Student loans have become a popular way to pay for college, but what are they? And how do they work? We’ve got the answers.
Student loans are a type of debt you can take from a bank or other financial institution to pay for college or other post-secondary education.
They’re based on your credit history and ability to repay the student loan—if you don’t make payments on time, bad things will happen (like interest accruing faster or being locked out of your bank account).
If you need money for school and don’t have it in savings, this is a great way to borrow money and get some breathing room so you can focus on your studies without worrying about how much money each week goes toward tuition fees instead of rent or groceries.
You probably have many questions running through your mind, but by the end of this post, you won’t feel that way. We’ll make things simple by reviewing their basics and a few surprising facts. Here’s what we’re going to cover:
Types of Student Loans
There are two main types of student loans: federal and private. Federal loans typically have lower interest rates and provide more flexible repayment options than private loans.
Private loans are funded by banks, lenders, or other organizations, and they may offer loan amounts that exceed the maximum offered by the federal government.
Federal Student Loans
Federal student loans, or Federal Direct Loans, are federally guaranteed student loans made by the Department of Education (ED). These loans are available to students who attend an eligible educational institution.
You must be enrolled at least half-time to qualify for these loans. You may still be eligible for these loans if you are enrolled less than half-time but have been accepted into the school and begun classes.
Federal Direct Loans require that you be making satisfactory academic progress. This is not a requirement for other types of federal student aid such as Perkins Loans or Stafford Loans.
However, you should contact your loan servicer immediately if you do not make satisfactory academic progress on your Federal Direct Loan and want to continue receiving them.
There are several federal student loan options, and they all depend on your needs. The following are the options:
Direct Subsidized Loans: These loans are available to undergraduate students with financial needs. The Free Application determines a financial need for Federal Student Aid (FAFSA).
A student with a high EFC is eligible for more in subsidized loans. The interest rate on this type of loan is fixed at 5%, which means that the interest is paid by the U.S. Department of Education and not the borrower during in-school and grace periods and periods of authorized deferment.
This loan must be repaid after graduation or when a borrower’s enrollment status drops below half-time.
A student must be enrolled at least half-time to qualify for this type of loan; however, there are some exceptions for part-time students such as teaching assistants, research assistants, or graduate assistants.
Direct Unsubsidized Loans: If you have a financial need, you may be eligible for Direct Unsubsidized Loans.
Like other federal student loans (except PLUS loans), interest accrues while you are in school, during the grace period, and during any deferment period. You’ll have to begin repayment after graduation or when you leave school without completing your program.
You must complete the Free Application for Federal Student Aid (FAFSA) to qualify for Direct Unsubsidized Loans.
If you qualify, the U.S. Department of Education will send your loan funds directly to your school’s financial aid office — not to you directly — so they can be used to pay for tuition and fees, books and supplies, room and board and other eligible expenses related to attending college.
Direct PLUS Loans: Direct PLUS Loans are loans made directly to students or parents who want to borrow money to pay for post-secondary education. The Parent PLUS Loan is a federal loan for which parents with bad credit or no credit history can qualify.
The Direct PLUS Loan has an interest rate set each July 1 and fixed for the life of the loan. The interest rate is based on the 10-year Treasury note rate, rounded to the nearest one-eighth percent (0.125%), plus an add-on of 2.05%.
The student who takes out a Direct PLUS Loan must be enrolled at least half-time in an eligible program, which includes most undergraduate and graduate degree programs, certificate programs, and other approved educational programs. Students may borrow up to their cost of attendance minus any other financial aid received.
Changes made by Congress in 2008 allow borrowers to consolidate both Direct Plus Loans and Federal Family Education Loans (FFEL) into a single Direct Consolidation Loan with one monthly payment and one interest rate.
This consolidation option will not affect your eligibility for other federal student aid programs like Pell Grants; however, it does not change your repayment terms or options.
Direct Consolidation Loans: Direct consolidation loans are the most common choice for students. These loans consolidate multiple types of federal student loans into one loan with a single monthly payment.
You can keep your original interest rate or have it recalculated based on the weighted average of all your loans. The new interest rate will be fixed for the life of the loan, which means it won’t change unless you prepay or default.
A direct consolidation is an excellent option if you have an income-driven repayment plan, or IDR, that requires you to pay more than 10 percent of your discretionary income. Consolidating will lower your monthly payment and make it easier to pay off your debt faster.
Private Student Loans
Banks, credit unions, and other private lenders offer private student loans. These loans are not guaranteed or subsidized by the federal government.
Unlike federal loans, private student loans aren’t based on financial needs or credit history. You’re not required to prove that you cannot afford to pay for school without taking out loans before getting a private student loan.
However, this means that interest rates can be higher than those of federal student loans. Private lenders don’t offer as many repayment options as the federal government, so switching to an income-driven repayment plan or deferment can be challenging if you have trouble making your monthly payments.
If you’re considering taking out a private student loan for college or graduate school, it’s essential to understand the fees involved in these types of loans.
Private student loans typically have higher interest rates than federal government-backed student loans, so if you borrow more than $5,000 or so in these types of loans, you’ll need to pay them back within five years or less to avoid paying extra fees on top of your interest rate.
Private student loans also have stricter eligibility requirements than federal student loans. For example, some lenders require students to be enrolled in a degree program at an accredited college or university to qualify for a private student loan.
How Does Student Loan Work?
Student loan interest is tricky, and it’s essential to understand how it works.
The first thing you need to know is that your student loan servicer—the company that handles all of your payments—is required by law to provide an annual notice of how much interest you’ve been charged during the year. If you don’t receive this notice, contact your servicer immediately.
This notice will also tell you what your current balance is. Because student loan interest is calculated as a percentage of this debt, knowing these numbers helps determine how much interest has been charged throughout the year.
The second thing you need to know is that student loan interest rates are set by Congress and vary depending on the type of loan and when it was disbursed.
For example:
Subsidized loans have an interest rate of 6%, which is fixed for the life of the loan; however, if you are eligible for a subsidized loan, any time after graduation or leaving school before completing at least half-time enrollment status begins accruing interest at a fixed rate set by Congress and varies depending on when your first disbursement occurred.
Students who receive unsubsidized loans must begin paying back their loans when they graduate from college or leave school.
Unsubsidized loans are not based on your financial need, and you don’t qualify for a subsidized loan if your family’s income is too high.
The interest rate for the unsubsidized loan is fixed, which means it doesn’t change over the life of your loan. The interest rate for this type of loan is usually fixed at 6.80% and remains that way throughout your repayment period.
The interest on a subsidized loan is calculated daily and added to the principal balance, which means no additional fees or charges are associated with this type of loan.
How to Apply for Student Loans
Student loans are so crucial to your education that it’s worth finding out how to apply for a student loan.
Student loans are a great way to help pay for your education, but knowing how to apply for them is essential.
Here’s what you need to know:
- Ensure you have all the information about your program and school to complete the application accurately.
- You’ll need to fill out the FAFSA (Free Application for Federal Student Aid) form every year that you’re in school; this form will determine whether or not you’re eligible for federal aid.
- You can apply for student loans directly through your college, university, or an outside lender like Sallie Mae or Wells Fargo. If you choose an outside lender, ensure they don’t charge fees or impose penalties on late payments!
The first step is to find out if you qualify for financial aid. How much you get depends on your family income, the number of people in your household, and other factors. You can find out more here.
You must fill out the Free Application for Federal Student Aid (FAFSA) if you qualify for financial aid. The FAFSA asks questions about your finances and your academic record.
This information will help determine how much financial aid you can receive. If you’re applying for federal student loans, make sure to include the results of the FAFSA in your application materials!
If you want to use private loans instead of government loans, then consider searching online for private lenders like LendKey or College Ave Student Loans.
They’ll let you know how much money they can offer and whether or not they have any special offers available right now!
If none of these options work out for you, consider asking a friend or family member if they would be willing to lend money towards your education costs!
What Can Student Loans Be Used For?
For many students, student loans are essential to paying for college. While it’s important to understand how to manage your debt and make the most of your investment, there are also some general guidelines about how student loans can be used.
Student loans can be used for various things, including tuition, fees, room and board, books and supplies, transportation costs (including parking fees), and even certain types of equipment or special services the school requires.
For example, suppose you have a disability that requires an accommodation to participate in a class or other activities on campus (such as a note-taker or interpreter). In that case, you may be eligible for assistance through your school’s disability office.
But these expenses aren’t covered by federal financial aid programs like Pell grants—so they’ll come out of your pocket unless you have private loans set up through the school.
How Much Do Student Loans Cost?
If you’re considering taking out a student loan, it’s essential to understand the cost of your loan. Understanding how much you’ll pay in interest and fees can help you decide what type of loan will work best for you.
The type of loan, your credit history, and other factors determine the interest rate on a student loan. For example, if you have poor credit, it will be harder for you to secure a low-interest loan than someone with excellent credit.
Student loans usually carry a fixed interest rate that does not change over time (except in cases where there is a variable rate).
The interest rate for federal student loans is set by Congress and remains constant throughout the life of the loan. Private lenders will typically base their rates on those offered by the federal government or other lenders.
In addition to an interest rate, student loans also charge borrowers origination fees or application fees based on their financial situation; these fees are often deducted from the amount borrowed during the first year of repayment rather than being paid upfront.
For example, some lenders may require borrowers who have little income or assets to pay upfront before they can receive their funds.
Here are a few general interest rates charged on student loans:
- Subsidized and unsubsidized loans for undergrads – 4.99%
- Direct unsubsidized loans for graduate and professional students – 6.54%
- Direct Plus Loans for both graduate and professional students or parents of dependent students – 7.54%
Student Loan Repayment Options
You have a lot of options when it comes to paying back your student loans. If you’re still in school, several repayment plans can help you avoid interest charges and keep your payments manageable.
If you’ve already graduated and landed a job, there are several different ways for you to make sure that your loan is paid off as quickly as possible.
It’s important to remember that no matter what kind of repayment plan you choose, always make sure that you get the best deal possible by comparing all of your options before signing on the dotted line or making any final decisions about how much money you should put toward your student loans each month.
Here are some of the repayment plans available to students who apply for student loans:
Income-based Repayment (IBR)
Income Based Repayment (IBR) is a federal loan repayment program that allows monthly student loan payments based on your income and family size.
Payments are capped at what it would take to repay the loans over 12 years, but monthly payments may be as low as $5.00. IBR is available for federal and private student loans, but not all lenders participate.
If you have more than one type of federal loan, you can consolidate them into one account and choose which type of payment plan you’d like to use (fixed or graduated). If you don’t want to reduce, choose which plan works best for you individually.
Suppose your loans were consolidated into one account after October 7th, 2015. In that case, they are eligible for this repayment plan by default unless they were consolidated with other non-qualifying loans (such as Parent PLUS or Perkins loans).
It’s important to note that if your income increases while using this repayment plan, your monthly payments will increase accordingly, so keep an eye on how much money comes in each month!
Income-Contingent Repayment (ICR)
This is the most common type of student loan repayment plan. It’s the default option for federal student loans, and it’s what you’ll get if you don’t choose another plan.
The ICR plan bases your monthly payments on your income and family size so that you pay off your loans faster if you have a higher salary and slower if you have a lower one.
That means that it may take longer for lower-earning graduates to pay off their loans, but they’ll end up paying less over time than those who have a high salary.
There are two types of ICR plans: standard and extended. The standard plan is calculated based on 10% of your discretionary income, while the extended plan uses 25%.
Both plans allow eligible students to make payments based on their monthly earnings—which means that they can pay more or less each month depending on how much money they make.
Pay as You Earn (PAYE)
Pay as You Earn (PAYE) is a popular student loan payment plan. It’s designed to help you pay off your loans while still being able to afford your other expenses and care for yourself.
Here’s how it works: You pay 10% of your discretionary income, calculated by taking your adjusted gross income and subtracting 150% of the poverty line for your state and family size.
So, if you live in New York City with a family of two, that would be about $18,000 per year—and you’d owe about $1,800 per year on your student loans.
You’ll continue making payments until your loans are paid off or until 25 years have passed (whichever comes first). If you’re married, you can combine your income with your spouse’s and qualify for PAYE.
Suppose you have Perkins or Direct Loans (except Federal Family Education Loan Program). In that case, they will be eligible for PAYE after 20 years of payments under an Income-Contingent Repayment Plan (ICRP).
Revised Pay As You Earn (REPAYE)
Pay As You Earn (REPAYE) is a student loan repayment plan that helps you get out of debt faster if you have a low income.
With REPAYE, your monthly payments are capped at 10% of your monthly discretionary income, defined as any money left over after paying taxes and living expenses.
If you’re married to someone with eligible federal student loans, then your spouse’s income will be added together with yours to determine how much money you have for discretionary spending.
If your monthly payments are higher than what the government would like to see, then they will adjust accordingly. The government wants its money back but doesn’t want to suffocate you in the process!
If you enroll in REPAYE, then after 20 years (or 25 years if you have graduate school debt), any remaining balance on your federal student loans will be forgiven.
FAQs About How Do Student Loans Work
What types of student loans are there?
There are a few different types of student loans available to students. The first is a federal loan, which is issued by the government and has its own set of eligibility requirements.
The second type is a private loan, which a private lender like a bank or credit union issues. These loans have their requirements for eligibility as well. Finally, there are student lines of credit, which offer more flexible repayment options than other types of loans but also require you to pay interest on the money you borrow until it’s paid off entirely
Can I obtain a student loan without a credit check?
Yes! You can obtain a student loan without a credit check by applying for a private or direct student loan.
Private student loans can be obtained from private lenders, who are not bound by the same regulations as federal and state-run lenders.
This means that they are not required to perform credit checks on applicants, and they may also offer better interest rates and payment terms than federal or state-run lenders.
Do student loans require a cosigner?
No, student loans do not require a cosigner. However, if you are seeking a private loan, some lenders may require one.
Additionally, if you have a credit score below 620 and want to borrow 10% or more of the cost of your degree program, you may need to provide documentation of your parent’s income and assets.
What is the best way to pay off my student loans?
The best way to repay your student loans is to do it early. If you have a large amount of debt, it can be tempting to put it off and focus on other things, but the sooner you start paying down your debt, the better.
If you have extra money to pay down your loans, we recommend doing so as soon as possible.
When do I have to start making payments on my loan?
Typically, you’ll have to start making payments on your student loans six months after you graduate or drop below half-time enrollment.
The exact date depends on your loan type and whether or not you’ve deferred your payments (which is an option for some loans).
You can begin making payments before this time if you want to, but it’s generally not a good idea. If you need help paying for school, contact your lender as soon as possible so they can help with a payment plan.
What can I do if I can’t repay my student loans?
If you are having trouble repaying your student loans, several options are available to help you.
First, we recommend reaching out to your lender and discussing your situation. They can help you understand what options are available to you, including deferment and forbearance.
If that doesn’t work, there are other options. You can request a hardship deferment if you have an economic hardship or medical emergency. You can also request an in-school or grace period deferment if you’re still in school or within six months of graduating.
You can apply for a consolidation loan or income-driven repayment plan if none works. These options will allow you to pay back less than the original amount due each month, making it easier on your budget!
Does having student loans affect my credit rating?
Student loans can affect your credit rating, but how much depends on the type of loan and when it was taken out.
Federal student loans do not affect your credit score because they are not reported to the three major credit bureaus: Experian, TransUnion, and Equifax.
But if you have private student loans or a private loan co-signed by a parent or other adult, those loans will be reported to the credit bureaus.
If you’re considering taking out a loan, shop around and ensure you know what impact it could have on your future credit rating before committing to anything.
Concluding On How Do Student Loan Work?
So there you have it. Student loans are a complicated, confusing, and often-misunderstood system that many people are forced to navigate alone.
But if you can get through the paperwork, there’s nothing stopping you from being able to afford college and thrive professionally in your field of choice.
If you’re unsure where to start, contact your school’s financial aid office or contact a private lender like.
They will help you sort out the details of your specific student loan situation and answer any questions you might have about student loans in general.
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