The Basics on How Student Loans Work

December 27, 2017 · 5 minute read

The Basics on How Student Loans Work

You can’t afford not to know how student loans work. With the cost of higher education rising quickly, you’ll probably need financial assistance to pay for tuition, fees, room, and board. The likelihood of college seniors are now graduating with student loan debt is nearly 70% in some states.

And not all of them are prepared to start making student loan payments after graduation. Of borrowers who started repaying their loans in 2013, or about 11%—defaulted within two years, adding to the 8.1 million total number of borrowers in default.

Taking out student loans may be one of the first major financial commitments you’ll make. And it’s a decision that may affect your financial situation for years to come. Understanding the terms you’re signing up for and which options are right for you is crucial. Make sure you read the fine print before signing on the dotted line.

To help you get started, here’s a quick guide to student loans. These are some basics of how student loans work, from start to finish.

Types of Student Loans

Student loan options fall into two main categories: federal and private. Federal loans, which are funded by the federal government, are very popular and offer many advantages that you may be eligible for throughout the life of the student loan. These include interest rates that are fixed and generally lower, income-based repayment plans, and temporary relief if you’re facing unemployment or other challenges.

Federal student loans include:

• Direct Subsidized Loans, available to eligible undergraduates with financial need.

• Direct Unsubsidized Loans, available to eligible undergraduates and graduate students regardless of financial need.

• Direct PLUS Loans, available to parents of undergraduate students and to graduate or professional students for expenses not covered by financial aide.

• Federal Perkins Loans, available to undergraduates and graduate students with exceptional financial need. (The school is the lender in this case.)

Private loans are issued by non-government lenders, such as banks and credit unions. Your eligibility and terms will depend on your credit history and other factors. Unlike federal loans, you may have to start repaying them while you’re still in school.

How to Apply for Student Loans

If you’re applying for federal student loans, you need to submit a Free Application for Federal Student Aid (FAFSA). Some people assume they won’t qualify for aid because of how much their parents make or a low GPA, but that’s a mistake. Everyone who needs help paying for college should fill out the FAFSA. The form is generally available on October 1 for the following school year, and you can apply online.

If you’re opting for private student loans, find a reputable lender and make sure your school and program are eligible for their offerings. The application process may be free, depending on the lender. Most lenders will want you to provide basic personal and financial details, and the lender may also consider your credit history. You can usually apply with a co-signer, such as a parent, which may give you a better chance of getting approved with a good interest rate.

Understanding Student Loan Interest Rates

Interest is a percentage of your principal loan that you pay the lender in exchange for borrowing money.

Fixed-rate student loans have an interest rate that stays the same over the life of the loan. Although the rate might start off higher than on variable-rate loans, it won’t change as general interest rates fluctuate.

Variable-rate loans, also called floating-rate loans, have an interest rate that may can vary every month, quarter, or year. It usually starts off lower than a fixed-rate loan, but can change dramatically over the life of the loan.

If you expect to pay off your student loans right away, a variable-rate loan may be a good option. But if you’re not sure how much you’ll be making after you graduate, you don’t think you’ll be able to pay your student loans off ASAP, or are risk-averse, a fixed-rate loan is a good choice.

All federal student loans have fixed-interest rates (see the interest rates for loans disbursed between 7/1/17 – 7/1/18 here ). Private student loans, on the other hand, will have different interest rates depending on the borrower’s credit history and lender options.

When to Repay Your Loan

As long as you’re still in school at least part-time, you don’t have to start repaying most federal student loans until after you graduate. The only exception for federal student loans is PLUS loans, which require you to start making payments as soon as you receive the entire loan amount.

Your loan servicer will give you a repayment schedule that will tell you when your first payment is due and how much you owe. Private lenders can decide when they want you to start repaying your loans, so make sure you review your student loan agreement closely before signing.

Most federal student loans have a six-month grace period, which gives you a break after you leave school before you have to start paying your loans back. (PLUS loans don’t offer this perk.) Some private lenders also offer grace periods, but it’s not a guarantee. Whether your student loans are federal or private, in most cases, you’ll still accrue interest during the grace period.

Many lenders offer interest rate reductions if you have your student loan payments automatically deducted from your checking account. Be sure to look into that—who doesn’t like a discount?

Recommended: Now that you know the basics are you ready to learn more? Check out SoFi’s student loan help center for guides, advice, and resources.

What to Do If You’re Having Trouble Repaying Your Student Loans

Even the best-laid plans can run into obstacles in the real world. If you’re struggling to pay your student loans, the worst thing you can do is ignore the problem and stop making payments altogether. Defaulting may destroy your credit, and unlike other forms of debt, you can’t get rid of student loans by declaring bankruptcy.

If you can’t afford your payment, contact your servicer to see what your options are. If you have a federal loan, you may be eligible to switch to an income-based repayment plan that makes your payments more affordable.

If you’re dealing with a temporary challenge, such as unemployment, you might be able to get your payments temporarily reduced or put on hold through a deferment .

Another option is consolidating or refinancing your student loans. These tools could can give you more time to repay your loans or potentially lower your interest rates. You can refinance your loans with either fixed or variable interest rates, and sometimes with no initial fees.

Some private financial service providers offer options to consolidate both federal and private student loans. Refinancing isn’t right for everyone, since it may mean you’ll be ineligible for some federal loan benefits, including income-based repayment and loan forgiveness programs. But it’s worth looking into whether it can save you money.

Struggling with how to manage your student loan debt? Find out whether refinancing your student loans with SoFi is right for you.


The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Notice: SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income Based Repayment or Income Contingent Repayment or PAYE. SoFi always recommends that you consult a qualified financial advisor to discuss what is best for your unique situation.
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