How Student Loans Work: Guide for First-Time Borrowers

 June 29, 2021
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how do student loans work

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Note that the government has paused all repayment on federally held student loans through the end of 2022, with no interest to be charged during that period and no loans to be held delinquent or in default.

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You borrow money for your education and agree to repay it, almost always with interest — that’s the crux of how student loans work.

While these loans may seem complicated, you can improve your understanding of them by learning about the types of loans available. Federal and private loans carry varying interest rates, fees and rules for repayment.

If you’ve ever asked “How do student loans work?”, here’s what you need to know.

How do student loans work: federal How do student loans work: private
How to get loans
Types of government loans
Interest rates, fees
How federal loan repayment works
How to apply
Types of private lenders
Interest rates, fees
How private loan repayment works

How do student loans work: federal

The Department of Education provides federal student loans that are managed by loan servicers on the government’s behalf.

Federal loans made up about 84% of the Class of 2019’s student debt, according to The Institute for College Access and Success. In general, it’s best to take out federal loans before considering private loans. Why?

How to get federal student loans

You must first submit the Free Application for Federal Student Aid (FAFSA). This form provides the government with information about your family’s finances and helps determine the financial aid you qualify for.

Once you’ve completed the FAFSA, the Department of Education will calculate how much it thinks your family can pay, known as your Expected Family Contribution (EFC).

As an undergraduate, you’ll be subject to federal loan borrowing limits. You can borrow $5,500 to $12,500 annually, depending on your school year and whether you’re financially dependent on your parents.

Federal student loans must be paid back. But, depending on your circumstances, you may be eligible for federal grants or work-study, which typically don’t need to be repaid.

Types of federal student loans

  • Direct unsubsidized loans: These are available to undergraduate, graduate and professional students with no regard for your financial need. Annual limits for direct unsubsidized loans range from $5,500 for first-year undergraduates to $20,500 for graduate and professional students.
  • Direct subsidized loans: These are for undergraduate students who show financial need. The government pays the interest on subsidized loans while you’re in school at least half time, during your six-month grace period after leaving school and when your loan payments are postponed through deferment.
  • Direct PLUS loans: These are for parents of undergraduates, as well as graduate and professional students. PLUS loans may help cover costs that aren’t covered with other forms of federal financial aid, but they come with higher interest rates and fees than direct subsidized or unsubsidized loans. They also require a credit check.

There are also direct consolidation loans, which let you combine all your federal student loans into one.

How does student loan interest work: Federal rates, fees

Interest rates for loans disbursed on or after July 1, 2021, and before July 1, 2022, are:

  • Direct unsubsidized loans: 3.73% for undergrads and 5.28% for graduate and professional students
  • Direct subsidized loans: 3.73% for undergrads
  • Direct PLUS loans: 6.28% for parents, graduates and professional students

Congress determines student loan interest rates and sets them each year according to a formula. Federal student loan interest rates are fixed for the life of the loan, meaning the interest rate you initially received won’t change throughout your loan term.

Origination fees for loans disbursed on or after Oct. 1, 2020, and before Oct. 1, 2022, are:

  • Direct unsubsidized and subsidized loans: 1.057%
  • Direct PLUS loans:4.228%

These fees are calculated as a percentage of your total loan amount. They are subtracted from your balance when you receive your loan money.

For even more detail, check out our guide to how student loan interest works.

How federal student loan repayment works

The standard repayment plan for federal student loans breaks up your balance into 10 years’ worth of payments. But only about 30% of borrowers paid off their federal or private loans within 10 years, according to a 2019 Student Loan Hero analysis.

Other federal repayment plan options include:

  • Graduated repayment plan: Starts off with lower monthly payments that increase every 2 years; payments are still made for 10 years
  • Extended repayment plan: Draws out your repayment timeline to up to 25 years, with the option of fixed or graduated monthly payments

Deferment and forbearance could allow you to take a break from loan payments for a certain period if you’re experiencing financial difficulty. But since interest will continue to accrue — unless you have subsidized loans and you’re in deferment — these programs can leave you with a heftier balance when they end.

If you’re looking for a way to lower payments or take more time to pay off your loans, one of the four income-driven repayment (IDR) plans could be your best bet. Your options are:

These plans typically reduce your monthly bill to a percentage of your income, offering forgiveness after 20 or 25 years of payments — though, you’ll likely have to pay income tax on the forgiven balance.

It’s important to note that your student loan servicer will generally provide an interest rate discount of 0.25 percentage points if you choose to use autopay each month for your loan payments.

How do student loans work: private

Banks, online lenders, credit unions, colleges and state agencies provide private student loans.

Private loans don’t have the same borrower benefits as federal loans. They also require a credit check, and applicants with good or excellent credit will get access to the lowest interest rates. Undergraduates who lack long credit histories will generally need a cosigner to take out private student loans.

While you should prioritize borrowing federal loans, private loans can be useful because they don’t have the same borrowing limits — and may offer lower interest rates, depending on your circumstances. Private loans can also fill funding gaps as a last resort to pay for college.

How to get private student loans

Private lenders may allow prospective borrowers to receive quotes that only require a soft credit inquiry. This means checking your potential annual percentage rate (APR) wouldn’t affect your credit score (your credit report will reflect it only after you’ve submitted a full loan application).

Private loans require sufficient credit or a cosigner. There are private loans available without a cosigner, but the options are limited. Plus, you may have to meet certain requirements, such as being in your junior or senior year of college or studying at the graduate level.

Types of private student lenders

There’s a variety of private student lenders, including:

  • Major banks, such as PNC
  • Online lenders, such as CommonBond and Earnest
  • Credit unions, many of which offer student loans through the LendKey marketplace

The bank with which you have a checking account may not offer student loans. As such, you should widen your search, comparing loan interest rates and features across several different lender types.

Take a look, too, at the protections lenders offer:

  • Is deferment or forbearance an option?
  • Is it possible to release your cosigner after a certain number of payments?

How does student loan interest work: Private APRs, fees

Private loan interest rates can vary. Here is a sampling of APRs available to undergraduates:

The average undergraduate borrower won’t qualify for the lowest interest rates, so they’re likely to pay a higher APR than if they borrowed federal loans.

But, as we noted above, private lenders typically offer variable and fixed APRs. Variable APRs often start out lower than fixed APRs, but they may increase in the future — and only the most creditworthy borrowers receive the lowest APRs.

Compare multiple offers from private lenders to get your best mix of interest rates and benefits possible. Try using an online comparison tool as a starting point to explore private student loans.

How private student loan repayment works

Repayment plans on private student loans typically range from five to 15 years.

These loans don’t come with the same range of repayment programs, so you won’t have the option to choose an income-driven plan. Plus, private lenders won’t cover your interest payments during certain periods, as is possible with federal direct subsidized loans.

You could, however, generally receive an autopay discount, and lenders often provide access to at least some forbearance if you need to postpone payments. Lenders may offer 12, 18 or 24 months of forbearance over the course of your loan term, for instance.

If your credit and income qualifies you, or if you’re able to use a cosigner, you could refinance your student loans later if a better interest rate is available to you through a different lender.

Before you borrow student loans

First, apply for scholarships, make use of work-study and grant aid, and check in with your employer about tuition reimbursement if you’ll work while in school. Student loans should be one of the final options to consider when planning how to pay for college.

Carefully evaluate how much you can safely borrow in student loans. That means taking the time to calculate how much your monthly payment will be after you graduate, and understanding the options your lender offers for lowering or deferring bills if necessary.

Andrew Pentis and Miranda Marquit contributed to this report.

Need a student loan?

Here are our top student loan lenders of 2022!
LenderVariable APREligibility 
2.49% – 13.85%1Undergraduate

Visit College Ave

2.55% – 11.44%2Undergraduate

Visit Earnest

3.25% – 13.59%3Undergraduate

Visit SallieMae

0.00% – 23.00%4Undergraduate

Visit Edly

3.25% – 9.69%6Undergraduate



Visit FundingU

* The Sallie Mae partner referenced is not the creditor for these loans and is compensated by Sallie Mae for the referral of Smart Option Student Loan customers.

1 Important Disclosures for College Ave.

CollegeAve Disclosures

College Ave Student Loans products are made available through Firstrust Bank, member FDIC, First Citizens Community Bank, member FDIC, or M.Y. Safra Bank, FSB, member FDIC.. All loans are subject to individual approval and adherence to underwriting guidelines. Program restrictions, other terms, and conditions apply.

  1. As certified by your school and less any other financial aid you might receive. Minimum $1,000.
  2. Rates shown are for the College Ave Undergraduate Loan product and include autopay discount. The 0.25% auto-pay interest rate reduction applies as long as a valid bank account is designated for required monthly payments. Variable rates may increase after consummation.
  3. This informational repayment example uses typical loan terms for a freshman borrower who selects the Deferred Repayment Option with a 10-year repayment term, has a $10,000 loan that is disbursed in one disbursement and a 8.35% fixed Annual Percentage Rate (“APR”): 120 monthly payments of $179.18 while in the repayment period, for a total amount of payments of $21,501.54. Loans will never have a full principal and interest monthly payment of less than $50. Your actual rates and repayment terms may vary.

Information advertised valid as of 9/15/2022. Variable interest rates may increase after consummation. Approved interest rate will depend on the creditworthiness of the applicant(s), lowest advertised rates only available to the most creditworthy applicants and require selection of full principal and interest payments with the shortest available loan term.

2 Rate range above includes optional 0.25% Auto Pay discount. Important Disclosures for Earnest.

Earnest Disclosures

Actual rate and available repayment terms will vary based on your income. Fixed rates range from 3.47% APR to 13.03% APR (excludes 0.25% Auto Pay discount). Variable rates range from 2.80% APR to 11.69% APR (excludes 0.25% Auto Pay discount). Earnest variable interest rate student loan refinance loans are based on a publicly available index, the 30-day Average Secured Overnight Financing Rate (SOFR) published by the Federal Reserve Bank of New York. The variable rate is based on the rate published on the 25th day, or the next business day, of the preceding calendar month, rounded to the nearest hundredth of a percent. The rate will not increase more than once per month. Although the rate will vary after you are approved, it will never exceed 36% (the maximum allowable for this loan). Please note, Earnest Private Student Loans are not available in Nevada. Our lowest rates are only available for our most credit qualified borrowers and contain our .25% auto pay discount from a checking or savings account. It is important to note that the 0.25% Auto Pay discount is not available while loan payments are deferred.

3 Sallie Mae Disclaimer: Click here for important information. Terms, conditions and limitations apply.

4 Important Disclosures for Edly.

Edly Disclosures

1. Loan Example:

  • Loans from $5,000 – $20,000
  • Example: $10,000 IBR Loan with a 7% gross income payment percentage for a Senior student making $65,000 annually throughout the life of the loan.
    • Payments deferred for the first 12 months during final year of education.
    • After which, $270 Monthly payment for 12 months.
    • Then $379 Monthly payment for 44 months.
    • Followed by one final payment of $137 for a total of $20,610 paid over the life of the loan.

About this example

The initial payment schedule is set upon receiving final terms and upon confirmation by your school of the loan amount. You may repay this loan at any time by paying an effective APR of 23%. The maximum amount you will pay is $22,500 (not including Late Fees and Returned Check Fees, if any). The maximum number of regularly scheduled payments you will make is 60. You will not pay more than 23% APR. No payment is required if your gross earned income is below $30,000 annually or if you lose your job and cannot find employment.

2. Edly Student IBR Loans are unsecured personal student loans issued by FinWise Bank, a Utah chartered commercial bank, member FDIC. All loans are subject to eligibility criteria and review of creditworthiness and history. Terms and conditions apply.

5 Important Disclosures for Citizens Bank.

Citizens Bank Disclosures

  • Variable Rate Disclosure: Variable interest rates are based on the 30-day average Secured Overnight Financing Rate (“SOFR”) index, as published by the Federal Reserve Bank of New York. As of September 1, 2022, the 30-day average SOFR index is 2.23%. Variable interest rates will fluctuate over the term of the loan with changes in the SOFR index, and will vary based on applicable terms, level of degree and presence of a co-signer. The maximum variable interest rate is the greater of 21.00% or the prime rate plus 9.00%.
  • Fixed Rate Disclosure: Fixed rate ranges are based on applicable terms, level of degree, and presence of a co-signer.
  • Lowest Rate Disclosure: Lowest rates are only available for the most creditworthy applicants, require a 5-year repayment term, immediate repayment, a graduate or medical degree (where applicable), and include our Loyalty and Automatic Payment discounts of 0.25 percentage points each, as outlined in the Loyalty Discount and Automatic Payment Discount disclosures. Rates are subject to additional terms and conditions, and are subject to change at any time without notice. Such changes will only apply to applications taken after the effective date of change.


    Undergraduate Rate Disclosure: Variable interest rates range from 3.25%-10.35% (3.25% – 9.69% APR). Fixed interest rates range from 4.24% – 10.59% (4.24% – 9.93% APR). 

    Graduate Rate Disclosure: Variable interest rates range from 3.75%-9.90% (3.75% – 9.68% APR). Fixed interest rates range from  5.22% – 10.14% (5.22% – 9.91% APR). 

    Business/Law Rate Disclosure: Variable interest rates range from 3.75%-9.35% (3.75% – 9.16% APR). Fixed interest rates range from 5.20% – 9.59% (5.20% – 9.39% APR).

    Medical/Dental Rate Disclosure: Variable interest rates range from 3.75%-9.02% (3.75% -8.98% APR). Fixed interest rates range from 5.18% – 9.26% (5.18% – 9.22% APR). 

    Parent Loan Rate Disclosure: Variable interest rates range from 3.25%-9.21% (3.25% – 9.21% APR). Fixed interest rates range from 3.96%-9.50% (3.96%-9.50% APR).

    Bar Study Rate Disclosure: Variable interest rates range from 6.58%-11.72% (6.58% – 11.62% APR). Fixed interest rates range from 7.39% – 12.94% (7.40% – 12.82% APR). 

    Medical Residency Rate Disclosure: Variable interest rates range from 5.67%-9.17% (5.67% – 8.76% APR). Fixed interest rates range from 6.99% – 10.49% (6.97% – 10.08% APR).

6 Important Disclosures for Funding U.

Funding U Disclosures

Offered terms are subject to change. Loans are made by Funding University which is a for-profit enterprise. Funding University is not affiliated with the school you are attending or any other learning institution. None of the information contained in Funding University’s website constitutes a recommendation, solicitation or offer by Funding University or its affiliates to buy or sell any securities or other financial instruments or other assets or provide any investment advice or service.