Student Loans 101: How Do Student Loans Work?
If you’re thinking about taking out a student loan to help pay for college, you might be navigating the loan process for the first time and encountering a lot of questions, number one on your list being: How do student loans work?
Student loans are a very common and oftentimes necessary way to cover the costs of college. The Institute for College Access and Success has reported that nearly 70 percent of college students nationwide borrow money to help pay for school-related expenses. Student loans make it possible for many people to attend college, which can open doors and opportunities for years to come.
Whether you’re a student or the parent of a student, you’ll want to understand exactly how student loans work, so you can find the student loan that’s right for you.
If you’re just beginning to answer the popular question “How do student loans work”, we’ll cover the basics here.
What is a Student Loan?
A student loan is money that you borrow to help pay for school with the expectation that you will pay that money back in the future.
Student loans don’t differ all that much from other types of loans. However, the process of obtaining and repaying a student loan does have some unique attributes.
How Do Student Loans Work?
Your student loan might be the first loan you’ve ever pursued or received, so keep in mind that it’s not just how much you borrow – it’s how much that amount costs in the long term.
Student Loan Interest Rates
One of the most important components of any loan that directly affects its long-term cost is the loan’s interest rate. An interest rate is, essentially, the cost of taking out your loan. It is calculated as a percentage of the amount you borrow and added on to your loan.
A fixed interest rate will not change for the life of a loan, while a variable interest rate can change.
Interest rates for federal student loans, which are issued by the government, are currently set once per year and are fixed. Private student loans, which are issued by banks, credit unions, private lenders, and other types of financial institutions, tend to have interest rates that are higher than federal direct student loans, and those rates can be fixed or variable.
Interest rates will differ depending upon the lender, so this should be a key question as you shop around for private student loans.
Student Loan Origination Fees
You’ll also want to be aware of loan origination fees, which are one-time fees charged when you initially take out your loan. The percentage will vary based on the type of student loan and lender. For federal student loans, the origination fee ranges from 1.057% to 4.228% of the amount you’re borrowing. Many private student loans don’t have origination fees, but that’s not a hard and fast rule.
When charged, an origination fee is usually added to the loan amount, so you typically pay the fee as part of the loan.
Student Loan Repayment Term
Your student loan repayment term is the amount of time you will take to repay the loan. It can vary greatly depending on what type of student loan you take out. Typical repayment terms range from 5 years to 15 years. Be sure you understand what your loan term is before taking out a student loan.
The 2 Types of Student Loans
Students have two main options when it comes to student loans: federal student loans, which are issued by the government, and private student loans, which are issued by nongovernment entities, like banks and other financial institutions.
1. Federal Loan Options
Federal loan options include Direct Subsidized and Direct Unsubsidized Loans.
- Direct Subsidized Loans are available to undergraduate students whose families can demonstrate financial need. These are the only federal student loans in which interest does not accrue while the student is enrolled in school at least half-time (or during the grace period following graduation – typically six months).
- Direct Unsubsidized Loans are not awarded based on financial need and they are available to most undergraduate and graduate students. Interest will begin accruing at the time of your loan disbursement.
There are annual and lifetime limits for Direct Subsidized and Unsubsidized loans, however, so students might not be able to cover the full cost of college with these federal loan options.
Once a student reaches the limit on Direct Subsidized and Unsubsidized Loans, in most cases they can access Direct Grad PLUS and Parent PLUS Loans.
Direct PLUS Loans have higher interest rates and higher origination fees than Direct Unsubsidized and Subsidized Loans.
2. Private Student Loan Options
Private student loans have different terms depending on the lender. Unlike federal student loans, private student loans typically require applicants to pass a credit and income review to verify that they will be able to repay the loan.
Because most students don’t yet have enough credit history or steady income to qualify on their own, private student loans are often cosigned by someone like a parent or guardian who can meet the criteria and take equal responsibility for repayment. The loan will appear on the credit bureau report for both parties – the student and the cosigner.
Our credit pre-qualification tool allows borrowers or cosigners to find out if their credit qualifies them for a loan, and what interest rates they can expect.
- Learn more about the difference between federal vs. private student loans.
- Learn more about cosigners for private student loans.
When Do I Start Paying Back My Student Loan?
Another popular question brought up when on the topic of student loans is “How are student loans paid out?”. Repayment terms on student loans vary based on the type of loan. Federal student loans are often designed to be paid off within 10 years, whereas private student loans might differ based on the lender’s terms.
Students usually won’t have to begin making their federal student loan payments until six months after graduation (or if they drop below half-time status). That said, you always have the option to begin making payments while you’re still enrolled in school.
Many private lenders also offer the option to delay payments until after school, and some, like College Ave Student Loans, offer in-school repayment plans, too. If you can begin making payments during school – even small ones – you’ll usually save money in the long run because you’ll pay less in interest charges.
How Much Will I Owe on My Student Loan Each Month?
This amount will differ for each student based on the amount they borrow and their interest rate. At College Ave, we offer a student loan calculator that allows borrowers to calculate how much their loan will cost and what their monthly payments will be.
Once it’s time to begin making monthly payments, lenders commonly offer the option to enroll in automatic payments, which allows your monthly payment to be regularly debited from your bank account. This can be a convenient option since you’ll never have to worry about missing a payment. As a bonus, you’ll often get a reduction on your interest rate for setting up auto-pay.
If you’re looking to cut down on interest costs, you can always make more than the minimum required payment each month. Even if you’re unable to pay off your loan in full before the repayment period is up, any little bit beyond the minimum can help – especially when you’re talking long-term.
Just be sure your lender won’t charge you a penalty fee if you pay your loan off early. While that type of fee is not common with student loans, it’s always a good idea to confirm.
If You Still Have Questions About How Student Loans Work…
If you have any questions about how a specific student loan works, contact us for clarification before you apply for a student loan. Taking out a student loan is a big decision and how you handle paying it back can affect your credit score. Your credit score can influence future loans and interest rates, so you’ll want to make sure you understand the terms and conditions of your loan before you sign.
If you’re taking on a federal student loan and need more information, you can always reach out to your school’s financial aid office. If you’re shopping around for a private student loan and have additional questions, be sure to contact the lender directly. At College Ave, we offer private student loans that fit your life and your budget.
You’ve answered the question “How Do Student Loans Work?”, so what’s your next step? Learn more about the student loans we offer at College Ave.
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