How Student Loans Work

University graduate unhappy at cost of education
••• Mark Airs / Getty Images

Education is important. Unfortunately, it’s also expensive. Most people can’t afford to pay the costs of higher education out of their savings or current income (many students don’t have an income), so they turn to student loans. Before you borrow, it’s important to understand how student loans work, and how to use them without creating problems down the road.

For many, student loans are a form of “good debt”--an investment in a future that otherwise wouldn’t be possible. And it often pays off: workers with a college degree tend to earn about $20,000 more than those with a high school education each year.

Use in Moderation

Before getting into the details, think of the big picture and consider a bit of advice that you simply can’t hear too often: Try to minimize your borrowing. Right now, it’s hard to imagine what life is like with student loan payments, and those loans are the key to a brighter future. But student loan debt is also a serious burden that can stay with you for life. To minimize that burden:

  • Apply for grants and scholarships to reduce the amount you borrow. Even small grants help.
  • Work part-time to pay some of your education costs. You might get valuable life experience that many of your peers won’t get until after graduation, and you can start steering your life in the direction you want.
  • Look into less expensive schools and in-state education. After graduation, how much will it matter where you went to school?
  • Cut costs where you can. Used books, inexpensive entertainment, and homemade food can go a long way here.

    Every time you get funds in the form of a student loan, remember that you’ll have to repay all of that money (plus interest) at some point in the future.

    How Student Loans Work

    Student loans are unique because they are designed for funding your higher education. What makes them different?

    Lower costs: Student loans often charge lower costs than other types of loans that you might be able to get. They are considered low-risk loans, and government policies keep costs low on certain loans. Interest rates are often fixed, so you don’t have to worry about severe changes in your interest costs, and interest might even be subsidized (or paid by the government).

    Easier approval: Most students don’t have high paying jobs or high credit scores. That means it’s harder to borrow unless you use a student loan. As your first loans, these loans will help you establish credit (another reason it’s important to borrow wisely as you want to start out on the right foot). Some student loans are available without any credit check, while others require at least decent credit.

    Benefits at payback time: Repayment is the worst part of any loan, but student loans can offer some borrower-friendly features that make it easier. Loans through government programs are the best, but some private lenders are willing to help as well. With some loans, you don’t have to start making payments until you’re out of school, and in some cases, your interest costs will be paid while you’re enrolled so your loan balance doesn’t increase.

    If you experience a stretch of unemployment, you might be able to stop making payments until you find a job, known as an unemployment deferment. The interest you pay on your loans might be tax deductible (check with your tax preparer). Finally, you might even get your loans forgiven or canceled after 10 years of repayment, depending on your career.

    Federal vs. Private Student Loans

    You can borrow from any lender you want. However, loans offered through government programs are typically your best bet, and you should use those loans first. Government loans are more likely to be generous with the benefits listed above.

    After you’ve borrowed everything you can using government loans, you can turn to private lenders if you still need more. These lenders are typically banks, credit unions, and online lenders. They might market the loans as “student loans,” or they might offer standard loans that you can use for anything you want.

    To get approved by a private lender, you’ll need good credit and sufficient income to repay the loan. Many students don’t have either, so a parent (or somebody else with good income and credit) often applies for the loan or cosigns the loan with the student, which makes both people 100% responsible for repaying the loan.

    Be sure to read your loan agreements carefully, and find out if you’ve got a variable rate loan.

    How to Get Student Loans

    To start borrowing, visit your financial aid office to start getting information. Find out what types of aid might be available, including grants and scholarships. Your next step is to fill out the FAFSA form, which gathers information about your finances (the government and your school use that information to determine your “need” for financial aid). Complete your FAFSA as soon as possible every calendar year. Do the best you can when filling it out; you can go back and correct any estimates later in the year.

    Apply for aid with your school’s financial aid office, and wait for the results. If approved, you can decide to take all or part of the aid available, and you’ll probably need to complete a basic entrance counseling session to get educated on how your loans work.

    If you’re getting private loans, you’ll need to find a lender and fill out a loan application with that lender. 

    Types of Student Loans

    As you go through the application process, you’ll want to get familiar with the most common types of loans available through the US government.

    • Perkins loans should be your first choice. They feature a low, fixed interest rate and are available to borrowers regardless of credit. However, they are need-based loans, meaning they’re not available to everybody, and they are in limited supply.
    • Stafford loans are also easy to qualify for, and they provide more money than Perkins loans. In addition, interest costs might be subsidized, and they are available for graduate students as well as undergrads. 
    • PLUS loans are similar to standard loans. They require a credit review, and repayment starts soon after disbursement. PLUS loans for undergrads go to parents, which allow them to cover large expenses for their children. In recent years, these loans have gotten bad press as parents can spend a lifetime paying off PLUS loans. Learn more about PLUS loans.
    • Consolidation loans are loans that combine multiple student loans into a single loan. The result is simpler repayment (one payment instead of many), and there may be other benefits. Consolidation works differently for federal and private loans. Learn the differences before you decide to consolidate or mix federal loans with private loans.