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The Basics on How Student Loans Work

September 30, 2019 · 6 minute read

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The Basics on How Student Loans Work

If you are thinking about going to college, it can be important to understand how student loans work. With the cost of higher education rising quickly, you may need financial assistance to pay for tuition, fees, room, and board. The likelihood of college seniors now graduating with student loan debt is pretty high, with over $1.6 trillion in student debt from 44.7 million borrowers.

And not all of them are prepared to start making student loan payments after graduation. Of current borrowers, 10.9% of them are delinquent over 90 days.

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.

The Two Main Student Loan Categories

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 than private student loans, income-driven repayment plans, and temporary relief if you’re facing unemployment or other challenges.

Federal Student Loans

Federal student loans are funded by the U.S. Government. Once funds are dispersed, your payments and loan management are usually handled through a student loan servicer. To see if you qualify for a federal loan, and other federal student aid, you need to fill out the Free Application for Federal Student Aid – commonly referred to as FAFSA®. The application needs to be filled out every year you want to apply for federal student aid.

While it seems like federal loans are just one generic type, there are actually a few different programs you can apply for. The main four to know are:

•   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 aid.

Check out our breakdown on the different Types of Federal Student Loans for further details on federal programs and the application process.

Private Student Loans

Private student loans are issued by non-government lenders, such as banks, credit unions, or other financial service companies. Your eligibility and terms will depend on your credit history and other factors.

If you think your credit might not be in the best standing, parents or even family friends can co-sign with you. Unlike federal loans, you may have to start repaying them while you’re still in school.

Related: Can You Get a Student Loan With No Credit History?

One positive about choosing some private student loans is that the funds may be able to be used to cover school-related expenses outside of just tuition.

Ask any recent graduate or parent to a college student – room and board, computers, transportation, books, and fees can all add up fast. Depending on the rates you qualify for, and the conditions of the loan, this may be a better route than putting qualifying school-related expenses a credit card.

It should be pointed out, though, that unlike their federal counterpart, private student loan lenders may not offer the same safety net protections in cases of financial hardship or unemployment. So, as always, understanding the terms of you before you sign on the dotted line is a good idea.

Recommended: Want a deeper dive on the in’s and out’s of private student loans? Read our Guide to Private Student Loans to get more familiar with private financing options.

Student Loan Application Process

If you’re applying for federal student loans, you need to submit a Free Application for Federal Student Aid (FAFSA®) every year you are attending college. Some people assume they won’t qualify for federal aid because of how much their parents make or a low GPA, but that’s not always the case.

Everyone who may need help paying for college should fill out the FAFSA—aside from federal student loans, there are state or school-related scholarships, grants, and work-study programs that you may qualify for. The FAFSA 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 private lenders typically want you to provide basic personal and financial details, and may also consider your credit history. As we mentioned above, you can usually apply for a private student loan with a co-signer, such as a parent, which may give you a better chance of getting approved with a good interest rate.

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Understanding Student Loan Interest Rates

Interest is a percentage of your principal loan that you pay the lender in exchange for borrowing money. Federal student loans currently have fixed interest rates. Private student loans typically either have fixed or variable interest rates.

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 can vary every month, quarter, or year. Rates usually start off lower than a fixed-rate loan, but can fluctuate 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 might be a better choice.

All federal student loans have fixed-interest rates (see the current interest rates for federal loans here). Private student loans, on the other hand, will have different interest rates depending on the lender and the borrower’s credit history (and other financial factors).

Repaying 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 exception for federal student loans is PLUS Loans, which require you to start making payments as soon as you receive the entire loan amount. But it is important to note that if you have an unsubsidized loan, interest starts accruing while you are in school.

Your federal loan servicer should give you a student loan 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.

Getting Help with Your Student Debt

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 on your student loans 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, you can contact your servicer to see what your options are. If you have a federal loan, you may be eligible to switch to an income-driven repayment plan that helps make 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 give you more time to repay your loans or potentially lower your interest rates. Consolidating your federal loans means taking out a Direct Consolidation Loan, which combines only your federal loans into one new loan with a new interest rate that’s a weighted average of your interest rates, rounded up to the nearest eighth of a percent.

Or you could refinance your student loans with a private lender and you may be able to choose either fixed or variable interest rates, and sometimes with no initial fees.

Some lenders, like SoFi, offer options to consolidate both federal and private student loans. Refinancing isn’t right for everyone, since it means you’ll be ineligible for federal loan benefits, including income-driven repayment and loan forgiveness programs. But it could be worth looking into whether it can save you money.

SoFi is a leader is the student loan space, offering both private student loans to help pay your way through school, or refinancing options to help you save on the loans you already have.

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SoFi Private Student Loans
Please borrow responsibly. SoFi Private Student Loans are not a substitute for federal loans, grants, and work-study programs. You should exhaust all your federal student aid options before you consider any private loans, including ours. Read our FAQs. SoFi Private Student Loans are subject to program terms and restrictions, and applicants must meet SoFi’s eligibility and underwriting requirements. See for more information. To view payment examples, click here. SoFi reserves the right to modify eligibility criteria at any time. This information is subject to change.

SoFi Student Loan Refinance
Notice: SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income-Driven Repayment plans, including Income-Contingent Repayment or PAYE. SoFi always recommends that you consult a qualified financial advisor to discuss what is best for your unique situation.

External Websites: 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.

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