When you’re entering college, understanding how student loans work may not be on your priorities list. You’re thinking about what subject to major in, what clubs to join, and where to find the best food on campus.
But learning the details of how student loans work is actually one of the most important things you can do to prepare for life during and after graduation. More and more students have to consider some form of student loans in order to graduate with their degree of choice due to the rising cost of college. According to the Education Data Initiative, the average cost of tuition increases by approximately 3.63% each year, amounting to a 36.7% increase from 2010 to 2023. Relatedly, student loan debt has risen to be the second-highest consumer debt category, and 20% of all American adults with an undergraduate degree have outstanding student debt.
Regardless of how much or little you expect to need to fund your education, student loans can be a helpful tool for students and their families. Understanding your student loan options can make a significant impact on how you navigate your college years and your long-term financial health. So, here’s your crash course in what you need to know and where to learn more.
What Is a Student Loan?
A student loan is a type of installment loan used to fund an undergraduate, graduate or professional school degree. Student loans can also be used for technical schools or community colleges. (Explore our blog for more specific details about how student loans can be used.)
Unlike college scholarships or grants, student loans must be paid after graduation or when the student drops below part-time status, whichever comes first. All student lenders charge interest, but the rates vary depending on the type of loan, credit history, and other factors. The term on a student loan depends on the lender and type of loan, but generally ranges from 5 to 20 years.
Types of Student Loans
There are two types of student loans: federal and private.
Federal loans are more common, making up more than 90% of all student loans. Federal loans are handled by the US Department of Education, while private loans are distributed by third-party lenders and banks. Federal loans typically provide more repayment, forgiveness, and forbearance options than private loans. Also, federal loans may have fewer application requirements. The student must be a U.S. citizen or permanent resident and enrolled at least part-time in an eligible school or degree program. There is no minimum income or credit score requirement.
The prerequisites for a private student loan depend on the specific lender. Most lenders have a credit score or income threshold, neither of which apply to federal student loans. Most private loans also require a cosigner legally obligated to take over the loan if the original borrower defaults. Federal student loans do not require a cosigner.
Federal Student Loans
There are several different types of federal student loans:
- Direct Subsidized Loans: Available to undergraduate students with a financial need. Interest accrues during enrollment, deferment, and the six-month grace period after graduation. However, the government pays this interest.
- Direct Unsubsidized Loans: Available for undergraduate and graduate students. There is no requirement to demonstrate financial need. Interest will accrue during all periods.
- Grad PLUS loans: Available for graduate or professional students. Interest will accrue during all periods.
- Parent PLUS Loans: Parents of undergraduate students can borrow up to the cost of attendance, minus any other financial aid. There is no credit score requirement, but parents cannot have an adverse event on their credit report. See the requirements for Parent PLUS Loans. Interest will accrue during all periods.
- Direct Consolidation Loans: After leaving school, borrowers can consolidate their loans into one loan to simplify their debt payments.
Students interested in federal student loans should submit the FAFSA as soon as possible. In fact, applying for FAFSA early can actually result in you receiving more federal aid. For example, if you submit after the semester has begun, you’ll have to pay for the cost of tuition with cash, a credit card, or a private loan. Also, the sooner you submit the FAFSA, the more grant and scholarship money you may receive from the college. Federal student loans have the following benefits:
- Student loan interest tax deduction: Students can deduct the lesser of $2,500 or the amount of interest they paid during the year, reducing their taxable income. The deduction is gradually reduced and eventually eliminated by phaseout when your modified adjusted gross income (MAGI) amount reaches the annual limit for your filing status. This deduction is available whether you itemize or take the standard deduction and is also available for borrowers with private loans.
- Income-driven repayment (IDR) plans: Borrowers can choose an IDR plan, which is based on their income and family size. Switching to an IDR plan will usually reduce their monthly payment.
- Student loan forgiveness: Borrowers with federal loans may be eligible for several types of loan forgiveness programs after making a certain number of payments.
Private Student Loans
Private student loans are offered by banks, credit unions, and other lenders. Students can apply for private loans whether or not they’re eligible for federal student loans or if they have maxed out their federal loans. Here’s what else you should know about private student loans:
- May have higher interest rates than federal loans
- Can cover the entire cost of tuition
- Will usually require a cosigner
- Borrower can choose from a fixed-rate or variable-rate loan
- Terms can range from five to 20 years
- Payments can be deferred until after you leave school, but interest will accrue
- Applying for student loans may impact your credit score
How Does the Student Loan Process Work?
Applying for a federal student loan often takes longer than applying for an auto loan, personal loan, or credit card. When completing your FAFSA, you’ll be asked questions about your family’s financial situation, including their total income and assets. The federal government uses that information to determine if you qualify for any need-based aid, like federal grants, and the types of federal student loans you qualify for. The federal government does not check your credit before giving you a student loan.
Students must submit the FAFSA by their school’s deadline, which may vary. If you submit the form by that deadline, then the student loan disbursement will occur by the time the semester begins. Applying for a private loan is more akin to applying for a personal loan or auto loan than a federal student loan. The lender will run a credit check on you and your cosigner, if you have one, and determine how much you qualify for. You can review repayment terms and choose the payment plan that fits your budget.
The loan limit you’re eligible to borrow will differ from lender to lender, and for what level of education you’re pursuing (i.e., undergraduate or graduate). A basic rule of thumb is to not borrow more than you’ll earn in your first year after graduation. This helps prevent students from taking on debt payments they can’t afford. Plus, planning ahead for your repayment can help you remain financially healthy.
Interest on Student Loans
How student loan interest works depends on the type of student loan. For subsidized federal student loans, interest accrues during enrollment, deferment, and the six-month grace period after graduation. However, the government pays this interest. Interest will accrue during all periods for borrowers with unsubsidized federal loans and private student loans. Accrued interest may be capitalized or added to the principal for federal unsubsidized loans after deferment or forbearance.
Private lenders will usually capitalize interest during any forbearance periods. Interest capitalization will result in a higher total balance and higher monthly payments.
Lastly, all federal student loans come with a fixed interest rate that is set before the start of the school year, meaning the interest rate you start with remains constant over the life of the loan. Private student loans may come with fixed or variable interest rates depending on the terms agreed to by the borrower and the lender. Variable interest rates fluctuate in response to changes to common financial indexes.
When Do You Have to Start Repaying Student Loans?
Federal student loans have a six-month grace period after graduation or dropping below part-time status. You must start making payments after the grace period expires, or request a deferment or forbearance if you can’t afford them. Private student loans may or may not have a grace period, depending on the lender. Whether you have federal student loans, private student loans or both, it’s important to plan ahead for your repayment so you’ll be ready when the time comes.
The options available for federal vs. private student loans vary depending on the type of loan, lender and your financial situation. And when it comes to the best way to repay student loans, it depends on how much you can afford, if you’re eligible for loan forgiveness and most importantly, the type of loan. In the end, how long it takes to pay off student loans depends on your other financial goals, total income and other factors.
Federal Student Loan Repayment Options
When it comes to federal vs. private student loans, federal loans offer more repayment options for borrowers. Here’s what borrowers can choose from:
- Standard repayment plan: Comes with a 10-year term for most loans and a 30-year term for Direct Consolidation Loans. Lowest total interest paid over the life of the loan. Payments remain the same the entire time.
- Extended repayment plan: Comes with a 25-year term. Payments may stay the same or increase every few years.
- Graduated repayment plan: Payments start out low and then increase every two years. The term is 10 years for most loans and 30 years for Direct Consolidation Loans.
- Revised Pay As You Earn Repayment Plan (REPAYE): Payments will be 10% of your discretionary income. Term is 20 years for undergraduate loans and 25 years for graduate loans. The remaining balance will be forgiven; borrower may owe taxes on that amount.
- Pay As You Earn Repayment Plan (PAYE): Payments will be 10% of your discretionary income. Term is 20 years. The remaining balance will be forgiven; the borrower may owe taxes on that amount.
- Income-Based Repayment Plan (IBR): Payments will be either 10% or 15% of your discretionary income. Term is 20 or 25 years depending on when you took out the loans. The remaining balance will be forgiven; the borrower may owe taxes on that amount.
- Income-Contingent Repayment Plan (ICR): Payments will either be 20% of your discretionary income or the amount you’d pay on a 12-year fixed repayment plan. The term is 25 years. The remaining balance will be forgiven; the borrower may owe taxes on that amount.
Private Student Loan Repayment Options
Private student loan companies offer different repayment options, depending on the lender and the student loan terms in the lending contract. Lenders may offer:
- Payment plans ranging from five to 20 years
- Variable-rate and fixed-rate student loans
- May offer a six-month grace period
- Some offer a forbearance period
Borrowers interested in ELFI private student loans can choose from varying repayment terms. They can also pick from one of the following repayment options:
- Immediate: Students start making payments as soon as the loan is disbursed.
- Interest-only: Students make interest-only payments while they’re in school and during the six-month grace period. Regular payments will begin after the grace period ends.
- Fixed: Students will make $25 monthly payments while they’re enrolled and during the six-month grace period. Regular payments will begin after the grace period ends.(1)
- Deferred: Payments are not due while the borrower is in school or during the six-month grace period. Regular payments will begin after the grace period ends.
ELFI customers can enjoy working with dedicated Student Loan Advisors assigned to their cases. That means if you have questions about your loan terms or repayment, you can speak with someone who understands your specific situation.
What Can You Do If You Can’t Afford Your Student Loan Payments?
Defaulting on student loans can harm your credit score, affecting your ability to qualify for other loans and credit cards. You may also be unable to receive more federal aid in the future. Fortunately, there are options available to students with overwhelming student loan payments:
- Switch to an income-driven repayment plan: These plans will use your current income to determine your new monthly payment. If you’re unemployed or only earn the minimum wage, your monthly payment will be $0. After 20 or 25 years of payments, your remaining balance will be forgiven. This option is only available to borrowers with federal student loans.
- Student loan forbearance and deferment: Students who are facing financial hardship, like medical bills or caring for a loved one, can apply for a deferment or forbearance program to temporarily postpone their payments. They’ll remain in good standing during this time. Deferment and forbearance programs last one year at a time and can be renewed for three years in total.
- Apply for an extended or graduated repayment plan: In some cases, a graduated or extended repayment plan will result in lower federal student loan payments than an IDR plan. Use the official loan simulator to find your best option.
Student Loan Refinancing to Lower Interest Rates or Monthly Payments
Student loan refinancing may mean switching your student loans to a new lender, usually for a lower interest rate, lower monthly payment or both. If you pay above the minimum every month, you’ll also pay off student loans faster and decrease the total interest paid over the life of the loan. Other student loan refinancing benefits include lowering your debt-to-income ratio so you can qualify for a bigger mortgage or freeing up more money in your budget to save for a down payment on a home, invest toward retirement or pay for a wedding.
Apply for Private Student Loans with ELFI
Now that you’ve learned a bit more about how student loans work, we’re sure you have questions! We encourage you to continue exploring ELFI’s Knowledge Hub and contacting us about how ELFI may be able to help you with your student loan needs.
