How Do Student Loans Work

October 31, 2019 by  
Filed under Debt, Student Loan

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Paying for higher education can be challenging. In fact, most of the colleges (about 70%) in the US are unaffordable for most Americans unless they get student loans. It is a common method of financing a college education, and you might ask yourself “how do student loans work?” Most learners will have to borrow one or more student loans prior to graduation, partly because there are no government grants that can cover all college costs.

When students are considering student loan options, the question “how do student loans work?” is common. We have researched student loans and have come up with the answers you might need. This article highlights all that you need to know about student loans as it reveals what student loans are, the different types of student loans, and how they work.

An Introduction To Student Loans

For you to answer the question, “how do student loans work?” you must first understand what student loans are. Student loans are so common these days as higher education is a necessity. Essentially, if you get a degree, you have a better chance of getting a job. The right degree is an avenue to follow your passion and make yourself marketable in the job force. But, if you don’t have the capital to finance your college education, you might be interested in applying for student loans.

A loan is typically borrowed money that is repaid over time. In addition to repaying the total amount you borrow, most of the borrowers will have to pay for a fee known as the interest.

Interest, which is the fee associated with a loan, is charged for the use of someone else’s money. It is charged on a monthly basis based on the loan balance that you have not repaid. This means that it isn’t a onetime fee and is typically expressed as a percentage of the loan balance. In most instances, the student loans will come with a fixed interest rate, which doesn’t change over the loan’s life. However, a variable interest rate will change periodically such as on a monthly or quarterly basis.

Who Provides Student Loans?

To adequately answer the question, “how do student loans work?” you should know who provides the student loans. You can get a student loan from many sources. However, most of them come from the federal government through the US Department of Education’s Federal Direct Loan program. Other student loans may come from private lenders, such as banks, among other financial institutions, colleges, and state governments. In most cases, students borrow from the federal government primarily because federal student loans are cheaper, more available, and have better repayment terms.

Amount You Can Borrow

The student loans come with a loan limit that specifies the maximum amount a student can borrow. Some loans may allow students to borrow the full college cost, but other loans have lower fixed annual and accumulative loan limits. Student loans are generally considered good debts simply because you are investing in your future. However, you should not borrow excessively since too much can be strenuous to pay in the future. We recommend that you borrow as little as you need, not as much as you can.

For subsidized and unsubsidized loans, undergraduate students can borrow between $5,500 and $12,500 per year. Graduate students can borrow up to $20,500 each year on the direct unsubsidized loans. Direct PLUS loans are borrowed for the remainder of the college costs not covered by other financial aids.

Different Types Of Student Loans

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To adequately answer the question of how do student loans work, you need to know the different types of student loans. There are two types of student loans: federal and private.

Federal Loans

These are the most common as they are offered by the federal government. They include direct subsidized, direct unsubsidized loans, Direct PLUS loans, and direct consolidation loans. Direct subsidized and unsubsidized loans are also referred to as Stafford loans.

For a direct subsidized loan, the government pays the interest as you study and during the deferment periods. As such, these types of loans subsidize your education by offsetting the college cost. Subsidized loans are mainly available only to undergraduates who demonstrate that they need financial aid. The amount of the subsidized loan is typically capped to only cover the student’s financial need as determined by the Free Application for Federal Student Aid (FAFSA).

For an unsubsidized loan, students are responsible for any interest that accrues when in school or after graduating. These loans are available to both undergraduate and graduate students. The loan amount is determined by the cost of attendance at your college or university and any other financial aid you might be receiving. You qualify for this loan even if you have no demonstration of financial need.

Direct PLUS loans are available to graduate, professional students, and parents of dependent undergraduates. They are given by the US Department of Education. For you to get this loan, you should have a decent credit history and a credit check. The loan amount is typically intended to cover any expense not covered by other financial aids.

Direct consolidation loans apply if you have multiple federal loans, which are combined into a single loan from a single servicer. The loans are available to students who want to combine multiple federal loans into one.

The following are the facts of federal loans:

  • Interest is tax-deductible
  • Interest is tax-deductible
  • Interest rates are typically fixed
  • Unless you are taking the PLUS loan, you will not need a credit check

Private Loans

Federal loans are the best, but you can also opt for private loans. However, private loans offer much less flexibility. Private loans usually come from lenders not affiliated to the government, for example, a school, credit union, a bank, or a state organization. The amount and the repayments options are decided by the lender.

Some of the facts about private loans include:

  • The loans may require a cosigner and a credit check
  • There is a possibility that you will begin repaying the loan while still in school
  • The interest rate is not tax deductible
  • Interest rates fluctuate with the financial market, meaning that they will be variable
  • Some interest rates are very high and can reach up to 18%
  • Most lenders will only quote you an interest rate after applying, so you will have to compare the best lenders

How Do Student Loans Work?

HOW TO APPLY

You must first apply for a student loan for you to be awarded the loan amount. To apply for federal loans, you should file the FAFSA. The loans will be available through the college’s financial aid office. To apply for the private student loans, you need to contact the lender.

The eligibility for most private student loans is based on the credit of the borrower. Since most students do not have good enough credit histories, they will need a creditworthy cosigner. The cosigner acts as a co-borrower and is equally responsible for repaying the loan amount. Once the loan is approved, the borrower has to sign a promissory note that describes the terms and conditions of the loan, including the repayment options and interest rates. For federal loans, there is a Master Promissory Note (MPN) that lasts for up to 10 years of continuous enrolment at a single university or college.

How You Receive the Loan Amount

Federal student loans are sent to the college financial aid office. For private loans, the funds are sent either to the borrower or to the college financial aid office. If the funds are received by the college financial aid office, they are applied to tuition and college fees, as well as housing. Money left is refunded to the student to pay for supplies, books, and other college needs.

How to Repay

For you to address the question, “how do student loans work?” you must know how to repay the student loan. After graduating or when you drop below half-time enrolment, you should start repaying the loan. For federal loans, you will be offered a 6-month grace period after which you should start repaying. Federal loans involve a standard 10-year repayment term with equal monthly installments. You can get 30 years for a direct consolidation loan. Other repayment options include graduate repayment, extended repayment, income-based repayment, income-contingent repayment, and income-sensitive repayment plans.

For private loans, ensure that you know the repayment options before applying. Some lenders have more flexible repayment options than others. Some may even allow forbearance and deferment or renegotiating a high variable interest rate. We recommend that you go for a lender with the best terms.

Conclusion

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Student loans are a viable method of funding your college education. However, you should not default the repayment (120 days from the due date for private loans and 360 days for federal loans). To minimize the potential damage, only borrow as much as you need, ensure that you have chosen the right repayment plan, pay on time (every month), pay extra often, take advantage of saving opportunities such as interest rate deductions, tax deductions, and refinancing at a lower rate. As such, instead of asking, “how do student loans work?” you should be asking. “how can student loans work best for me?” We hope this article has adequately addressed the various types of student loans and how student loans work.

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