Written By Kevin Payne
Every fall, students begin the journey toward earning a college degree. In 2019, more than 19.9 million students attended a college or university. Student loans are one of the ways students choose to pay for college expenses.
A student loan is money that’s borrowed, either from the government or a private lender, to pay for college. The lender loans you the money, which you agree to pay back over time, with interest. Student loan funds can be used to pay for tuition, room and board, books and supplies, and other expenses.
Here’s a look at how student loans work, why they exist, how to get student loans and repay them, and what you need to know before taking out a student loan.
A brief history of student loans
Student loans haven’t always been a part of life for millions of Americans. It wasn’t until the introduction of the Servicemen’s Readjustment Act in 1944, also known as the GI Bill, that the government helped fund college education. The bill provided subsidized college funds for service members in exchange for their service.
Before that time, students who wanted to go to college got financial help directly through their college or private loans from banks.
The first government-backed student loans were offered through the National Defense Education Act in 1958. These direct student loans were only made available to students pursuing select fields and were capitalized with U.S. Treasury funds. Then came the Higher Education Act of 1965, which provided financial assistance for postsecondary education to even more students.
The Higher Education Act has been amended several times to include new legislation designed to help students:
- 1992: The creation of unsubsidized student loans
- 1992: The creation of the Free Application for Federal Student Aid (FAFSA)
- 1993: The creation of the Federal Direct Loan Program
The Federal Direct Loan Program is now the primary lending option for most student loans originated today. The move to federally backed student loans created low-cost financial solutions for college students.
How to get student loans
College students have two options for student loans — federal student loans and private student loans. Here’s what you need to know about how to apply for both types of loans.
Federal student loans
To apply for federal student loans, start by filling out the FAFSA. The government uses this form to determine a student’s level of financial need.
Students and parents are required to provide detailed financial information along with school choices. The listed colleges use the information submitted through the FAFSA to determine eligibility. Types of aid awarded through this form include grants, scholarships, work study and loans.
You’ll receive a Student Aid Report (SAR) and award letters from colleges letting you know how much financial aid you qualify for, including loans.
If a student decides to go forward with a loan offer, they’re required to sign a Master Promissory Note (MPN), which is a contract between the student borrower and the lender indicating that the student will repay the loans based on the agreed timeline. Students might also be required to complete student entrance counseling as well.
The school’s financial aid office applies any aid students receive. Any remaining balance is the student’s responsibility.
Types of federal student loans
There are three primary student loans available from the federal government:
Subsidized Federal Direct loans: Only open to undergraduates, these student loans are for students who demonstrate a financial need to pay for college expenses.
Unsubsidized Federal Direct loans: These loans are available to undergraduate, graduate and professional students but aren’t based on financial need.
Federal Direct PLUS loans: Parent PLUS loans are for parents who opt to help pay for their undergraduate child’s education expenses. Grad PLUS loans are for graduate or professional students. PLUS loans help pay for any college expenses not covered by other financial aid. They are not need-based loans but do require a credit check.
Students can combine all their eligible federal loans into one loan called a Direct Consolidation loan. Most federal loan payments are deferred during a six-month grace period following graduation or dropping below half-time enrollment.
Related: Student Loans for the 2020-2021 Academic Year
Private student loans
The federal government doesn’t fund private student loans. Instead, these loans are obtained from private lenders. Typically, private loans feature higher student loan rates compared to federal loans. Borrowers also are responsible for starting repayment on private student loans as soon as the funds are issued.
All private student loans require a credit check. Eligibility and the interest rate you receive are based on your credit history and may require the help of a cosigner if you don’t meet requirements on your own.
The best way to use private loans is as a last resort to pay for any college expenses after exhausting all federal financial aid options.
Repaying student loans
Receiving student loans also means that you’re required to pay them back at some point. Here’s a look at how to repay each loan type.
Federal student loan repayment
Repayment on many federal student loans doesn't start until after a student graduates or drops below half-time enrollment. At that point, there’s a six-month grace period before repayment starts.
The Department of Education is your lender, but you’re assigned a loan servicer when it’s time to pay back the loans. Your servicer is the company that manages your loans and collects your payments. There are currently 10 federal student loan servicers, but the Department of Education just contracted five new loan servicers going forward. If you have federal loans now, your loan service is changing soon.
The Standard 10-Year repayment plan is the default plan for most borrowers. It has a repayment period of 10 years. Borrowers are assigned to the Standard repayment plan by default but can change plans for free at any time.
Other repayment options include:
- Graduated Repayment Plan
- Extended Repayment Plan
- Pay As You Earn Repayment (PAYE) Plan
- Revised Pay As You Earn Repayment (REPAYE) Plan
- Income-Based Repayment (IBR) Plan
- Income-Contingent Repayment (ICR) Plan
- Income-Sensitive Repayment Plan
Each repayment plan has specific requirements, terms and conditions.
If you have federal student loans, you may be eligible for student loan forgiveness. Federal loans come with protections like deferment and forbearance, which are helpful if you’re struggling to make payments.
Private student loan repayment
When you borrow private student loans, your repayment terms are stated on your loan agreement. Repayment rules vary with each lender, but you may start repaying your loans immediately as soon as funds are disbursed.
Repayment terms range from five to 15 years. Some private lenders offer deferment and forbearance, but this isn’t common. Private student loans also don’t offer federal protections or student loan forgiveness.
How does student loan interest work?
When you take out a student loan, you end up paying back the loan amount, called the principal, and any interest that accrued. How much interest you’ll end up paying is based on the interest rate, loan terms and how quickly you pay off your loan.
Federal subsidized loans: The Department of Education pays interest on Direct Subsidized loans as long as you’re in school at least half-time during the six-month grace period and during deferment.
Federal unsubsidized loans: Borrowers are responsible for paying all interest on unsubsidized loans as soon as funds are disbursed. You can choose to defer interest payments until you’re out of school, but the interest will accrue and capitalize, leaving you paying interest on your interest.
Private loans: Similar to unsubsidized loans, private student loans start accruing interest when they are disbursed. Some lenders allow you to defer part or all your interest while you’re in school, but it continues to accrue and capitalize.
For more detailed information, check out our guide on how student loan interest works.
What to do before taking out student loans
Although most students end up paying for at least a part of their college expenses with loans, take time to analyze your situation beforehand. You may be eligible for grants, scholarships and work-study programs to help pay for your education.
Student loans are a useful way to fund an education, leading to your dream career so that you can meet other life goals. Make sure you understand what you’re getting into, though, especially if you choose a costly program or school.
If you plan to pursue a graduate degree and expect to take out student loans, Student Loan Planner® can help. Schedule a pre-debt consultation with one of our consultants and we’ll help you create a customized repayment plan so you’re prepared after graduation. Avoid costly mistakes and head off to college with a solid game plan.
Not sure what to do with your student loans?
Take our 11 question quiz to get a personalized recommendation for 2024 on whether you should pursue PSLF, Biden’s New IDR plan, or refinancing (including the one lender we think could give you the best rate).
