How Do Student Loans Work?

Margaret Wack
A graduation cap sitting on top of a 100 dollar bill and a 1 dollar bill, alluding to the amount of money it takes for a college education.
Reading Time: 8 minutes

Whether pursuing undergraduate or graduate education, most students finance their time in school through the use of student loans. Student loans can be used to pay for tuition, living expenses, and other related costs such as books, course materials, and school supplies.

For many people, student loans are an unavoidable expense that helps them to invest in their education and career. While you may not be able to avoid taking out loans in order to pay for college, it’s still important to make sound financial decisions when it comes to your future. You should borrow only as much as you need, and make sure that you’re fully informed about your future debt burden and options for repayment.

Student loans are a lot like other types of loans, but with some important exceptions. Like other loans, student loans accrue interest over time, starting either immediately after the loan is taken out, or in some cases, after you graduate. Student loans generally have less stringent requirements than other types of loans, and often have more generous interest rates and terms. Student loans come with a variety of different possible repayment plans, with the option to pay back loans according to your income level.

What Is a Student Loan?

Student loans are loans that can be used to help students pay for post-secondary education. This can take the form of classes at a community college, undergraduate school, or graduate school. Student loans are designed to help students cover any expenses related to their education, not just the cost of college classes.

Student loans can help you cover tuition for school, as well as other associated costs such as living expenses, books, and other necessary supplies and materials. There are a variety of different loan types available, including both federal and private student loan options.

Federal Student Loans

Federal student loans are issued by the government, and come with a variety of associated benefits. Federal student loans feature fixed interest rates, meaning that the rate of interest won’t change over time, as is sometimes the case with private loans. In addition, students with federal student loans can apply for income-based repayment plans that cap monthly minimum payments according to a student’s income after graduation. There are multiple types of federal loans.

Direct subsidized loans:

Direct subsidized loans are a type of federal student loan available to undergraduate students. Direct subsidized loans are interest-free while you’re still in school, so the loan won’t start accumulating interest on the money you’ve borrowed until after you graduate. These loans are only available to students who demonstrate financial need; the availability and amount of the loans are determined by the Free Application for Federal Student Aid, also known as FAFSA.

Direct unsubsidized loans:

Direct unsubsidized loans, also sometimes known as Stafford loans, are another variety of federal student loans available. Direct unsubsidized loans are available to both undergraduate and graduate students. These loans begin accumulating interest after they’re taken out, even if you’re still in school. Rather than being determined by financial need, the amount of the loan is based on the cost of attendance, minus any other tuition assistance you may have received.

Direct PLUS loans:

Direct PLUS loans are offered to graduate students and parents of undergraduate students to offset any costs that may not be covered by other financial aid. Direct PLUS loans require a credit check, and borrowers with poor credit may not be eligible.

Perkins loans:

Perkins loans were a type of subsidized federal student loan for students with high financial need. Unlike other types of federal student loans, Perkins loans were borrowed directly from the school, and often featured different loan servicers and repayment terms. The Perkins loan program ended in 2017.

Private Loans

Private loans originate from private lenders such as banks, credit unions, or state-affiliated organizations. While the terms and conditions for private loans vary from lender to lender, private loans often offer less favorable interest rates and repayment terms than federal loans.

Private loans are unsubsidized, so interest starts accruing on them right away. The interest rates for these loans may also change over time, resulting in additional accumulated interest and increased monthly payments for borrowers. While private loans are another viable way to finance your education, you should only turn to them when you’ve exhausted all of your other options.

How Much Student Loan Money Can I Get?

The amount of student loan money that you are eligible for depends on a variety of different factors, including your financial needs, the cost of your education and related expenses, and the type of school you choose to attend.

While you can theoretically take out as many private loans as you qualify for, there are different borrowing limits for federal student loans. Undergraduate students can borrow anywhere from $5,500 to $12,500 a year to finance their education. Graduate and professional students can borrow up to $20,500 a year. Graduate students and parents of undergraduate students can also take out PLUS loans in order to cover additional expenses. The amount of federal student loans you are eligible for is determined by your FAFSA and based on financial need.

When deciding how much student loan money to borrow, it’s important to make a long-term plan for repayment and to think carefully about your financial needs. Any money that you borrow for your education must be repaid at a later date, and student loans can pose a significant financial burden when you’re just starting out in your career.

Before you borrow, you should exhaust all other possible options for financing your education. If you do need loans to cover college costs, try to rely on federal student loans as much as possible, as these loans usually offer more favorable interest rates and repayment terms. Only turn to private loans as a last resort.

What Can Student Loans Be Used for?

Depending on the type of loan you take out, you may be able to use it for a variety of different educational expenses. Federal student loans can generally only be used for expenses directly related to education, while private loans are more flexible.


Tuition is often one of the largest expenses students face when paying for college. Tuition pays for the classes that you will take in order to earn your degree, and may be billed per semester or per-credit-hour.

Living expenses: 

Living expenses are another common cost for prospective students. Whether you decide to live on- or off-campus, buy a meal plan or cook your own food, the cost of room and board can be pricey, especially in big cities and populous college towns. Student loans can usually be used in order to help finance living expenses.

Other fees: 

Aside from tuition and living expenses, students are also saddled with a variety of other fees. These can be activity fees used to finance clubs and extracurricular activities, fees for parking, and other miscellaneous expenses.

Books and supplies: 

Students also need to buy their own books and supplies for college classes. While you can generally spend conservatively when it comes to supplies like notebooks and pencils, some textbooks can get pricey. See if you can rent textbooks, purchase a digital copy, or share with a friend if you’re looking to save money on required reading.

When added together, all of these fees and expenses can seem like an incomprehensibly large number, especially for students who haven’t had many financial responsibilities in the past. It’s important to put these numbers in perspective, and only borrow what you need. You’ll have to repay all of the money that you borrow soon after graduation, and you don’t want to be stuck with a hefty student loan bill if you can help it.

How Does Student Loan Interest Work?

Student loan interest can be the most confusing and expensive part of borrowing money to pay for school. When taking out student loans, whether as a student or parent, it’s important to make sure you understand the terms of your loan, and are aware of when and how interest accumulates.

Interest is a percentage of the total balance of the loan. Interest accumulates over time. Subsidized loans don’t begin accumulating interest until after you graduate, while unsubsidized and private loans may begin accumulating interest right away. Interest rates can vary from year to year — in 2019, the interest rates were 4.53%,

for direct subsidized and unsubsidized undergraduate student loans, 6.08% for direct unsubsidized graduate and professional student loans, and 7.08% for PLUS loans.

For loans that start accumulating interest immediately, students may face the prospect of repaying a balance that includes deferred interest, or interest that has accumulated on a loan but has not been paid yet. This may also occur if your minimum monthly payment is less than the interest that has accumulated that month. Most student loans accumulate fixed or simple interest, meaning that interest is only charged on the principal balance. However, at certain points — usually at the end of a period of forbearance, deferment, or a grace— student loans accumulate compound interest, where the unpaid interest is capitalized and added to the existing loan. This new number represents the new principal of the loan, which will then accumulate interest based on the new balance. All student loan payments go towards paying off interest and any associated fees before you begin to pay off your principal loan balance.

Interest During School

Depending on what type of loan you take out, you may begin to accumulate interest while you’re still in school. Direct subsidized federal loans don’t accumulate interest until you graduate, but other types of loans begin accumulating interest as soon as you take them out. Despite this, other kinds of federal student loans allow you to defer making payments until after graduation, allowing you to focus on your studies rather than immediately paying back debt. After you graduate, you’ll have to start paying back any deferred interest that may have accrued in addition to the principal of the loan.

Interest After Graduation

After graduation, most loans include a grace period before you have to start repayment. During this time, interest will still accrue on the loan, and will have to be paid off before you can begin to chip away at the principal balance. In some cases, any accumulated interest will be added to the principal balance at the end of the grace period. Interest continues to accumulate on the loan as you work to pay it off, but the accumulated interest will be smaller as the balance shrinks. You can use a repayment calculator in order to calculate your repayment time, as well as total interest costs.

When Do You Start Paying Back Student Loans?

When you need to start paying back student loans depends on the type of loan you take out, the terms of the loan, and any other pertinent details such as your income or enrollment status.

Grace Periods

Grace periods occur after you’ve graduated from school. Federal student loans usually include grace periods during which you don’t have to make any payments, while private student loans generally do not. Subsidized student loans do not accumulate interest during the grace period. Grace periods typically last for nine months after you graduate or enroll for part-time studies.

Income-Based Repayment Plans

Most traditional student loan repayment plans operate on a 10-year schedule, after which point you’ll have completely paid off your student loans. For some recent graduates, particularly those with high student loan balances or low incomes, these monthly payments may be unaffordable.

For these students, federal student loans also offer income-based repayment plans. Recent graduates generally have to apply for these programs and provide proof of income in order to qualify. These plans generally require that you pay 10% to 20% of your discretionary income each month toward student loan balances, and are forgiven after 20 to 25 years.

Consolidation and Refinancing

For some borrowers, applying for loan consolidation and refinancing may help you to secure lower interest rates and combine multiple loans together for ease of repayment. While consolidation and refinancing come with some benefits, they mean you are often no longer eligible for income-based repayment plans or student loan forgiveness.

How to Get a Student Loan

There are a variety of steps to complete in order to secure a student loan to finance your education. Make sure that you plan ahead and leave plenty of time for yourself, as many schools have financial aid deadlines well before the start of the term.

Budget for school: 

When applying for financial aid, it’s important to figure out exactly how much your education will cost and budget accordingly. Your budget may look very different depending on whether you are applying for undergraduate or graduate school, whether you are living at home or at school, and what school you choose to attend.

Apply for grants and scholarships: 

If you’re looking for outside sources of financial aid in addition to loans, there are a variety of grants and scholarships available. Research what grants and scholarships might be the right fit for you, and take the time to compose a personalized application for each one.

Fill out FAFSA forms: 

FAFSA, or the Free Application for Federal Student Aid, is one of the most important documents when it comes to financial aid. Make sure to fill out the required forms on time, and go over them with a parent or college advisor if you need help.

Stay informed: 

Research the different loan options available to you, and get as much information as possible about interest rates, repayment terms, and how these loans will affect your financial future.

Apply for loans:

If you’re looking for other forms of student loans besides federal student loans, apply for private loans, making sure to shop around for the best terms and most competitive interest rates.

Accept student loan disbursements: 

Colleges typically apply your student loans to tuition, fees, and room and board if you choose to live on campus. Any remaining funds are disbursed to you to use for books, supplies, and other related expenses.

While student loans can be overwhelming, investing in your education is a sound move for your professional and financial future. In order to make the best of the loan options available to you, make sure that you educate yourself to the best of your ability, and only borrow as much money as you need!

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