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Smart Money

Student Loans 101: What to Know About Borrowing for College

Getting a college degree doesn't always come cheap. Here's everything you need to know about using student loans to help pay for college.

Rebecca Lake • June 3, 2021

When it comes to paying for college, student loans can help ease some of the financial pressure. 

After all, a college degree doesn’t always come cheap. According to CollegeBoard, the typical student attending a four-year school pays anywhere from $10,560 to $37,650 per year. And without a college savings fund to bank on or scholarships and grants, student loans may be necessary to help you get through school. 

But what is a student loan? And how do student loans work? 

Let’s break down some of the most important things to know about using student loans to pay for college

In This Article

  1. What is a student loan?
  2. How do student loans work?
  3. Different types of student loans
  4. Paying student loans: What to consider
  5. Where to apply for student loans
  6. The bottom line

What is a student loan?

A student loan is money you borrow specifically to pay for higher education costs. You can get student loans from the federal government or through private lenders. 

Student loans can help pay for a variety of college expenses, including:

  • Tuition
  • Fees
  • Room and board (If you live on-campus)
  • Off-campus housing costs
  • Transportation
  • Books and equipment

When you take out student loans, you’re using that money to invest in your education. The idea is that your investment will pay off down the road if you’re able to use your degree to land a good job. That’s why student loans — even though they’re debt — are usually considered “good” debt because they serve a distinct purpose. 

How do student loans work?

When you apply for and receive student loans, a lender is giving you the money you need to pay for school. You agree to pay that money back to the lender with interest. 

Typically, the money from a student loan is sent directly to your school. The school will apply the loan funds to your costs of attendance. Again, this can include tuition, fees, and room and board.

If there’s any money left over, it can be refunded back to you. At that point, you have two options:

  • Apply refunded money as a payment to your student loans
  • Use the money to pay for other education costs (i.e. off-campus housing, books, etc.)

Applying a refund toward your student loan balance means there will be less for you to pay back. If you decide to spend a refund or overage, then you’ll have to repay it along with the rest of the money you borrowed. 

The good news is that you typically don’t have to repay student loans while you’re still enrolled in school, at least half-time. And, once you graduate, you may have a grace period before you have to begin making regular payments. 

In terms of how to pay off student loans, your repayment plan options can depend on the type of loans you have. 

Different types of student loans

Not all student loans are alike. There are two main categories of student loans: federal and private. Whether you choose one or the other, or a combination of the two, can depend on how much money you need to pay for school. Here’s more on how the different types of student loans compare:

 

Private student loans

What is a private student loan?

In simple terms, it’s a student loan that you receive through a private lender. Banks can offer private student loans, along with other banking products. There are also companies that specialize exclusively in offering private student loans. Sallie Mae is one of the best-known examples of companies that offer private student loans. 

So how do private student loans work? 

First, you need to apply. During the application process, a private student lender may check your credit and income to make sure you can repay what you borrow. 

If you’re approved, the private student loan lender can disburse your loan funds to your school. And again, if there’s any overage then this money can be refunded back to you by the school. 

Private student loans can offer a deferment period while you’re in school, meaning you won’t need to make any payments while you’re enrolled. After graduation, your lender may also offer the grace period mentioned above to give you time to plan your student loan repayment budget. 

You’ll pay interest on private student loans and — depending on the loan — this could be a fixed or variable interest rate. Lenders can set their own limits on how much you can borrow per year, per loan or over the course of your lifetime. 

Private Student Loan Pros and Cons
ProsCons
  • Student loan interest may be tax-deductible
  • Fixed or variable rates can offer flexibility
  • Lenders can offer higher borrowing limits compared to federal student loans
  • Good credit can help you qualify for the lowest rates on private student loans
  • Not eligible for federal student loan benefits, including CARES Act forbearance
  • Poor credit may require you to have a cosigner to qualify for a private student loan
  • Prepayment penalties may apply if you pay loans off early
  • Depending on the lender, you may still be required to make payments while you’re in school

Federal student loans

Federal student loan programs are administered by the U.S. Department of Education. 

But how do federal student loans work? 

Like private student loans, first you need to apply. The biggest difference is that most federal loans don’t require a credit check the way some private student loans do. 

Federal student loans only have fixed interest rates and these rates are set each year by Congress. Rates are based on the 10-year Treasury Note yields. 

There are different types of federal student loans, including:

  • Direct Subsidized Loans – With this type of federal student loan, the government subsidizes or pays the interest on your loans while you’re in school, during your grace period and when you’re on deferment. 
  • Direct Unsubsidized Loans – With unsubsidized federal loans, the government does not pick up the tab on interest charges at any time. Unlike subsidized loans, approval for unsubsidized loans is not based on financial need. 
  • Direct PLUS Loans (for graduate and professional students) – Direct PLUS loans allow graduate and professional students to borrow money for college. A credit check is required for approval. 
  • Direct PLUS Loans (for parents) – Parents can also take out PLUS loans to help pay for higher education costs for eligible students. 
  • Direct Consolidation Loans – A Direct Consolidation Loan allows you to consolidate other types of eligible federal student loans together to streamline monthly payments. 

Federal Perkins Loans are no longer offered to new borrowers. But these loans may be eligible for Public Service Loan Forgiveness. 

What is loan forgiveness? 

Under the PSLF program, eligible borrowers can have some of their student loan debt forgiven after making 120 qualifying monthly payments. Eligible borrowers include graduates who are working in public service careers. Once the 120 payments are made, anything remaining on the loan can be forgiven. Borrowers who are hoping to qualify are encouraged to choose an income-driven repayment plan, which can offer the lowest monthly payments. 

Note: This is how student loan forgiveness works today, however, the Biden administration has discussed plans to update loan forgiveness in the future, so these guidelines may change. 

Federal Student Loan Pros and Cons
ProsCons
  • Student loan interest may be tax-deductible
  • Fixed interest rates mean your monthly payments are predictable
  • Choose from standard or income-driven repayment plan options
  • You may be able to qualify for federal Public Service Loan Forgiveness (PSLF)
  • Defer loan payments while in school and during the grace period
  • Eligible for federal CARES Act protections
  • Federal loan borrowing limits may not be enough to cover costs of attendance
  • Choosing an income-based repayment option could mean paying more interest total over the life of the loan
  • Refinancing federal loans into a private student loan means losing certain benefits, including deferment and forbearance periods
  • Qualifying for federal student loan forgiveness can sometimes be difficult

Paying student loans: What to consider

When considering how to pay off student loans, your options may depend on the type of loans you have.

For example, with federal student loans you may be able to choose from a standard repayment plan or income-driven repayment options. Private student loan lenders may offer standard, interest-only or graduated payment plans but they aren’t required to base your payments on income. 

If you’re wondering, how long does it take to pay off student loans, the answer is it can depend on your loan terms, how consistent you are with making payments, and whether you’re able to pay extra toward your loans. Here are some things to keep in mind about how to pay off student loans. 

 

Calculating monthly payments

When creating your student loan repayment plan, it’s important to consider how much you can afford to pay. 

Again, if you have federal student loans you may be automatically enrolled in the standard repayment plan. This plan calculates your monthly loan payments using a 10-year repayment term. 

Here’s an example of what you might pay, based on the national loan balance of $26,946 for students who attend public four-year schools. If you have a 3.9% interest rate on your federal loans, the standard repayment plan would require you to pay $272 per month. Altogether, you’d repay $32,585 with interest factored in. 

If you choose an income-driven repayment plan, on the other hand, that could lower your monthly payments to $257 per month. You’d save around $15 per month. But in terms of total interest paid, you’d hand over around $400 more. 

With private student loans, calculating monthly payments can depend on how much you borrow, your interest rate and your loan term. And if you have multiple private student loans, you’d have to calculate monthly payments for each one. 

But it’s important to calculate payments before your grace period ends to make sure it works for your budget. Otherwise, you might be scrambling to qualify for a deferment period so you have more time to get your finances in shape. 

 

How to defer student loans

Student loan deferment allows you temporarily pause payments to your loans for a set time period. Federal student loans automatically offer deferment periods but it’s up to private student loan lenders to offer this option. 

If you want to defer payments on federal loans, you’ll need to apply for a deferment through your loan servicer. Your loan servicer is the company that collects the payments for your loans each month and applies them to your balance. 

Interest can continue to accrue on your loans while they’re in deferment. Depending on whether you have subsidized or unsubsidized loans, you or the government may be responsible for paying this interest. Once the deferment period ends, you’d resume making payments unless you qualify for an additional deferment. 

If you want to defer private student loan payments, you’d have to reach out to your loan servicer or lender to see if this is an option.

 

Calculating interest

Aside from knowing how much you’ll pay per month for student loans, it helps to understand what you’re paying in interest. Interest (and fees, if your lender charges them) add to your total cost of borrowing. 

Using a simple student loan payment calculator can help you determine your interest costs. But keep in mind that how much you might pay in interest can vary based on whether you have fixed or variable rate loans. 

With fixed-rate student loans, your interest rate remains the same for the life of the loan. With variable-rate loans, the interest rate can go up or down over time. That’s because variable rate loans are tied to a benchmark rate. When the benchmark rate changes, so does the rate on your loan. 

Again, federal loans will have fixed interest rates. But if you’re taking out private student loans, you may want to calculate potential interest charges with fixed and variable rate options before deciding which one to choose. 

Where to apply for student loans

If you’re interested in how to get a student loan, it’s important to know how to apply for student loans and when to submit your application. 

When you’re specifically wondering about how to apply for federal student loans, completing the FAFSA is the first step. This is the Free Application for Federal Student Aid. 

The information you provide about your household income and assets and your choice of school is used to determine how much federal aid you qualify for. This includes federal student loans as well as federal grants. 

The deadline for completing the FAFSA runs from October 1 through June 30 of the next year. But the Department of Education encourages you to get your application in as soon as possible, since individual schools can set their own deadlines for completing the form. 

You can fill out the FAFSA online at FAFSA.gov. You’ll need to create a Federal Student Aid ID and provide your name and Social Security number. Once you’re ready to complete the FAFSA, you’ll want to have the following information on hand:

  • Your parents’ Social Security numbers if you’re a dependent student
  • Your driver’s license number if you have one
  • Federal tax information for your parents if you’re a dependent student
  • Records for any untaxed income your household has
  • Records for assets, including bank accounts, investment accounts and college savings accounts

Note: This form is free so you don’t need to pay anything to apply for federal loans. And unless you’re applying for graduate PLUS loans or parent PLUS loans, there’s no credit check required. 

If you want to apply for private student loans, the first step is choosing a lender. When comparing private student loan lenders, pay attention to:

  • Minimum credit score requirements
  • Cosigner requirements
  • Minimum and maximum loan limits
  • Loan repayment terms
  • Fixed and variable rate options
  • Loan interest rates
  • Fees, including prepayment penalties

Also, you may want to consider whether a lender offers things like deferment periods or grace periods while you’re enrolled or after you graduate. Once you find a lender, you can apply for private student loans. This involves filling out the lender’s application and providing any supporting documentation that’s requested, such as tax forms or bank statements. 

If you’re not able to get approved by yourself, based on your credit score, a cosigner can help. Having a cosigner with a good credit history can help you get approved for private loans at favorable rates. But there’s a catch.

Both you and the cosigner are legally responsible for the debt. So if you fail to make payments for any reason and default on your loans, both of your credit scores could take a hit. And the lender could pursue debt collection actions against both of you. 

The bottom line

When working out a plan for paying for college, consider scholarships, grants and personal savings but don’t count out student loans altogether. Knowing more about how student loans work and what mistakes to avoid can help you decide on the best way to pay for college. 

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