How do student loans work? Everything you need to know

Heading off to college soon? You can look forward to meeting new friends and having awesome experiences. But you might also be sweating the financial stuff. Don't worry, you're not alone.  

We'll break down the basics of student loans, from what they are to how to apply for them. Consider this your “student loans explained” guide — we’ll cover everything you need to know to head off to college with financial confidence!

What are student loans?

Student loans are a type of financial aid designed to help students borrow money to cover the costs of higher education. Unlike scholarships or grants, student loans need to be repaid, usually with interest. This usually means you borrow money for school now and pay it back later, usually after you graduate. Sounds easy enough right? 

The trick is finding the right kind for you. We'll break down the types of student loans you can choose from in the next section.

Federal vs. private student loans: Key differences

You have two main options when it comes to student loans: federal student loans and private student loans. Let’s compare them.

Federal student loans:

• Offered by the government

• Generally have lower, fixed interest rates

• Offer more flexible repayment options

• May be subsidized (which means that interest doesn’t accrue while you’re in school) based on financial need, or unsubsidized

Private student loans:

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• Offered by banks, credit unions, and online lenders

• Interest rates can be fixed or variable

• May require a co-signer

• Fewer repayment options

How do student loans typically work? While both federal and private loans provide money for you to put toward school, one key difference between the two is interest. Federal loans generally have simple interest, while private loans tend to use compound interest, although some use simple. Simple interest is based only on the original loan amount, while compound interest is calculated on both the initial amount and any interest that has built up over time. That means a loan with compound interest can end up costing more.

Types of federal student loans:

There are a few types of federal student loans available:

• Direct Subsidized Loans: For undergraduate students with financial need. The government pays the interest while you’re in school.

• Direct Unsubsidized Loans: For undergraduate and graduate students, regardless of financial need. Interest starts accruing immediately.

• Direct PLUS Loans: For graduate students or parents of dependent undergraduate students.

• Direct Consolidation Loans: Combines multiple federal loans into one.

You apply for federal loans through the Free Application for Federal Student Aid (FAFSA). Private loans require separate applications with lenders. 

The student loan application process

Now that we’ve covered the basics, let’s look at how to get a student loan. The process is a little bit different depending on whether you’re applying for federal or private loans.

To apply for a federal loan:

1. Fill out the FAFSA. This form will determine your eligibility for federal student aid, including loans, grants, and work-study programs.

2. Review your Student Aid Report (SAR) to understand what aid you’re eligible for.

3. Review the financial aid offer from your school, which will include any federal loans you’re eligible for.

4. Accept the federal loans you need. Remember: You don’t have to accept the full amount offered!

To apply for private student loans:

1. Shop around with different lenders to compare interest rates and terms.

2. Choose a lender and complete their application process. This usually involves providing information about your financial situation and may require a co-signer (like a parent or guardian).

3. Wait for approval. If approved, review the loan terms carefully before accepting.

4. Your school will likely need to certify the loan amount before the funds are disbursed.

Try to explore all of your federal loan options before turning to private loans. Loans from the government usually offer more benefits and protections, like income-driven repayment plans.

Managing your student loans during college

While you’re hitting the books, your student loans might be the last thing on your mind. But keeping tabs on your loans during college can save you a lot of headaches (and money) down the road. Here are some tips:

• Keep track of your loans: Make a list of all your loans, including the lender, amount, and interest rate.

• Understand your interest: Interest starts accruing immediately for unsubsidized federal loans and most private loans. If possible, consider making interest payments while you're in school to prevent your outstanding balance from growing.

• Only borrow what you need: It’s tempting to take all the loan money offered, but remember — you’ll have to pay it back with interest!

• Explore part-time work: Consider a part-time job or work-study program to reduce the amount you need to borrow.

• Look for scholarships: Keep applying for scholarships throughout college. Every bit helps!

Repayment plans and options 

Graduation day has come and gone, and now it’s time to start thinking about repayment. But don’t worry — you’ve got options!

Federal loans offer a few repayment plans:

1. Standard Repayment Plan: Fixed payments over 10 years.

2. Graduated Repayment Plan: Payments start low and get bigger over time, up to 10 years.

3. Extended Repayment Plan: Stretch payments over 25 years.

4. Income-Driven Repayment Plans: Payments are based on your income and family size.

Private loans may have fewer options — check repayment options with your lender before you commit!

Grace period, explained

Most student loans offer a grace period, usually six months after you graduate, leave school or drop below full or half-time enrollment. A grace period means you don't have to make payments during this time. It gives new college graduates a chance to find work and adjust to post-college life. Use this time wisely to:

• Understand your loans and repayment options

• Create a budget

• Set up your repayment plan

• Consider consolidating your loans or refinancing them with a different provider, potentially with a better interest rate

Loan forgiveness and repayment strategies

Looking for ways to tackle your debt? A standard repayment plan isn’t your only option. Here are some strategies you can consider:

• Public Service Loan Forgiveness (PSLF): If you work for a government or non-profit organization, you may be eligible for forgiveness after 120 qualifying payments.

• Teacher Loan Forgiveness: Teachers working in low-income schools may be eligible for loan forgiveness of up to $17,500 after five years.

• Income-Driven Repayment Plan (IDR): Monthly payments in IDR plans are based on a portion of the extra money you have left after covering basic living expenses. Any remaining debt is forgiven after 20 to 25 years of qualifying monthly payments.

• Make extra payments: Paying more than the minimum can help you pay off your loans faster and save on interest.

• Refinancing: You may be able to get a lower interest rate by refinancing, especially if your credit score has improved or your income has gone up since you took out the loans.

Remember, federal loans offer more forgiveness options than private loans. If you’re considering refinancing federal loans with a private lender, make sure you understand what benefits you might be giving up, like access to Public Service Loan Forgiveness (PSLF), income-driven repayment plans that cap monthly payments at a percentage of income, and discharge in cases of permanent disability.

FAQ

When you get a student loan, do you get the money? 

No, you typically don’t receive the money directly. For federal loans, the funds are sent directly to your school to cover tuition, fees, and room and board if you’re living on campus. If there is money left over after covering these expenses, the school will send it to you to pay for other educational expenses (like textbooks). Private loans generally work the same way, although some lenders might send the funds directly to you. 

How are student loans paid back?

Student loans are typically paid back in monthly installments after you leave school. For federal loans, you can choose from several repayment plans, including options that adjust your payments based on your income. You may be able to refinance private loans for better terms.

Prepare for college with a savings plan using Greenlight 

While understanding how student loans work is important, the best strategy is to minimize the amount you need to borrow in the first place. If you haven't already, check out ways to pay for college without loans.

Money-saving options like scholarships, grants, work-study programs, or even starting a savings plan early can help reduce the amount you need to borrow.

That’s where Greenlight comes in! Greenlight is a money app for families that can help you save for college before you even start applying. You can set savings goals, learn about investing, and even set up automatic transfers to your college savings every time you spend.

Ready to start your college savings journey? Give Greenlight a try. It’s never too early to start preparing for your future!