How Student Loans Work

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 after graduation. The average cost of college rose by 25% from 2008 to 2018 – and there’s little chance that tuition costs will decrease anytime soon. In other words, if you want a degree, you’ll likely have to take out a student loan in order to fund it.

Unfortunately, skipping college isn’t an option for most. Experts predict that by 2027, 70% of jobs will require more than a high school degree. 

So what can you do? Read on to understand how student loans work so you can prepare ahead of time.

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 linked here for 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. The term on a student loan depends on the lender and type of loan, but generally ranges from five to 20 years.

How Does The Student Loan Process Work?  

Applying for a federal student loan takes more time than applying for an auto loan, personal loan, or credit card. The federal student loan application is known as the Free Application for Federal Student Aid (FAFSA). 

The FAFSA asks 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. There are two main categories of federal student loan: subsidized and unsubsidized student loans.

Subsidized loans are only available for students with a demonstrated financial need, while unsubsidized loans are available for all students. 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.

Types of Student Loans   

There are two types of student loans: federal and private. Federal loans are more common and make 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 provide more repayment, forgiveness and forbearance options than private loans.  

Federal loans also 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, who is 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 for those with financial need. Interest does not accrue during enrollment, deferment and the six-month grace period after graduation.
• Direct Unsubsidized Loans: Available for students who do not have financial need. Interest will accrue during all periods.
• Graduate PLUS loans: Available for graduate or professional students. Interest will accrue during all periods.
• Parent PLUS Student 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. 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 the FAFSA 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 up to $2,500 in interest every year, which will reduce their taxable income. 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 are 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 who are not eligible for federal student loans or who have maxed out their federal loans can apply for private 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 Much Can You Borrow?

Student loans have the following limits:

• $31,000 for undergraduate student loans for dependent students with federal loans
• $57,500 for undergraduate independent students with federal loans
• $138,500 for graduate school student loans for graduate and professional students
• Limits for private student loans vary depending on the lender

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.

Student Loan Interest for Federal & Private Student Loans 

How student loan interest works depends on the type of student loan. Interest will not accrue during enrollment, the six-month grace period and deferment periods for borrowers with subsidized federal student loans. 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 such as LIBOR or SOFR.

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.

Student Loan Repayment 

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. 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; 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; 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. Term is 25 years. The remaining balance will be forgiven; 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 

ELFI customers can enjoy working with dedicated Personal 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 means 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.  

Can You Avoid Taking Out Student Loan Debt? 

Before taking on federal or private student loans, students should find ways to maximize grants and scholarships to minimize their loan totals.

Here are some basic strategies that can reduce how much you have to borrow:

1. Apply for scholarships
2. Fill out the FAFSA early to receive more grants, scholarships and work-study
3. Appeal your financial aid if you feel entitled to more need-based aid
4. Apply for jobs to avoid student loan debt 
5. Save on tuition by attending a public in-state college

Apply for Private Student Loans with ELFI

Borrowers interested in ELFI private student loans can choose from five, seven, 10 and 15-year 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.
• 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.