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What Are Student Loans? A Beginner's Guide

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updated: May 28, 2024

If you’re planning to go to college or trade school, you may need help with tuition and program costs. Student loans are a popular solution: More than half of American undergraduates borrow to cover education expenses.

Student loans are funds borrowed from the federal government or a private lender to cover the costs of higher education programs.

Types of student loans

There are two main types of student loans: federal loans from the government and private loans from banks and other lenders.

Federal student loans

There are four types of federal student loan programs available:

Direct subsidized loans

Undergrad students who can demonstrate financial need may qualify for subsidized loans. Subsidized loans have low fixed interest rates, and the government pays the loan’s interest while students are in school and during their grace period, which is six months for most loans. Subsidized loans are the most affordable, but they can’t cover the entire cost of many programs. As of 2024, total subsidized loans for a four-year degree can’t exceed $23,000.

Direct unsubsidized loans

Students who need to borrow more than the subsidized loan limit—or who don’t qualify for subsidized loans—can apply for unsubsidized loans. The interest on them accrues while borrowers are in school and during their grace period. The current limits on unsubsidized loans are $57,500 for a four-year degree and $138,500 for a graduate degree. These limits are adjusted downward for students who also have subsidized loans.

Direct PLUS loans

Direct PLUS loans include both Grad PLUS and Parent PLUS loans. Students in graduate and professional programs can take out Grad PLUS loans to cover their higher education. Parent PLUS loans are made to parents of qualifying undergraduate students. Both loans have a maximum borrowing limit of the total cost of attendance minus any other ‌financial assistance.

Direct consolidation loans

Direct consolidation loans allow borrowers to combine multiple federal student loans (even from different lenders) into a single monthly payment. While Direct consolidation won’t reduce the borrower’s interest expense, it does simplify repayment. And the borrower may gain access to certain income-driven plans with lower payments.

Some of the benefits of federal student loans include:

  • Subsidies. With subsidized federal loans, the government covers the interest while students are in school, which keeps balance from growing.
  • Income Driven Repayment (IDR). Many federal student loans offer plans that base the required payment on income and family size. According to the US Department of Education, millions of borrowers qualify for payments as low as $0 per month.
  • Loan forgiveness. Eligible graduates can apply for loan forgiveness programs. They typically require the borrower to make a certain number of payments and/or work in underserved areas after graduation.
  • No credit check. Borrowers don’t have to pass a credit check for federal student loans, except for PLUS loans.

Private student loans

Private student loans are available from local banks, credit unions, and online lenders such as Earnest. These loans don’t offer the same protections and perks that federal loans do. They can also be harder to get, especially for those with lower income or credit scores.

Earnest

Earnest Student Loan

Earnest Student Loan

APR
4.36% to 16.15% fixed; 5.87% to 18.51% variable
Loan amount
Up to $57,500
Term
N/A
Min. credit score
650

For well-qualified borrowers, however, private loans may provide lower interest rates than federal programs, and private lenders process applications much faster than the U.S. Department of Education. Most private loans have fixed interest rates, but some lenders also offer variable-rate options.

Private student loans don’t typically feature loan forgiveness, deferment, or subsidies. And, unlike federal loans (except PLUS loans), students must pass a credit check and have sufficient income.

How do student loans work?

Students and parents take out student loans to pay for higher education. Borrowers repay them in regular monthly installments.

Usually, the student must enroll at least half-time and pursue a college degree or professional certification. Loan disbursements for tuition, fees, and room and board are typically paid directly to the educational institution at the beginning of each semester. Students can use leftover funds for additional costs such as books and class supplies.

Student loans, like most other loans, require monthly payments and charge interest. However, borrowers can usually defer repayment while they’re in school (interest for unsubsidized loans continues to accrue during deferment).

Note that student loans are very difficult to discharge in bankruptcy. Most borrowers must repay their balances in full or qualify for loan forgiveness/cancellation.

Pros and cons of student loans

Pros:

  • Improve access to higher education.
  • Federal programs offer income-based repayment, subsidies for low-income students, easy approval and loan forgiveness options.
  • Repayment can often be deferred until the student leaves school.

Cons:

  • Student loan payments can be expensive.
  • Private student loans don’t offer many borrower protections.
  • Defaulting on loans can severely hurt borrowers’ finances and credit score.
  • It’s extremely difficult to discharge student loans in bankruptcy.

How to apply for student loans

The application process is different for federal loans and private loans. Private lenders need to make money, so they process applications very efficiently, and their underwriters review income and credit scores carefully before approving an applicant. Department of Education underwriters don’t have a profit motive, so their guidelines are less strict. In addition, government loan processing tends to take longer.

Federal student loans

Deadlines

The federal deadline for submitting the 2024-2025 FAFSA is midnight Central Time on June 30, 2024 for the 2024-2025 school year. The deadline for corrections or updates to the FAFSA is midnight CT on Sept. 14, 2024.

Most states and schools also have their own deadlines, which are generally sooner than the federal deadline. Students must meet state and school deadlines to access state and school scholarships and grants, so it’s smart to review them right away.

FAFSA requirement

To apply for federal student loans, students must submit the Federal Application for Student Aid (FAFSA). This form determines eligibility for financial aid, including scholarships, grants and loans.

First, applicants create an account at StudentAid.gov. Next, they complete the FAFSA form, providing personal and financial information, and supporting documents. Supporting documents can include:

  • Tax returns, W-2s and/or recent pay stubs.
  • Bank and brokerage statements.
  • Divorce decrees and child support orders.
  • Proof of disability

Applying for private student loans

The application process for private student loans is similar to applying for personal loans, and most private student lenders offer quick online applications. Applicants fill in the required fields and document their income and assets. (FAFSA is not required for private loans, just federal ones.)

Private student loans require a credit check. Without sufficient credit history or income, applicants may have to add a co-borrower or co-signer to be approved. Most lender websites have a “pre-approval tool” that shows students and parents how much they might qualify to borrow.

Eligibility requirements for student loans

For federal loans, students must enroll at least half-time at a school that is eligible to participate in the federal student loan program. These schools may include community and four-year colleges, as well as professional, trade, certification, and technical schools.

Note: For subsidized federal loans, applicants must demonstrate financial need, which is the difference between the cost of attendance and the expected family contribution.

To be eligible for private student loans, students typically need to be enrolled at least half-time in a qualifying school or certification program. They must also meet the lender’s minimum income and credit score guidelines. Otherwise, as noted earlier, lenders may require a co-signer or co-borrower.

How interest works for student loans

All student loans charge interest on loan balances. Most loans come with fixed interest rates, though some private lenders offer variable interest rate loans.

Lenders usually calculate accrued interest with a daily simple interest formula:

(Outstanding Principal Balance x Daily Interest Rate) x Days Since Last Payment

The daily interest rate equals the annual rate divided by 365. (A few lenders use 360 days.) For most student loans, the monthly payment clears the accrued interest and pays down some of the principal balance. Over time, less of each payment goes toward interest and more goes toward paying off the balance. This process is called amortization. .

Sometimes, though, the accrued interest exceeds the monthly payment. The unpaid interest is added to the loan balance. That’s “negative amortization,” and it increases loan balances over time. Negative amortization is common with income-driven repayment plans, when payments are often lower than the interest owed.

How interest accrues for each loan type

Student loan interest accrues differently with subsidized student loans vs. unsubsidized loans and private student loans.

  • Subsidized loan interest. With subsidized federal student loans, the government pays the interest charged while the student is in school and during the loan grace period. After the grace period ends, interest starts accruing.
  • Unsubsidized loan interest. Interest begins as soon as the loan is disbursed and is added to the loan balance each month, even while the student is in school and during the grace period.
  • Private loan interest. Interest typically starts accruing right away and is added to the loan balance each month, even when the student is in school and during the grace period..

Note: If the borrower doesn’t make payments while in school or during the loan grace period, private and unsubsidized loan balances will grow.

Repayment options for student loans

There are several repayment options for student loans. They vary by loan type and repayment schedule.

Federal student loan repayment

There are four main repayment plans for federal student loans:

  • Standard repayment. The standard term is a 10-year repayment schedule with equal monthly payments.
  • Graduated repayment. A graduated payment option still entails a 10-year repayment schedule, but starting with lower payments that increase over the life of the loan.
  • Extended repayment. Allows borrowers to extend the standard or graduated repayment schedule up to 25 years.
  • Income-driven repayment. Income-driven repayment (IDR) bases the monthly payment on the borrower’s income and family size. IDR terms can be up to 25 years, and remaining balances after that may be forgiven.

Private student loan repayment

Private student loan repayment terms vary among lenders. Most private loans offer repayment terms of 5-to-20 years. Some private student loans have variable interest rates, which means their payment will probably change over time.

How long does it take to pay back student loans?

Repayment terms for student loans vary based on the type of loan and the repayment plan selected. Generally, private student loan repayment terms range between five and 20 years.

Federal student loan repayment works differently. The standard federal student loan term is ten years, while graduated repayment, extended repayment and income-driven repayment terms run up to 25 years. Federal loan programs also offer eligible borrowers several types of student loan forgiveness or cancelation.

Alternatives to student loans

While student loans can help cover the high cost of higher education, there are other ways to pay those expenses. Here are a few student loan alternatives that students and parents should know about. Some reduce education costs and others rely on alternative payment sources.

Grants

Students without many financial resources may qualify for grants. Grants are public or private funds given (not lent) to eligible students. Students apply for state or college grants by submitting a FAFSA form.

Scholarships

Scholarships are similar to grants. Schools, agencies, private companies, charities, and clubs offer need-based and merit-based scholarships to those who meet their eligibility guidelines. Some require applicants to compete by writing an essay or completing a project. Good resources for scholarships include Scholarships.com and Fastweb.

Personal savings

Instead of borrowing the entire cost of college, students may be able to save up money to cover some of the costs. And if parents or other family members opened a college savings account (such as a 529 plan), those funds can provide funding for schooling and possibly a tax break.

Work

If you can work while attending school, you’ll be able to offset some education expenses. In addition, some schools offer federal work study programs to help students earn while they learn.

TIME Stamp: Study the options and consider the long-term implications

Student loans are designed to ease the burden of paying for college, but their balances can reach unaffordable levels if borrowers aren’t careful. Students should pursue scholarships and grants before applying for student loans.

Not all student loans are created equal. Federal loans offer more benefits and lower interest rates for those with imperfect credit. It’s important for borrowers to review loan costs and repayment terms before committing to any program.

Those planning to take advantage of federal loan consolidation and other programs should be careful to keep their federal loans and private loans strictly separated; only the federal loans will qualify for federal perks.

Frequently asked questions (FAQs)

How does a student loan work?

Student loans help borrowers pay for college or professional education, including tuition, books, fees, and room & board. They don’t typically require repayment until the student leaves school. But, for most programs, interest starts accruing as soon as money is delivered. Federal student loans are backed by the government and offer more borrower protections than private student loans. Applicants must submit the Financial Application for Student Aid (FAFSA) form to apply for federal loans, or they can apply with banks and lenders for private financing.

What are student loans pros and cons?

Student loans help cover higher education costs and make college degrees, trade school certification, and professional diplomas more accessible for cash-strapped students and families. Federal student loans can also be forgiven or canceled, in many cases. However, student loan repayment can be lengthy and difficult. And these loans are very difficult to discharge in bankruptcy unless the filer is deeply in poverty.

What are the 4 types of student loans?

The four types of federal student loans are Direct Subsidized Loans, Direct Unsubsidized Loans, Direct PLUS Loans, and Direct Consolidation Loans.

Do student loans give you debt?

Yes, student loans are installment debt repaid with regular monthly payments. Large student loan balances can make financing purchases like cars and homes difficult for graduates. Federal student loans offer forgiveness or loan cancelation for eligible borrowers, but most forgiveness programs require a minimum of 10 to 25 years of payments.

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