and any additional learning materials.
  • Buy personal and housing supplies, ranging from blankets and dishes to shampoo and medicines.
  • Pay for licensing, testing, obtaining certificates, as well as courses and training programs in other countries.

But what you should not do is spend student loans on concerts, a car, or other expensive equipment, go on vacation, and travel. You won’t thank yourself for it.

Federal student loan

So, as we already know, it is a loan the federal government gives to graduate or professional students. Federal student loans usually break up loan payments into ten years. These types of student loans offer lower interest rates compared to private loans.

Who can apply for federal loans?

  • Students who are enrolled at least part-time at the school. Important thing: be sure that the school participates in the Federal Direct Loan Program.
  • Academic progress must be at least satisfactory.
  • You must have a diploma or equivalent diploma.
  • You must have a valid social security number.
  • U.S. citizenship or eligible non-citizenship
  • You must not have a problem with any loan payment for a previous loan.

There are some options to repay federal student loans:

Standard repayment plan. Federal loans have a schedule with a set monthly payments amount. So, for example, you’ll have to do student loan payments for ten years to pay off your loan balance.

Graduated repayment plan. It means you start off with a bit lower monthly payment, with an increase every two years. Anyway, the loan term is still ten years.

Extended repayment plan. The good news is that the loan term is extended up to 25 years. And your monthly payment can be fixed or graduated.

Income-based repayment plan. This plan bases your payments on a percentage of your income. Usually, it’s between 10–15%. It would be best if you remembered that payment of federal student loans is based on your total income before taxes and other expenses, instead of your discretionary income. The payments are recalculated every year. They are based on the size of your family and your current earnings.

Income-contingent repayment plans. This plan of student loan is similar to the previous one. This financial aid is different because it is based on 20% of your discretionary income. That is the amount of income that you will have left after you take care of your fixed expenses. The interest payments of this option of federal loan can be adjusted, usually every year. And the balance can be forgiven, but usually, it takes 25 years.

Income-sensitive repayment plan. It is similar to the previous two student loans, which are also based on your income. The difference is that loan payment is based on your total income, before taxes and other expenses.

If you think that now you know everything about federal student aid, well you don’t. However, there are a few things to consider about it.

loans for college students

Subsidized loans, unsubsidized loans, direct PLUS loans, and consolidation loans

The U.S. Department of Education can offer you four types of loans for college students – direct subsidized loans, direct unsubsidized loans, direct PLUS loans, and consolidation loans for graduate and professional students. Each of these federal loans has its own advantages, like low interest rate or even student loan forgiveness.

Subsidized loans

The most important thing to know about direct subsidized loans is that they are available to undergraduate students with financial needs. So, as you understand, you will have to show your income to the federal government to prove your financial need.

In addition, the loan amount cannot exceed your needs. Therefore, the school will determine the amount you can borrow, so it is impossible to exceed this limit.

The good thing about subsidized loans is that the U.S. Department of Education will pay interest on a direct subsidized loan for at least half of the time you are in school and another six grace months after graduation.

Unsubsidized loans

As you may have guessed, this is a type of student loan that is not subsidized by the federal government. Direct unsubsidized loan is more expensive for one reason: student loan borrower starts paying at the same moment they borrow money. There are no delays, as with a subsidized loan.

There is some good news too. For example, you can get unsubsidized loans regardless of your financial condition. So your credit history does not matter.

The second good news is that direct unsubsidized loans are federal loans for college students with a higher limit than subsidized ones.

Subsidized loans vs. Unsubsidized loans

Let’s make a summary.

Subsidized loan:

  • Need to provide financial needs;
  • Smaller credit limit;
  • There is a delay in student loan payment;
  • Available only to undergraduate students.

Unsubsidized loan:

  • No need to provide financial needs;
  • Bigger credit limit;
  • There is no delay in monthly payment;
  • Available to undergraduate and graduate or professional degree students.

Apply for a Loan with No Credit Check!Apply

Direct PLUS loans

Direct PLUS loans are the federal loans available to parents of a student (Parent PLUS) or graduate students (Grad PLUS). To qualify for these loans for college students, you will need to pass a credit check.

  • Parent PLUS loans are designed for parents of dependent undergraduate students or graduate students. They can cover any expenses up to the total cost of tuition. However, only biological or adoptive parents can take them. These student loans are not available to guardians.
  • You will need to pass a credit check to obtain such student loans. But even if you have a bad credit history, you may be given a loan if you can explain the extenuating circumstances that influenced this state of affairs.
  • Grad PLUS loan is the student loan that is available for graduates and professional students.
  • You must also pass a credit check to qualify for this student loan. In case you cannot do this due to bad credit history, you can find a guarantor. They must agree to repay your student loan debt if you cannot do it yourself.

Consolidation loans

This is not a separate loan. Instead, the direct consolidation loan is an opportunity to combine multiple federal student loans into one. Direct consolidation loans are free, and they are solely for your convenience.

Private student loans

private student loans

So we are done with a bunch of federal loans. But not only federal aid can help you. There are private student loans that have a number of positive and negative options. Private student loans also have monthly payments, variable interest rates, and loan agreements, as most federal student loans have.

For private student loans, like some federal student loans, there is a need to check your financial condition. A private lender will be even more attentive than the government. So, yes, private loans can still help you. But there is a big difference between federal and private loans.

How do private student loans work?

Let’s start with the fact that private lenders have nothing to do with the government. Usually, these are banks, credit unions, and other financial institutions. Because they give out earnest private student loans, private lenders will check everything they actually can.

Each lender can set its own rules and criteria, so getting private loans can be more complicated than federal student loans. In addition, interest rates on a private student loan are usually higher than federal ones.

Student loan payments: The interest rate on a private loan vs. interest rate on a federal loan

There are two types of student loan interest rates: fixable interest rates and variable interest rates. But only federal student loans always have fixable interest rates. So let’s check this out.

Federal student loans interest rates:

  • Undergraduate – 4.99%
  • Graduate – 6.54%
  • Parent PLUS or Grad PLUS – 7.54%

Private student loans interest rates:

  • Fixed – 3.34% to 14.99%
  • Variable – 1.04% to 11.99%

According to analytics, the average student loan interest rate is 5.8%. So that is how private student loan interest works.

What if you can’t pay your monthly payments?

To be honest, nothing good will come of this. Loan money is always very demanding, and student loan lenders are more strict. If the government can make concessions, provided that the situation is tough, then loan servicers are unlikely. But there are several temporary solutions to this problem.

Forbearance. In this case, your payment is delayed, but just as importantly, the interest continues to accumulate. And the accrued interest must be paid anyway, now or later. Forbearance can be general or mandatory. General forbearance is determined by the student loan servicer. Mandatory forbearance is for:

  • Medical or dental residency students
  • Employees of AmeriCorps who received a national award
  • Active members of the National Guard without deferment from the army
  • Loan payments greater than 20% of your income

But you need to know that these and several other categories are definitely eligible for mandatory federal forbearance. When it comes to private lenders, well, it’s only their rules.

Deferment. Deferment is similar to forbearance, but in this case, you can not only miss а payments (temporarily, of course) but also not worry about the interest of the loan.

The list of those who are eligible for a deferment is not extensive:

  • Unemployed;
  • Soldiers during the war;
  • Peace Corps employees.

Student Loan Forgiveness. Undoubtedly, this is the most desirable thing that a person who has taken a loan can get. But this is exactly what you should hope for the least. You can get it if you get a job for the government (at the same time, in a suitable position), be a teacher with a low income for more than five years, etc.

Default. This is something that should be avoided at all costs. If you miss loan payments, you are in default. And this has very serious consequences that no one usually wants to face. You will not be able to receive any other pecuniary aid. You will be required to repay the entire loan balance immediately. You will be taken to court. And do not forget about the collectors, which the bank will definitely send. In other words, default is the thing that can ruin your life.

Refinancing. Student loan refinance is actually a good option. With the help of refinancing, you replace your existing loan with another one, the terms of which are more favorable. Refinancing is possible in any case, whether you took money from the government or the bank. At the same time, it is important to pay attention to the fact that the interest rate on a loan is lower. Then refinancing student loans definitely makes sense.

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Alternatives

Of course, no thirst for knowledge will soften the conditions in which credit puts you. And, of course, not everyone has the desire to take on such responsibility, especially for many years. In this case, the search for alternatives is very important.

Explore scholarships and grants. In fact, there are fellowships, grants, and financial aid programs in almost every field you might be interested in. At the moment, many organizations are ready to help students. Do not be afraid to take time to search; they will help you save money and avoid loans.

Reconsider the requirements for an educational institution. This can be very banal advice, but you need to be realistic nonetheless. Perhaps you should start studying at a community college, instead of a private school, choose a public one. Undoubtedly, everyone has a dream university but is it worth paying off loans for a very long time and giving up everything?

Don’t attend classes longer than you need to. This is not obvious advice. Even while studying in high school, you can enroll in A.P. courses or dual enrollment. In this case, you will already make some progress, and yes, this will really help save money.

Think carefully about whether you need a bachelor’s degree. Undoubtedly, there are professions in which it is difficult to achieve real success without a bachelor’s degree. But there are also a huge number of professions for which good courses and self-education are enough. Almost all popular I.T. specialties, for example, are based on this.

FAQ

  1. What is a student loan?
    This is financial aid for education.
  2. What type of student loan exists?
    There are federal and private types of student loans.
  3. How to take out a student loan?
    In the case of a federal one, you need to file FAFSA. In the case of a private loan, you need to choose a lender, provide the necessary guarantees, and sign the papers.
  4. How much can I borrow on a student loan?
    In the case of a federal one, you need to file FAFSA. In the case of a private loan, you need to choose a lender, provide the necessary guarantees, and sign the papers.If you’re an undergraduate, you can borrow each academic year between $5,500 and $12,500. If you’re a graduate professional student, you can borrow up to $20,500 each academic year.
  5. What if I can’t pay my monthly payments?How much can I borrow on a student loan?
    For a temporary solution, forbearance and deferment are suitable.

Kerry Vetter is a consumer finance expert and writer, who has been engaged in creating finance-related content for more than ten years. Her expertise is approved by obtaining a Bachelor of Science in Finance from Boston College, as well as receiving three major certificates as a professional advisor and counselor.  At the moment, Kerry is an author of multiple educational articles and insights that have been created in order to increase and develop financial literacy and responsible borrowing among US citizens. Her expert relevant savings advice has helped a lot of people overcome their financial issues and find out more about principles of smart spending, the right investment decisions, and budgeting.  You can read more about Kerry’s professional background here.

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