How Do Student Loans Work: Guide to Federal, State and Private College Loans

How Student Loans Work

How Do Student Loans Work: Guide to Federal, State and Private College Loans

Published November 15, 2023

How Student Loans Work

Students and parents often must borrow money to help pay college tuition and other educational expenses. However, understanding how student loans work and navigating the process can be daunting. This article explains the different types of student loans and how they work, and it offers insights on finding the student loan that’s right for you.

What Is a Student Loan?

A student loan is money that the government or private lenders disburse to students or parents to cover tuition, room and board, books and other educational expenses. After graduation, borrowers pay back student loans with interest, which differs significantly from scholarships or grants, which do not require repayment.

Types of Student Loans

The three basic types of student loans are federal, state and private. Each has different eligibility requirements and terms. Some government loans are subsidized to make them more affordable, and some are not. Generally, government loans have lower rates and are more flexible than private loans.

There is also a distinctive class of interest-free student loans accessible to some students, but they are typically harder to get.

Federal College Loans

The U.S. Department of Education disburses federal college loans directly to eligible students and parents, providing a dependable financing option. Experts advise maxing out federal loans before considering private loans, as the federal benefits include flexible repayment options and potential loan forgiveness.

Here are the different sub-types of federal college loans:

  • Direct Subsidized Loans: 

Upon completing the Free Application for Federal Student Aid (FAFSA), students may receive a direct subsidized undergraduate loan based on financial need. While the student remains in school, the government covers the interest. A six-month grace period follows graduation or departure from school before the repayment process commences and interest accumulates.

  • Direct Unsubsidized Loans: 

Unsubsidized loans are available to undergraduate and graduate students without documented financial need. Students are still required to complete the FAFSA. The government does not cover the interest during enrollment; instead, interest begins accruing when the funds disburse.

>> RELATED: Subsidized vs. Unsubsidized Loans and Choosing Your Best Option

  • Parent PLUS Loans: 

Also called Direct PLUS loans, these loans can go to the parent of a dependent undergraduate, graduate or professional student, or an independent graduate student. Undergraduate students are not eligible to apply for this loan directly. The application process involves completing the FAFSA and assessing the borrower’s credit during the application process. It’s worth noting that a PLUS loan features the highest fixed interest rate among all federal loans. A 4.228% disbursement fee also applies; therefore, the net loan amount you receive is 95.7% of the loan amount, even though you are responsible for repaying the total amount.

>> RELATED: What Is a Federal Parent PLUS Loan?

  • Direct Consolidation Loans: 

Students and parents can consolidate one or more federal education loans through a direct consolidation loan. This allows parents and students to lower their monthly payments and access federal forgiveness programs. There is no application fee to apply for a direct consolidation loan.

State Student Loans

In addition to federal student loans, parents and students should explore state student loans offered by state agencies as an additional source of money for college expenses.

State loan programs provide the advantage of lower interest rates, sometimes with the option for in-school deferments. They may also offer flexible post-graduation repayment plans based on income, opportunities for loan forgiveness in exchange for public service, and provisions for deferment in cases of financial hardship.

Certain state programs extend the same interest rate to all borrowers, regardless of their credit scores. These programs also offer fixed interest rates. While specific requirements may vary by state, the primary criterion is residency. Applicants typically need to be residents of the state or enrolled in a college in that state.

Private Student Loans

You should maximize your federal loans before going the private loan route. The repayment terms, rates, and other features will differ for each borrower based on credit history and information. Private student loans with fixed and variable rates are available for parents and students from banks, credit unions, and state agencies.

  • Private parent loans: With the rise in Parent PLUS loan interest rates, more parents are turning to private lenders to finance their student’s education. It’s wise to compare lenders since interest rates vary based on your financial and credit history. 
  • Private student loans: These loans require a credit check, including a review of your credit history and score. Without a satisfactory credit rating, a cosigner will be necessary. Unlike federal loans, private loans have more stringent repayment terms, and most lenders don’t offer deferment or forbearance. (See table below for examples of private lenders.)

How Much Can You Get in College Loans?

The college assesses your eligible loan types and loan amounts for each academic year, considering the information provided in your FAFSA. Loan amounts are subject to specific limits contingent on your school year and whether you are a dependent or independent student.

Federal Student Loan Limits

These loans have both annual and aggregate loan limits. The aggregate limit represents the total federal student loan debt you can borrow throughout your undergraduate and graduate years.

Dependent Undergraduate

Year Overall Subsidized
1st -$5,500.00 $3,500.00
2nd -$6,500.00 $4,500.00
3rd + -$7,500.00 $5,500.00
Total limit -$31,000.00 $23,000.00

 

Independent Undergraduate 

Year Overall Subsidized
1st -$9,500.00 $3,500.00
2nd -$10,500.00 $4,500.00
3rd + -$12,500.00 $5,500.00
Total limit -$57,500.00 $23,000.00

 

Graduate and Professional 

Annual limit -$20,500.00
Total limit including undergraduate loans -$138,500.00

 Parent PLUS Loan Limits

There are no specific caps for Parent PLUS loans. The maximum amount of PLUS loans you can borrow is the school’s cost of attendance minus other financial aid you receive.

Private Student Loan Limits

Private student loan limits vary by lender. Generally, the amount you borrow can’t exceed your school’s total cost of attendance. 

State Student Loan Limits

Each state is different and designates its loan amounts for particular programs.

How Student Loan Interest Works

Most government and private student loans start accruing interest when the funds are disbursed. That means your loan balance actually grows. Hower, the advantage is you don’t have pay this interest while you’re in college. One exception is direct subsidized loans, which don’t accrue interest while you’re in school.  

Student Loan Interest Rates

Federal Loans

Interest rates for federal loans are usually announced annually each June. Here are the current interest rates for funds disbursed after July 1, 2023, and before July 1, 2024: 

Type of Loan Borrower Fixed Interest Rate
Direct Subsidized* or Direct Unsubsidized Undergraduate 5.50%
Direct Unsubsidized Graduate or Professional 7.05%
Parent PLUS (Direct PLUS) Parents and Graduate or Professional Students 8.05%

*Subsidized loans do not accrue interest while the student is still enrolled full-time or part-time.

State Loans

States usually offer lower interest rates fixed by each state and program.

Private Loans

Private loans are available with fixed and variable rates, typically higher than federal or state loans. Even though variable rates may be lower, they can change over time, which makes it difficult to calculate future payments and interest. Some private lenders may offer forbearance or deferment options, but it’s rare. It’s wise to shop and compare rates before choosing a lender.

Compare These Private Lenders

LenderCo-Signer ReleaseRepayment OptionsTermInterest Rates
Yes- Flat Payment (In-School)
- Full (principal & interest)
- Deferred
- Interest-only
5, 8, 10, 15 years4.11% - 15.44% (Fixed)
5.59% - 16.65% (Variable)
Check Rate
Yes- Deferred
- $25 Minimum Amount
- In-School Interest Only
5, 7, 10, 12, 15 years4.09% - 15.71% (Fixed)
6.16% - 16.09% (Variable)
Check Rate
Red circle with sallie mae written in the center Yes- Pay now or later: Make interest payments
- Pay a fixed $25 payment
- Defer payments until after school
-Undergraduate loan rates displayed. Lower interest rates shown include the auto debit discount.
10-15 years4.50% - 15.49% (Fixed)
6.37% - 16.70% (Variable)
Check Rate
SofiYes- Immediate repayment
- Interest-only
- Fixed monthly payments in school
- Fully deferred
5, 7, 10, 15 years4.44% – 14.70% (Fixed)
5.99% – 14.7% (Variable)
Check Rate
Yes- Full payments (Principal and Interest)5, 10, 15 yearsAs low as 4.39% (Fixed)
As low as 6.07% (Variable)
Check Rate
- Deferred
- $25 Minimum Amount
- In-School Interest Only
5, 7, 10, 12, 15 years8.89% - 14.81% (Fixed)
9.26% - 15.19% (Variable)
Check Rate

How to Pay Less Interest

There are multiple ways to pay less interest on a student loan:

  • Pay more than the minimum monthly payment to reduce the accrued interest.
  •  Enroll in autopay from a checking or savings account.
  • Take advantage of discounts offered by the lender.
  • Refinance your student loans when lower interest rates become available.
  • Negotiate with your existing lender during periods of low interest rates.

Determining the Role of Loans in Your Financial Aid Package

College costs can overwhelm families. So, start by assessing what you can afford. Then, build a college list that fits the student’s needs and the family’s budget. Explore merit scholarships and need-based financial aid, which don’t require repayment. If possibile, minimize your student loans.

The process for evaluating your financial aid package should include these steps:

  1. Complete the FAFSA for state and federal-funded student aid consideration. States and colleges also use the FAFSA information to determine their grant, scholarship, and loan distributions.
  2. Review your FAFSA Submission Summary and compare the financial aid packages received for grants, scholarships, and work-study funds.
  3. Maximize the grants, scholarships, and work-study funds offered to you.
  4. Review your eligibility and terms for federal student loans, including possible loan forgiveness.
  5. Consider applying for a state student loan that may be offered at a low rate.
  6. Apply for private loans when all other options have been exhausted.

How to Avoid or Lessen Student Loans

Families can become overwhelmed by the total cost of an undergraduate, graduate, or professional education. In the How America Pays for College 2023 study by Sallie Mae, over 20% of students and families resorted to student loans to pay for college.

Understanding what you can afford, choosing the right school, and maximizing grants, scholarships, and work-study funds are essential to avoid or lessen student loans.  In the 2022-2023 school year, 29% of students used eligible grants and scholarships to prevent or reduce student loans, and more than 75% ended up eliminating a school from consideration based on cost.

>> RELATED: How to Pay for College Without Loans

How to Choose the Best Student Loan

The best student loan is the one that best fits your situation now and in the future. When you start repaying it after college, you need a budget with room for your loan payments. So, to find the best loan, you’ll need to compare loan offers.

Consider these key factors in comparing loans:

  • Interest rate over the term of the loan, and whether it’s variable or fixed
  • Low or no loan origination fees
  • Repayment options, including whether you’ll make payments while you are still in school, or whether you can defer payments and interest until after graduation.
  • Monthly payment, and whether it fits your current and future budget
  • Loan term, such as 10 or 20 years

Use Our Tool to Compare Crowdsourced Loan Offers

Road2College offers a tool called Compare College Offers to give you crowd-sourced information on college and loan offers. Register for free.

How Do You Apply for a Student Loan?

Applying for a federal student loan begins with completing the FAFSA. All students who submit a FAFSA are eligible for federal direct student loans, regardless of financial need or income level. 

A new loan application must be submitted at the start of each academic year since the cost of attendance is determined annually. See our complete guide on how to submit the FAFSA application and a link to apply for FAFSA.

When you receive your financial aid award package, the college will let you know what subsidized or unsubsidized student loan amounts you qualify for. At this point, you must accept or reject the loan offers and complete all paperwork required by the deadline to receive the loan disbursement.

To apply for a Parent PLUS loan, a FAFSA application must be completed. All parents are eligible to apply for a PLUS loan, and most are approved. Once you have your FSA ID, sign on to the StudentLoans.gov website and follow the directions for the PLUS loan. Once you receive approval, complete the required forms and paperwork to have the funds released to the college.

To apply for a state loan, use the U.S. Department of Education website to find the Department of Education or Higher Education Agency contact information for the college.

The process for applying for a private student loan is at the lender’s discretion. Before initiating the application, knowing the school’s cost and the financial aid awarded is important. While the school may suggest preferred lenders, conducting your own comparison of lenders is advisable. You can compare up to five loans simultaneously with the Road2College Loan Calculator. Upon approval, the lender will furnish loan documents detailing the interest rate, repayment terms, and any other additional costs.

What Can Student Loans Be Used For?

Student loans can be used for these expenses related to attending college and obtaining an education:

  • College tuition and fees
  • Room and board (on campus or off campus)
  • Books and supplies
  • Transportation (bus, train, or other ground transportation expenses)
  • Technology (computers, laptops, and other requirements)
  • Lab fees
  • Utilities
  • Groceries or personal supplies (including clothes, housewares, bedding, and eating out)
  • Childcare or other dependent care
  • Medical expenses
  • Car expenses, including gas

Just remember, the money borrowed accrues interest so determining how to spend it should be considered wisely.

How Do You Get Your Money?

Before you can receive your first federal direct subsidized or unsubsidized loan as an undergraduate, or your first Parent PLUS loan as a graduate/professional student, you must complete the “entrance counseling,” which can be done online in about 30 minutes.

Once your federal student loan is ready to be disbursed, the Department of Education will send it directly to your college. They will then apply that money to cover tuition and any other fees. If money is left over, you will receive it to cover living expenses for the semester. You will usually receive the money before classes start, but first-time borrowers may have a 30-day waiting period after enrollment. The funds typically disburse twice a year — one payment per semester.

State loans are disbursed based on the guidelines specified for each state. Once you have applied and been approved, you can contact the state lender for accurate disbursement information.

For private loans, each lender determines its disbursement policies. Some lenders pay the borrower directly. In this case, the student is responsible for paying the tuition bill with the loan disbursement and will manage the remaining funds, if any, to cover living expenses. Other lenders will disburse the loan directly to the college after getting confirmation of enrollment and the cost of attendance.

How Do You Repay a Loan?

After graduation, if you reduce enrollment to less than half-time or leave school, your federal student loans go into repayment. A six-month grace period is usually granted before payments are due, except for PLUS loans, which usually lack a grace period.

When payments begin, the lender typically enrolls you in a standard repayment plan, which you can modify upon request if it doesn’t align with your financial situation. Fortunately, many private lenders recognize that students cannot repay loans while still in school and follow the same repayment regulations as federal loans. Certain lenders may necessitate in-school payments, so make sure you review your loan documents and any correspondence from your lender post-graduation.

Your loan servicer will furnish a billing statement containing your repayment schedule, payment due dates, total number of payments, frequency, and payment amount. Opting for electronic deductions often results in an interest rate reduction of 0.25% with federal loans.

Student Loan Repayment Options

Eight federal student loan repayment plans are available to choose from. If you do not select a repayment plan, your lender will automatically enroll you in the Standard Repayment Plan.

  1.     Standard Repayment Plan: Features fixed payments for a maximum of 10 years, which is the shortest repayment period.
  2.     Graduated Repayment Plan: Involves lower initial payments that increase every two years, typically concluding within a 10-year period.
  3.     Extended Repayment Plan: Applicable if you have outstanding loans exceeding $30,000, allowing an extension of the repayment period up to 25 years. Monthly payments may be fixed or graduated.
  4.     Revised Pay as You Earn Repayment Plan (REPAYE): Sets monthly payments at 10% of your discretionary monthly income for 20 or 25 years.
  5.     Pay as You Earn Repayment Plan (PAYE): Suitable for those with a high debt-to-income ratio, establishing monthly payments at 10% of your discretionary income, capped at the Standard Repayment Plan amount.
  6.     Income-Based Repayment Plan (IBR): Monthly payments are 10 or 15 percent of discretionary income, depending on the loan origination date, never exceeding what would be paid under the 10-year Standard Repayment Plan.
  7.     Income-Contingent Repayment Plan (ICR): Monthly payment is the lesser of 20% of discretionary income or the amount under a fixed 12-year repayment plan.
  8.     Income-Sensitive Repayment Plan: Available to low-income borrowers with a 10-year repayment period, and the monthly payment is determined based on annual income.

For detailed explanations and guidelines for each payment plan, refer to StudentAid.gov.

When Do I Start Repaying My College Loan?

When you start repaying your college student loan depends on the loan terms. Federal student loans have the most flexible repayment terms and offer a six-month grace period, so you don’t have to start repaying the loan until six months after graduation.

If you borrow from your state’s educational funding, the state sets the repayment plans and options.

The most common repayment plan for private student loans involves level payments for a fixed number of years based on the debt amount. Some lenders offer extended repayment terms of up to 30 years or the option of interest-only payments for the first year or two, with the total principal and interest payments beginning afterward.

Ensure you fully understand your lender’s repayment options before receiving private student loan funds.

How Much Will I Owe Each Month?

The amount of money you will owe each month will be based on the amount you borrowed (the loan amount plus fees), the length of the repayment plan, and the interest rate. Use our Student Loan Calculator to help determine what your monthly payments will be.

What Happens If You Don’t Repay Your Student Loans?

If you cannot repay your student loan, don’t panic. You have viable options, but ignoring the loans isn’t one of them. 

In cases of short-term financial difficulty with federal student loans, you may qualify for a deferment or forbearance. Private student loans offer fewer options, usually requiring refinancing to achieve lower payments.

Failure to repay your student loans can lead to the following consequences:

  • Government Intervention: If it’s a federal loan, the government will take your money. After nine months of non-payment, they can garner wages without a court order, seize tax refunds, intercept other federal benefits within limits, and hinder access to additional financial aid for further education. Also, note that federal student loans are not dischargeable through bankruptcy.
  • Legal Action: Private lenders may resort to legal measures by suing you to start the collection process. They often engage in aggressive tactics through collection agencies, involving phone calls, emails, and mailed letters. Private lenders don’t tolerate missed payments. A single late payment can lead to potential collection or legal action.
  • Credit Score Impact: Non-payment of student loans will inevitably hurt your credit score. A lower credit score translates to increased costs for mortgages, car loans, insurance, personal loans, cell phone plans, and credit cards. It could also impact your prospects for future employment, as many employers conduct credit score checks during the hiring process.

If you can’t make your payment, contact your lender and try to negotiate the terms or ask for a grace period. You can also ask to set up a different payment plan or choose another repayment option that fits your financial situation. Ignoring the problem is not advisable as it will only worsen the situation.

Will My Student Loan Be Forgiven?

The U.S. government has several programs that offer student loan forgiveness, but you must meet specific eligibility requirements to qualify. 

For example, the Public Service Loan Forgiveness (PSLF) program forgives the remaining balance on your direct loans after you have made 120 qualifying monthly payments under a qualifying repayment plan while working full-time for a qualifying employer. However, the program has strict eligibility requirements, and only a small percentage of applicants get approved for loan forgiveness.

Other loan forgiveness programs include the Teacher Loan Forgiveness Program, the Perkins Loan Cancellation and Discharge Program, and the Closed School Loan Discharge Program. Each program has its own eligibility requirements, and some may forgive only a portion of your loan balance.

As of this writing, the U.S. government has not announced any plans to forgive all student loans, and it remains a highly controversial issue in U.S. politics.

Are Student Loans Worth It?

If you decide to pursue student loans, borrow only what you need. Most experts agree that a good rule of thumb for total undergraduate borrowing is to limit your loans to what you expect to earn your first year after graduation. The student loan payment should be limited to 8-10 percent of your gross monthly income.

It’s also important to ask yourself if the money you borrow is worth its return on investment (ROI). For example, incurring $200,000 in student loan debt for a career that pays an average of $40,000 yearly would not be considered a good ROI.

If you aren’t sure of the starting salary for a particular profession, check the Bureau of Labor Statistics Occupational Outlook Handbook. You’ll also find information on the growth potential in various careers and projections for future hiring needs.

Student Loan FAQ

How does a student loan work?

How a student loan works depends on the type of loan and who the lender is. If you borrow money from the government or a private lender to pay for college tuition and other educational costs, you must repay the loan with interest. 

How are student loans paid back?

The lender typically enrolls you in a standard repayment plan after graduation if you reduce enrollment to less than half-time or leave school. In most cases, a six-month grace period is granted before payments are due, except for PLUS loans, which usually lack a grace period.

Do student loans get paid to you or the school?

All federal and most private student loans are typically sent directly to the school. Some private lenders may offer to distribute the funds to the borrower directly.  

How long does it take to pay off $30k in student loans?

The payoff time depends on the repayment plan and how much you pay monthly. The standard repayment plan would take ten years to repay the student loan. Repayment can take up to 25 years if you change your repayment plan.

What happens to student loan debt when you die?

The government discharges federal student loans upon the death of the student. It also discharges Parent PLUS loans if the parent who borrowed the money dies and only one parent is on the loan. Some private lenders terminate student loans at death, and others do not.

How long does it take to pay off student loans on average?

According to the Education Data Initiative, the average time to pay off a student loan is 20 years. 

*Writer Suzanne Shaffer contributed to this article.

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Other Articles You Might Like:

Understanding Subsidized vs. Unsubsidized Loans and Choosing Your Best Option

Answers to Your Top 5 Questions About Student Loans

How to Avoid Student Loans: How Parents Can Help

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