How Do Student Loans Work?

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Jeff White, CEPF

By Jeff White, CEPF

July 2, 2024

If you don’t have enough money to pay for college, a student loan will enable you to borrow money and pay it back later, with interest.

College loans are like any other loan in that you’ll have to repay the principal with interest, though some offer favorable repayment terms. Interest rates, loan terms, and fees can all impact how much you need to pay over the entire life of any student loan.

Let’s dive into how student loans work. When you’re borrowing for college, it’s important to understand what you’re agreeing to repay.

Types of Student Loans

Two main types of lenders offer student loans to college students. The U.S. federal government offers federal student loans through the U.S. Department of Education, and banks, credit unions, state loan agencies, and other financial institutions offer private student loans.

Federal Loans

The U.S. government offers federal student loans. It’s a good idea to take out federal loans first because they are less expensive and usually come with more borrower protections than loans from private lenders. Federal loan eligibility is determined by filing the FAFSA.

The advantages of a federal loan over a private loan include:

  • Fixed and, sometimes, lower interest rates
  • The ability to borrow money without a cosigner
  • A 6-month grace period after graduation before repayment
  • Flexible repayment plans like income-driven repayment and extended repayment
  • There is also the possibility that some of your loans can be forgiven — that is, you don’t have to repay them — if you work in certain professions, such as teaching and public service

There are four types of federal student loans for college:

  1. Direct Subsidized Loan: Subsidized Stafford loans, also known as direct subsidized loans, are available to undergraduate students with demonstrated financial need. You won’t have to pay interest on the borrowed amount while enrolled in college at least half-time and for six months after you graduate or drop below half-time enrollment. This can be a huge cost savings.
  2. Direct Unsubsidized Loan: Unsubsidized Stafford loans are available to undergraduate and graduate students, regardless of financial need. Unlike subsidized loans, you will need to pay the interest accrued on your loan while you are in college, or the interest will be capitalized (added to the loan balance).
  3. Federal Direct PLUS Loan: Grad PLUS and Parent PLUS loans are available to graduate and dependent undergraduate students’ parents. PLUS loans aren’t subsidized, so interest will start accruing once the loan is fully disbursed. Repayment can be deferred while the student is enrolled in college and for six months after graduation.
  4. Federal Direct Consolidation Loan: Consolidation loans allow you to combine multiple federal student loans into one loan without losing the benefits of the federal loans. Consolidation can be used to streamline repayment or to switch your loan servicer. A Federal Direct Consolidation Loan will not impact the interest rates of your student loans.

Private Loans

Private student loans come from a private lender, usually a bank, a credit union, a state loan agency, or a non-bank financial institution. These loans can come with fixed interest rates or variable interest rates and often require the student borrower to have a cosigner.

Private student loan interest isn’t subsidized, so as soon as you borrow money, the loan will begin accruing interest like unsubsidized federal loans. They have higher interest rates than several types of federal loans, but borrowers with good credit or a credit-worthy cosigner may find that private loans offer lower interest rates than the Parent PLUS Loan. Private student lenders generally do not charge origination fees as federal loans do.

How Interest Works for Student Loans

Because you’re not just paying back the amount you borrow, you’re paying back interest (just like credit cards), it’s important to understand how much that will add to the total amount you pay.

How much you pay in student loan interest depends on several factors, including whether your loan is subsidized or unsubsidized, the interest rate on your loan, the amount you borrow, and the loan term.

For example, you graduate with a $10,000 loan with a 5% interest rate and plan to pay it off over 10 years. You will pay $2,728 in interest over the 10 years you repay the loan. Your monthly student loan payment will include payments to reduce the principal balance (the amount borrowed) and interest payments. The total amount repaid will be $12,728, including principal and interest. 

Interest generally continues to accrue during forbearances and other periods of non-payment. So, if you take a break from repaying your loans or skip a loan payment, the loan’s total cost will increase, not just because of late fees.

Loan payments are applied to the loan balance in a particular order. First, they are applied to late fees and collection charges. Second, they are applied to the interest accrued since the last payment. Finally, any remaining money is applied to the principal balance. So, paying more each month will make quicker progress in paying down the debt.

Congress determines the interest rates for federal subsidized and unsubsidized loans, and rates vary for different types of loans.

For the 2024-2025 academic year, student loan interest rates are:

Federal loan type
Interest rate
Direct subsidized and unsubsidized undergraduate loans
Direct unsubsidized graduate loans
Direct PLUS loans (for parents or graduate and professional students)

For private loans, lenders require a credit check and set an interest rate based on your situation, such as your income and credit history.

You can use a loan calculator to calculate exactly how much you’ll pay in interest, and this article explains how student loan interest works.

How to Pay Less Interest

You can reduce the amount you pay in interest by making extra loan payments to pay it off sooner or by refinancing your student loan to a loan with a lower interest rate. However, refinancing federal student loans into a private loan means a loss in many benefits – income-driven repayment options, possible student loan forgiveness or widespread forgiveness, generous deferment options, and a death and disability discharge.

How Much You Can Borrow Through Student Loans

You will have to repay the money you borrow with your student loans for college; you only have to borrow what you really need. The loan amount that you can borrow depends on the type of loan. For federal loans, your college will determine the amount of money that you can borrow, but there are some limits:

  • Undergraduate Federal Direct Stafford Loans: Depending on your year in school, the borrowing limits are $5,500 to $7,500 per year for dependent undergraduate students and $9,500 to $12,500 per year for independent students. Aggregate limits between $31,000 and $57,500 also apply.
  • Graduate Federal Direct Stafford Loans: The borrowing limit is up to $20,500 per year for graduate and professional students, with aggregate limits of $138,500 and up to $40,500 per year for medical school students.
  • Private Loans: The maximum amount you can borrow from a private lender varies. Most lenders don’t let you borrow more than your college’s cost of attendance minus other financial aid.

Direct loans are also subject to aggregate loan limits, meaning there’s a maximum amount that you can have in outstanding loans. The borrowing limit for Federal Direct PLUS loans is generally the remainder of the cost of college not covered by Federal Direct Stafford loans and any other financial aid.

Expenses You Can Use Student Loans For

Federal subsidized and unsubsidized student loans can be used to pay for most expenses associated with your college education, such as:

  • Tuition
  • School fees
  • Room and board
  • Meal plans or groceries
  • Utilities
  • Books and supplies
  • Computers and other needed technology
  • Transportation

How private student loans work and their exact terms can vary depending on the lender. While most are very similar to federal student loan allowances, some may put different limitations on the expenses you can pay with the loan funds.

Costs of Student Loans in 2024

The total amount you’ll need to pay over the life of your student loan includes the principal, interest, and loan fees. All federal loans are subject to loan origination fees: around 1% of the loan amount for direct subsidized and unsubsidized student loans and around 4% for direct PLUS loans.

Private student loans may also have origination fees, though these are normally built into the interest rate. They may also be subject to other charges, such as late payment fees.

Let’s look at examples of how much a student loan costs throughout the full repayment period based on different APY ranges. (The APY is the annual interest rate plus fees, considering the impact of compound interest over time.)


Original loan amount

Repayment period


Loan Fee

Total repayment cost

Direct subsidized federal loan


10 years




Direct PLUS loan


10 years




Private loan example #1


10 years




Private loan example #2


10 years




All calculations were made using our free loan calculator

How to Apply for Student Loans

The application process for federal student loans and private student loans is different. Remember, you should only apply for a private student loan once you have exhausted your federal loan options.

Applying for Federal Student Loans

You must file the Free Application for Federal Student Aid (FAFSA) to apply for a federal student loan. The information on the FAFSA will determine how much you can borrow. Your college will send you a financial aid offer, including details on how to accept your loan. You will then need to sign a Master Promissory Note (MPN).

Applying for Private Student Loans

To apply for a private loan, you don’t need to file a FAFSA. You’ll need to apply with an individual lender. The lender will check your credit score and often requires a creditworthy cosigner.

It is helpful to apply to multiple lenders to find the best interest rate and terms for you. Find private student loan options here

How Repayment Works for Student Loans

Federal Direct Stafford loans require that you begin loan repayment six months after you graduate, leave school, or drop below half-time enrollment. Although Federal Direct PLUS loans previously entered repayment within 60 days of full disbursement, since 2008, borrowers have been able to defer repayment until six months after the student graduates or drops below half-time enrollment.

Federal student loans offer a range of repayment options, and this flexibility can be highly beneficial, allowing you to choose the student loan repayment term or plan that best suits your individual needs. Along with the Standard Repayment Plan, which is fixed monthly payments over 10 years, federal repayment plans include:

  • Income-driven repayment plans: You make monthly repayments based on your income, between 5% and 20% of your discretionary income. This includes the Saving on a Valuable Education (SAVE) Plan—formerly the REPAYE Plan, Pay As You Earn (PAYE) Plan, Income-Based Repayment (IBR) Plan, and Income-Contingent Repayment (ICR) Plan.
  • Graduated repayment plans: Start with lower monthly payments that gradually increase so that you still pay the loan off in the standard 10 years.
  • Extended repayment plans: Typically designed to be paid off in 25 years, they offer fixed or graduated repayments.

Private loan repayment depends on the terms set by the lender. You may find that your lender requires you to make loan payments while still in school, though there may be options to defer (postpone) making loan payments. Interest continues to accrue during an in-school deferment and grace period.

Student loans are a great option for financing your education if you don’t have the money to pay for college. But it’s important to understand how loans work so there aren’t any surprises when it’s time to begin repayment.

The Bottom Line

When understanding how student loans work, it’s important to consider factors such as fees, interest, and the impact of compound interest over the life of your loan. Lower interest rates mean that you’ll pay less over the life of the loan, but paying off your loan sooner can also make a big difference.

Federal student loans generally offer more favorable interest rates and terms, while private student loans can be a good option for those with established credit or if federal loans aren’t available.

Frequently Asked Questions (FAQs)

What happens to student loan debt when you die?

This depends on the type of loan: Federal student loans may be forgiven if you die. Equally, federal Parent PLUS loans are usually forgiven if the student benefitting from the loan dies or if the parent who took out the loan does. For private student loans, this depends on the loan, as each lender has its own policies. It’s important to check the lender’s specific policy, though many will discharge the debt owed upon the primary borrower’s death.

How long does it take to pay off student loans on average?

Depending on the type of loan and the repayment plan, you can take five to 30 years to repay your student loans. A 10-year repayment plan is standard for federal student loans, but there are federal plans that you can repay in 20, 25, or even 30 years. For private student loans, you’ll usually have a choice of a range of repayment periods between five and 20 years, though you’ll typically enjoy lower interest rates if you opt for a shorter option.

Do student loans destroy credit?

Not necessarily. Paying off your student loans promptly will be good for your credit, just like any other loan. However, if you are late with your repayments or default on your loan, this can be disastrous for your credit score.

Can I get a student loan without my parents’ help?

Yes, it’s possible to get student loans without your parents’ help, though some borrowing options may be more difficult or impossible as an unsupported student borrower. However, federal student loans work without a parent borrower or cosigner. You could also use tuition installment plans, qualify as an independent student to increase federal student loan limits or have someone other than a parent act as a cosigner on a private loan.

Check this guide for more advice on getting student loans without your parents’ help.

A good place to start:

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