How Do Student Loans Work? (Federal & Private)

Since most students don’t have enough cash on hand to pay for college out of pocket, many turn to student loans to help cover their education costs.

If you’re thinking about getting a student loan, it’s a good idea to learn how they work and what types of loans there are before taking on the debt. This guide will cover how student loans work and what your options are as a new borrower. 

Types of student loans

Student loans are loans made specifically to help cover the costs of tuition, room and board, and other expenses that come with going to college. You generally need to be enrolled in an accredited education program to qualify for student loans.

There are two main types of student loans:

• Federal student loans: Federal student loans are backed by the U.S. government. These loans have fixed interest rates and come with federal benefits and protections. This includes access to deferment and forbearance options, income-driven repayment plans, and loan forgiveness programs.
• Private student loans: Private student loans are issued by private lenders. Unlike federal student loans, these loans require a credit check and verifiable income. You’ll also need to meet any other requirements set by the lender.

How do student loans work? 

Many college students end up with a mix of both federal and private student loans to help them pay for school.

It’s typically a good idea to start with federal student loans since they come with more borrower benefits and protections. Then, you can consider using private student loans to help fill any financial gaps.

Here’s how both types of student loans work:

Federal student loans

Federal student loans are issued by the U.S. Department of Education and have interest rates set by Congress. They also come with several repayment options.

To apply for federal student loans, you’ll need to complete the Free Application for Federal Student Aid (FAFSA).

There are three main types of federal student loans:

• Direct Subsidized Loans: These loans are available to undergraduate students with financial need. The government pays for all interest on subsidized loans while you’re in school at least half time.
• Direct Unsubsidized Loans: These loans are available to both undergraduate and graduate students, regardless of financial need. Unlike subsidized loans, you’re responsible for all interest charges on unsubsidized loans.
• Direct PLUS Loans: Graduate PLUS loans are for graduate students, while parent PLUS loans are taken out by parents paying for their child’s education. PLUS loans also require a credit check.

Federal student loans offer several repayment plans including the standard 10-year repayment plan, income-driven repayment (IDR) plans, or graduated or extended repayment plans.

If you sign up for an IDR plan, your monthly payment will be based on your income. After 20 to 25 years of payments (depending on which IDR plan you choose), any remaining balance will be forgiven.

There are also other student loan forgiveness programs available for federal student loans.

Private student loans

Private student loans are offered by private lenders. If you apply for a private student loan, your interest rate will depend on the lender as well as your credit score and income. You do have the option to apply with a student loan cosigner, which could make it easier to get approved.

Unlike federal student loans, private student loans don’t have built-in deferment and forbearance programs if you run into financial hardship. Instead, assistance is at the discretion of the lender. Private student loans also don’t offer any forgiveness programs.

Check Out: How to Take Out a Student Loan

How much can you borrow?

There are student loan limits that could impact how much money you’re able to borrow, depending on the type of student loan you have:

• Federal loan limits: The borrowing limits for both subsidized and unsubsidized federal student loans depend on your year in school and your dependency status. Generally, independent graduate and graduate students can borrow more than dependent undergraduate students. With PLUS Loans, you can borrow up to the cost of attendance minus any other financial aid received.
• Private student loan limits: With private student loans, you might be able to borrow up to the cost of attendance, but the exact limits will depend on the individual lender.

How to apply for student loans

The application process is a little different for federal and private student loans. Here’s how to apply for both types:

Federal student loans

Submit the FAFSA: The FAFSA is used to determine which federal student loans you’re eligible for. To complete it, you’ll need your financial information from your tax returns. You might also need your parent’s info if you’re a dependent student.

Review your financial aid award letter: Your school’s financial aid office will send a letter detailing your financial aid package. This will include any federal student loans, grants, and work-study programs you qualify for.

Accept your loans: After you review your award options, you can accept the federal student loans you want. These loans are typically disbursed at the start of the term. Any funds left over after your school costs are paid for should be refunded to you within a couple of weeks. These leftover funds can be used to cover living expenses such as housing, food, and transportation. 

Private student loans

Shop around and compare rates: Before taking out a private student loan, be sure to consider as many lenders as possible to find the right loan for you. Your credit and income stability will impact what interest rate you qualify for. 

Complete the loan application: Once you’ve reviewed your options, you can complete a full application with the lender. You’ll likely undergo a hard credit check at this point.

Accept your student loan: If your application is accepted, you’ll get a final student loan offer. Once you accept the loan, you’ll need to sign your loan documents. Most private student loans will need to be certified by your school before the funds are sent to your school’s financial aid office. Any leftover money will then be given to you to use toward other education-related expenses. 

Find Your Student Loan

How does interest work on student loans?

Depending on the type of student loan you get, you’ll have either a fixed or variable interest rate. Your interest rate will impact both your monthly payment along with the total cost of your loan.

• Federal student loans: Federal student loans come with fixed interest rates. A fixed rate will stay the same during the life of the loan, which also means your payment won’t change (unless you change payment plans). However, your payments and interest charges could vary depending on if your loan is subsidized or unsubsidized, as well as if you’re on an IDR plan.
• Private student loans: With a private student loan, you could have a fixed or variable rate. While fixed rates stay the same, variable rates can change with the market. This means your payment could go up or down in the future with a variable-rate loan.

If you decide that a private student loan is right for you, be sure to consider whether a fixed or variable rate would be better for your situation. 

Student loans FAQ 

Find answers to your most frequently asked questions about how student loans work. 

What can student loans be used for? 

Student loans can generally be used to cover any education-related expenses. When your loan is disbursed, the funds will initially go toward paying your school’s tuition and fees. Any leftover funds will be returned to you, unless you decline, to cover other expenses like housing, food, transportation, textbooks, and other school-related expenses. 

Is it worth it to get a student loan?

If you can’t afford to pay for college, a student loan may be worth considering. Just remember that student loans need to be paid back with interest, which can add a significant amount to your overall debt. Before taking out a loan, evaluate your potential earnings post-graduation and consider other forms of financial aid before making a decision.

Are student loans hard to pay off?

Student loans can be challenging to pay off because of the interest that accumulates over time. You may or may not have a hard time paying off student debt depending on your financial situation after graduation, including your income and other financial obligations. If you do take out a student loan, try to borrow only what you need. 

What if I never used my student loans?

If you have unused federal student loans contact your school to see what your options are for canceling a portion of the loan. You also have the option to return the funds to the lender within 120 days of disbursement without accruing interest. If you return the funds more than 120 days after they’re disbursed, you’ll have to pay interest and a loan fee on the returned amount. Private lenders may have their own rules around returning unused funds, so be sure to check with your lender.