Student Loans Explained: Understanding How They Work and How to Apply

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1.04% to 11.98% 1
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3.80% to 9.36% 3
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Understanding student loans and how they work is crucial if you’re heading off to college or graduate school. After all, loans can be a useful tool for covering the costs of your degree, but they can become burdensome if you borrow too much.

This Student Loans 101 guide explains your federal and private student loan options so you can make the right borrowing decisions for you and your family.

Understanding student loans: What is a student loan?

A student loan is money that you borrow for college and pay back with interest. These college loans help pay for tuition, books, room and board, and other education-related costs.

Although all student loans serve the same purpose in helping you fund your education, they come from two distinct sources: the government (federal student loans) and private lenders (private student loans).

How do student loans work?

For both federal and private student loans, you’ll need to go through an application process to find out if you’re approved and how much money you’re allowed to borrow. You’ll also learn about your repayment terms. Once you’re approved for a student loan, the money will be disbursed to your school to cover educational costs.

The process for securing a student loan is different depending on whether it’s federal or private. Knowing the differences is key to ensure you get the best repayment terms for your situation.

Types of student loans explained

As mentioned, there are two types of student loans: federal and private. Each has its own benefits and drawbacks.

Below are the basics of these student loans explained, but you can also check out our complete guide for more information on how private and federal student loans differ.

Federal student loans

Loans issued by the government are considered federal student loans. There are three types: direct subsidized, direct unsubsidized and direct PLUS loans. Here’s a handy chart to understand the basic differences between them.

Loan typeInformationInterest rates (2019 – 2020)One-time loan fee (2019-2020)
Direct SubsidizedYou have to prove financial need and be enrolled no less than half-time to qualify for this type of loan. You can borrow up to $23,000 as a dependent undergraduate student, depending on a few factors. The Department of Education will cover your interest charges while you’re enrolled, for the first six months after you leave school and during deferment.5.05%1.062%
Direct UnsubsidizedTo qualify, you don’t need to prove financial need. But you must be enrolled at least half-time. Dependent undergraduates can borrow up to $31,000 in subsidized and unsubsidized loans combined; graduate and professional students can borrow up to $138,500. Interest accrues while you’re in school.5.05% for undergraduate students and 6.6% for graduate or professional students1.062%
Direct PLUSPLUS loans are available to parents of dependent students and to graduate and professional students. You can borrow up to the cost of attendance of your school, minus any financial aid already received. To qualify, you or your parents must pass a credit check. Payments can be postponed while you’re enrolled, but interest accrues while you’re in school.7.08%4.236%

How to apply for federal student loans

To apply for federal student loans, you must fill out the Free Application for Federal Student Aid (FAFSA). States and schools use the FAFSA to determine your eligibility for aid, from federal work-study to grants and student loans.

The application process opens Oct. 1 every year, but submission deadlines may vary based on your school and state. So, fill out the FAFSA early to ensure you qualify for the most aid.

When looking for ways to pay for school, prioritize federal student loans over private ones. Federal loans tend to have more flexible repayment terms and borrower protections. Undergraduate students can also qualify for loans without a cosigner.

Private student loans

Beyond understanding student loans from the federal government, it’s also important to learn about your options for private student loans. Private student loans are issued by financial institutions, such as banks, credit unions and online lenders.

As private student loans are offered by a variety of companies, the interest rates and repayment terms you’ll find will vary. Federal loans, on the other hand, have interest rates and repayment terms set by the government. That’s why it’s important to shop around with different lenders before taking out a private student loan.

How to apply for private student loans

To apply for a private student loan, you have to submit an application to each lender you’re considering. Private lenders consider your credit and debt-to-income ratio when determining your eligibility for a loan. However, lenders can have different application requirements.

Most undergraduate students can’t apply on their own, so they apply with a creditworthy cosigner, such as a parent. Alternatively, some private lenders offer loans for parents who want to borrow on behalf of their kids.

If approved, the lender will inform you how much you’re allowed to borrow, your interest rate and your repayment schedule. In many cases, private lenders will allow you to defer payments until after you leave school. However, you can expect interest to accrue starting on your disbursement date.

Since there are so many variables, you should only consider private student loans after you’ve secured federal financial aid, grants and scholarships.

Using student loans to help pay for college

Unless you’ve scored a full ride to college or your family has enough money to pay out of pocket for school, you’re likely going to need to take out loans to cover some educational costs. If you do, you won’t be in the minority.

In fact, about 45 million people have student loans, according to the latest student loan debt report. And Americans owe over $1.64 trillion in student loan debt. Some borrowers have even taken out more money than they can afford to repay.

By taking the first step to understand the basics and different types of student loans, you’ll be in a much better position to make the best financial decision. Loans can be a helpful way to pay for college. But be sure to review all the details of your federal and private loans. That way, you don’t get stuck with debt you can’t pay back.

Rebecca Safier contributed to this report.

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