How do student loans work? Like most things in life, it depends. There are two types of student loans, and each one has its own set of rules and regulations.
So, if you’re planning on taking out a student loan, here’s a quick rundown of what to expect.
What Are Student Loans?
Let’s start with a student loans definition. Student loans are a type of financial aid that helps students pay for their education. Loans are available from the federal government or private lenders.
Student loans aren’t the same as scholarships or grants. I.e., student loans have to be paid back, while scholarships and grants do not.
Another way to explain student loans is to consider them an investment in your future. By taking out a loan, you’re investing in your education and future earnings potential.
Are student loans secured loans? Student loans, both private and federal, are unsecured, meaning they’re not backed by collateral. In other words, the lender cannot repossess your diploma even if you’re not able to make your student loan payments.
What Does a Student Loan Cover?
Student loans cover the following:
- The cost of tuition and student activity fees: on average, annual tuition at a public two-year college is $3,800. The average tuition for a private four-year university is over $38,000 per year.
- Housing expenses: on-campus housing prices typically fall between $9,100 and $13,300.
- Transportation expenses: college students spend between $1,050 and $1,800 on transportation costs.
- School-sponsored meal plans: the average cost for a college meal plan is $4,500 per academic year.
- Textbooks and school supplies: students spend between $628 and $1,471 per year on books and supplies.
Types of Student Loans
There are two different types of student loans — federal and private. What distinguishes the two is that the former is provided by the government, while the latter comes from various sources, such as schools, banks, state agencies, or credit unions.
Federal Student Loans
Federal student loans can be divided into:
- Direct subsidized loans: these are given to undergraduate students with demonstrated financial need.
- Direct unsubsidized loans: these are available to both undergraduate and graduate students but don’t take into account financial needs.
- Direct PLUS loans: available to graduate students, as well as the parents of dependent undergraduate students.
- Direct consolidation loans: if you have multiple federal loans, you can consolidate them into a single loan.
Student loans also have an interest. The federal student loan interest rate for the 2022–2023 school year is set at a fixed rate:
- 4.99% for undergraduate students with direct subsidized or unsubsidized loans
- 6.54% for graduate and professional students with direct unsubsidized loans
- 7.54% for graduate, professional students, and parents of dependent students with PLUS loans.
Private Student Loans
Private loans are also an option to cover your education expenses, but they do not come with the same protections as federal loans.
This means that students with private loans won’t be able to take advantage of income-driven repayment plans or student loan forgiveness if they encounter financial difficulties or work in specific public service industries.
Furthermore, private lenders usually require borrowers to go through a credit and income check to determine eligibility. Although every lender has different standards, you will generally get the best rates and terms with a good or excellent credit score (670 or higher).
Depending on your credit score, the average student loan interest rate will fall between 2% and 14%. At the time of writing, the average interest rate for a fixed-rate loan is usually between 3.22% and 14.96%. For variable-rate loans, that number falls between 2.52% and 12.99%.
Student Loan Application Process
The process of applying for a student loan differs depending on the type of loan: federal or private.
Applying for the Federal Student Loan
If you plan on taking out federal student loans, the first step is filling out the Free Application for Federal Student Aid (FAFSA). You’ll also need a Federal Student Aid ID (FSA ID), which you can get by creating an account on the FSA website.
The FAFSA requires applicants to list their income, investments, and other circumstances that may affect college costs — like having more than one child attending college simultaneously.
The FAFSA will estimate your Expected Family Contribution (EFC) for the upcoming school year based on the information you provide. The EFC is the sum of money that the government has calculated you can afford to spend on college based on your current financial situation.
In short, that explains how to get a student loan. Now, the next step is getting accepted.
If you are successful in this endeavor, you’ll receive an award letter from the institution that details how much student aid you qualify for. This could include grants, federal work-study funds, and/or student loans. You can accept or decline the offered loan by responding to your award letter.
Since every school’s award letter is different, it’s crucial to make a side-by-side comparison. More specifically, look at the amount of money each college offers in loans and whether those loans are subsidized or unsubsidized.
Applying for the Private Student Loan
How to get student loans from private lenders? Easy — the process is pretty straightforward. Unlike federal loans, you don’t need to file a FAFSA to qualify for a private loan.
To apply, reach out to individual lenders and fill out an application with the required information, like your credit score — which they will check. In some cases, you also may need a cosigner that the lender deems creditworthy.
How Much Money Can You Borrow?
The money you can take out in loans will depend on the two mentioned types of college loans.
Federal Loan Limits
Although your college will dictate the amount you can borrow in federal loans, there are some restrictions.
For example, the maximum amount you can borrow per year in direct subsidized and direct unsubsidized loans as an undergraduate student ranges from $5,500 to $12,500.
On the other hand, graduate or professional students can get a maximum of $20,500 per year in direct unsubsidized loans.
Private Loan Limits
The maximum amount you can borrow varies from $75,000 to $120,000 if you’re an undergraduate and from $150,000 to $300,000 if you’re a graduate or professional student.
So, how much should you take?
Try not to borrow more than you’ll make in your first-year post-graduation. Otherwise, you may have difficulty paying back your student loans, along with other expenses.
Based on the latest stats, the average student loan debt amounts to $39,351 per person.
How Does Interest on Student Loans Work?
The interest rate determines how much money you will have to pay back on your loan.
The amount of interest you accrue on your loan depends upon several things: if your loan is subsidized or not, the current interest rate, how much money you borrow, and the length of your loan.
For example, repaying a $10,000 student loan with 5% interest over 10 years would amount to $2,728 in interest. Since your loan terms will include two types of payments — those towards the principal (the amount initially borrowed) and interest — you’ll end up paying $12,728 in total.
That said, the student loan interest is also tax-deductible (you can deduct a maximum of $2,500 in interest payments made throughout the year).
If you’re interested in student loan interest deduction, the requirements are:
- You need to have paid interest on a qualified student loan in the tax year.
- You need to have a legal obligation to pay interest on a qualified student loan.
- Your filing status is not “married filing separately.”
- Your MAGI is lower than the amount specified annually.
- If you and your spouse file taxes jointly, neither of you can be listed as someone else’s dependent.
How to Calculate the Interest Rates
When it comes to understanding student loans, one of the most important things to know is how to calculate the interest rate.
If you have a student loan with a fixed interest rate and a standard repayment period, use this method to figure out the interest:
- Determine your daily interest: divide your annual interest rate by 365. For example, if you take out a loan for $10,000 with 6% annual interest, your daily interest rate would be 0.016% or $1.64.
- Estimate your monthly payment: multiply the days in your billing cycle by the daily interest rate. For example, if you’re billed on a 30-day cycle, your monthly student loan interest rate would be $49.20 ($1.64 x 30 equals $49.20).
If you have a private loan, you can ask your loan servicer to find the best repayment plan for your circumstances.
The interest rate you get on a private loan is set by your lender. However, if the lending institution views you as a riskier candidate, the loan will have a higher interest rate. On that note, students usually apply with a cosigner to get a low student loan rate.
Many students ask relatives to cosign for them, but this isn’t mandatory. Any creditworthy adult who meets the requirements can be a cosigner.
The requirements for a cosigner are as follows:
- Being a US citizen or have permanent residency status
- Having a valid SSN
- Passing a credit check
- Being at least 18, 19, or 21 years old (depending on the state) to apply.
Can you get private student loans without a cosigner? It is possible to get a private student loan without having one. Ascent is one of the most popular lenders that offer private student loans without the need for a cosigner.
However, you would have to have a high credit score (700 or higher) and provide proof of income.
Can Student Loans Affect Your Credit Score?
Student loans can affect your credit score in both a positive and negative way.
If you make your payments on time, it will improve your credit score. If you don’t make your payments on time, it will damage your credit score.
How do student loans affect a credit score in detail? If you make a late payment, your lender will report you to one or all three major credit bureaus, which will result in a drop in your credit score. The time it takes for the lender to report you to the credit bureau(s) will depend on the loan type.
For example, it can take up to 90 days for federal student loan providers to report late payments. On the other hand, private student loan providers can report late payments as soon as they’re 30 days overdue.
Now that you know how to take out loans for college, be mindful of the amount of money you borrow. In other words, only take out loans for an amount you know you’ll be able to pay off with your first year’s post-graduate salary.
Always keep in mind your future when making decisions about your education. Pick a major that will help you pay off loans after graduation, and read over your promissory note carefully before signing!
How much money can you get on student loans?
Regarding federal loans, undergraduate students can borrow between $5,500 and $12,500 per year in direct subsidized and direct unsubsidized loans.
Graduate and professional degree students can borrow up to $20,500 per year in direct unsubsidized loans.
The amount you can take out in private loans as an undergraduate ranges from $75,000 to $120,000. For graduate or professional students, that number increases to anywhere from $150,000 to $300,000.
How much is a student loan monthly payment?
Students pay an average of $393 per month in student loan payments. However, this number can be higher or lower depending on your loan type, repayment plan, and other factors.
Is getting a student loan a good idea?
Yes and no. For example, one could consider student loans “good debt” because the money spent on schooling is an investment in your future career. With a degree and a well-paying job, that debt should eventually pay for itself.
However, student loans can also be labeled as “bad debt” since having a degree does not guarantee you will get a job.
How does paying a student loan work?
If you take federal loans, you will have a six-month grace period after graduation before you are required to begin making payments.
You will likely be automatically enrolled in a standard repayment plan, which gives you up to ten years to repay your debt.
You will make fixed monthly payments for the duration of the repayment period, and you will be required to pay interest on your loans from the day they are disbursed until they are paid in full.
How do student loans work with private lenders? They have more flexible repayment schedules of 5 to 20 years. Private lenders also offer 12–24 months of forbearance for those unable to make the payments.