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How do student loans work: student carrying some files while walking

May 15, 2023

From application to repayment, how do student loans work?


- A student loan is money loaned to you by the federal government or a private entity to help you pay for college.

- Student loans bridge the gap between your available savings, grants and scholarships, and the total price of your education.

- There are many student loan options for you to choose from, but federal loans are the most common.

The journey through college can be exciting and transformative. Students won’t just come away with a higher education; they’ll also learn so much about themselves as people and about who they want to be in the future. And if they borrow money to go to school, part of that future will be managing their student loans. 

But what is a student loan — and how do student loans work? It may seem like a pretty simple concept on the surface, but once you get into it, you might find you have more questions than you thought you'd have. Like, who lends you the money? What is a subsidized loan? Does your credit score matter? What are you allowed to spend the loans on? And when do you have to pay it back?

Don’t fret if you can’t answer these questions yet, we got you. By the time you read through this you’ll know more about how the process works and how to find the best options available to you.

What is a student loan? 

A student loan is a type of financial aid. Student loan borrowers can use the funds to pay for school-related costs like tuition, books, and housing. What makes it a loan is that, at some point, the borrower has to pay it back, usually with interest. 

There are many ways to pay for college, such as with savings, work-study programs, grants and scholarships, part-time jobs, and more. Student loans bridge the gap between your remaining financial need and the total cost of attendance. In some cases, it pushes the responsibility of paying for school to a time when you’re likely to be making more money. 

Student loans can usually be classified as either federal student loans or private student loans. Federal means the federal government is the lender. Private loans could come from a school, a bank, a credit union, or a state funding program. 

How do student loans work?

Students studying together

Like so many things in life, student loans have a life cycle and can be broken into several stages. Let’s take a look at the different stages. We’ll focus mostly on federal student loans. 


Finding out the types of financial aid available to you starts in the application process. To apply, students must fill out the Free Application for Federal Student Aid (FAFSA).

Some opportunities are first-come, first-served, so filling out your FAFSA as early as possible during the application window can be beneficial. 

After submitting your FAFSA, you’ll receive a summary of the information you provided on the application called a Student Aid Report (SAR). The Department of Education recommends you to review the SAR to make sure all the information on it is correct. 

The SAR will tell you your Expected Family Contribution, which is used to determine your eligibility for a Federal Pell Grant. It will also be sent on to the colleges you listed on your FAFSA form. 

The schools that receive your SAR will use it to determine the federal and non-federal aid available to you. This can include federal student loans, work-study programs, and grants you are eligible for. (Grants are money you don’t have to pay back.) 

After you verify the information on your SAR is accurate, it's a good idea to contact your school's financial aid office. They may have additional requirements before they build you a financial aid package. 

Acceptance and disbursement

After you thoroughly examine your financial aid offer, you can choose the loans or aid you want to accept. You’ll then sign the master promissory note and do any required loan counseling. Once that happens, your loan servicer will send any loan money to the school you're attending. The school will deduct your tuition, fees, and anything else they would otherwise directly bill you for. They will then give you what’s leftover from the loan for your other education expenses. 

Appropriate uses of student loan funds could be things like food, room and board, software, textbooks, or child care so you can attend classes. 

School years

For federal loans, you don’t have to make payments while you’re in school, but depending on the structure of the loan agreement, interest might be accruing. We’ll talk later about the types of loans, but for now, we’ll just say that if interest is accruing, making interest payments while in school could save you a lot of compounded interest later on. 

Grace period and repayment

Once you graduate from school or go below at least half-time as a student, you will have a six-month grace period before you’ll need to start making monthly payments on your federal loan balances. This could be different if you have private loans. 

For federal loans, you have some choices as to how you pay the loan amount. You might choose a standard repayment plan, a graduated plan, or an income-contingent repayment. There are even options for student loan forgiveness offered in exchange for public service. 

If you ever find yourself unable to make the full payments on time, federal loans come with certain protections to help you out. By contacting your loan servicer, you may be given options for lowering your payment or be able to take advantage of deferment or forbearance to temporarily stop your payments. 

What types of federal student loan programs are there?

While there are many choices when it comes to student loans, by far the most popular are federal loans. In fact, since over 93% of the outstanding student loans are federal loans, we’ll continue our focus on those.

All federal student loans share some similar traits, including:

  • Fixed interest rates

  • The ability to consolidate multiple loans into a Direct Consolidation Loan

  • Deferment of payments

  • Loan forgiveness programs

  • No prepayment penalties

  • Postponement protections for those struggling to pay

  • Multiple repayment options 

  • Max loan amounts are capped by the cost of your school

Now let’s look at each federal loan type individually. 

Direct Unsubsidized Loan

This standard federal loan is available to students in both undergrad and grad programs. Here are some traits specific to the Direct Unsubsidized Loan: 

  • The interest rate is fixed but is higher for graduate students than undergraduate students.

  • The loan limit depends on the cost of the school you’re attending and which year you’re in.

  • You do not need a credit check for this type of loan.

  • While student loan payments are deferred until you leave school, interest starts accruing on this loan immediately. You can opt to make the student loan interest payments from the beginning to save money over the life of the loan.

Direct Subsidized Loan

The subsidized and unsubsidized loans are almost exactly the same except for three main differences. Here’s what sets the Direct Subsidized Loan apart:

  • It’s subsidized by the U.S. Department of Education who pays your interest payments while you’re in school. 

  • Eligibility for this program is based on financial need.

  • It’s only available to undergrads.

Direct PLUS Loan for graduate or professional students

Direct PLUS loans are targeted at graduate students and professional students who require larger loans. These differ from the direct subsidized and unsubsidized loans in the following ways:

  • This loan does require a credit check to be approved. 

  • It comes at a higher interest rate. 

  • If the student is not approved based on credit history, getting a cosigner could be an option. 

Direct PLUS Loan for parents

These loans are just like the Direct PLUS loans, but instead of going direct to the student, it's the parents that take on this loan. Here’s a few more details that set the Parent PLUS Loans apart:

  • Parents are responsible for paying these loans back.

  • Loans can be used for undergraduate or graduate programs. 

  • Credit checks are required for approval.

  • They come with the highest interest rate of all federal student loans.

What are private student loans, and how do they work?

Private loans can vary depending on the lender. They tend to be a less popular option for college students and their parents, but with so many choices, you might find a loan agreement that works better for your particular situation. 

Keep in mind that not all private loans will follow these rules, but here are some common ways private loans differ from federal loans:

  • They require student loan payments to begin immediately. 

  • They come with variable interest rates that could be determined by credit scores.

  • They can be for higher loan amounts than their federal counterparts offer. 

  • There are very few, if any protections, if you or your parents run into trouble with the student loan repayment terms. 

Determining whether your student loan debt should be federal or private could require some shopping around. It’s possible private loans could be a money-saving option under the right circumstances. 

Student loans help you bridge the gap to higher education

Graduates raising their diplomas

Student loans help you pay for the expense of college. A variety of options are available to borrowers, and the biggest lender is the federal government. By filling out FAFSA, you can determine your eligibility and be on your way to all of the opportunities and memories college has to offer. 

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