In the United States, 48 million borrowers owe a cumulative total of $1.75 trillion in student loan debt. As we can see, while student loans can cover a significant portion of educational costs, it means that you’ll owe a significant portion as well.
If you plan to take out student loans to pay for the cost of education, you’ll want to prepare for the new responsibilities you’ll have as a borrower.
Here’s what you need to know about how student loans work.
Jump Ahead > What Are Student Loans? • Types of Student Loans • How Much Can You Borrow? • When Do I Need to Pay Back My Student Loans?
What Are Student Loans?
Student loans are a type of loan that specifically covers educational costs like tuition, school books, supplies, as well as room and board. There are two types of student loans that you can borrow: federal student loans and private student loans. Undergraduate students, graduate students, professional students, and even parents of students can take out student loans.
To qualify, however, you must enroll in an accredited institution.
Types of Student Loans
It is recommended that students give preference to federal loans over private student loans because they are generally more affordable and borrower-friendly. However, most students need to take out a blend of both to cover the entire cost of tuition.
Federal student loans and private student loans have many differences that borrowers should be mindful of.
Federal Student Loans
Federal student loans are offered by the federal government. There are three types of federal student loans: Direct Subsidized Loans, Direct Unsubsidized Loans, and Direct PLUS Loans.
| Direct Subsidized Loan | The Direct Subsidized Loan is for undergraduate students who demonstrate financial need. The federal government pays the interest on the loan while you are in school, during your grace period, and also during any deferment periods. |
| Direct Unsubsidized Loan | The Direct Unsubsidized Loan is available for undergraduate, graduate, and professional students from all financial standings. Unlike the Direct Subsidized Loan, the federal government does not pay for the interest during school, your grace period, or any deferment periods. Interest accrues throughout the entire life of the loan. |
| Direct PLUS Loan | Within the Direct PLUS Loan exists the Parent PLUS Loan and the Grad PLUS Loan. The Parent PLUS Loan is available to parents of undergraduate students, and the Grad PLUS Loan is available to graduate and professional students. Interest accrues throughout the entire life of all Direct PLUS Loans. |
To borrow a federal student loan, you must submit your Free Application for Federal Student Aid (FAFSA). The FAFSA opens every year on October 1st and closes on June 30th.
You do not need a cosigner or a minimum credit score for federal student loans, except for the Direct PLUS Loan.
Federal student loans also come with a handful of borrower protections, such as:
- Loan deferment: pausing payments on your loan without any interest accrual
- Loan forbearance: pausing payments on your loan with interest accrual
- Loan forgiveness: forgiving your loan balance so that you no longer are in debt
Private Student Loans
Unlike federal student loans, which are provided by one entity, private student loans come from an array of lenders. Thus, each lender will set their own loan terms, interest rates, borrower qualifications, and everything in between.
Private student lenders are more selective with who they lend and offer competitive loan terms to. Because college students usually do not have sufficient enough credit histories and scores to be deemed trustworthy borrowers, private student lenders usually do one of the following:
- Require a cosigner, or someone who agrees to take responsibility for the loan if the borrower fails to.
- Give out less favorable loan terms, such as higher interest rates or shorter repayment plans to raise the stakes to keep students from defaulting.
Generally, private student loans do not offer any borrower protection plans like loan forbearance, deferment, or forgiveness unless you have special circumstances like disability, military service, etc. Additionally, seeking any needed assistance is the responsibility of the borrower.
Federal Student Loans vs Private Student Loans
| Loan Type | Federal Student Loans | Private Student Loans |
| Borrower Requirements | The Direct Subsidized Loan is only for undergraduates with financial need; Direct Unsubsidized Loans, Grad PLUS Loans, and Parent PLUS Loans are for undergraduates, graduate students, professional students, and parents of all financial backgrounds. | No financial need is required; anyone can apply. |
| Cosigner Needed? | No for the Direct Subsidized Loan and Direct Unsubsidized Loans; yes for Direct PLUS Loans. | In most cases, yes. Most students do not have long enough credit histories to qualify for a competitive private student loan or a private student loan at all. |
| Interest Rates | Interest rates tend to be lower than the interest rates of private student loans and are always fixed, meaning that they do not change. | Interest rates tend to be higher for students because of their lack of a strong credit history; may vary with a cosigner. Interest rates can be fixed (meaning that they do not change) or variable (meaning that they change based on the economic market). |
| Borrower Protection Plans | The federal government offers loan deferment, loan forbearance, and loan forgiveness to qualifying federal student loans. | Depends on the lender, but selections are often limited. |
| Credit Score Requirements | Typically, federal loans do not look at credit scores except the Direct PLUS Loans. | Most private lenders will be looking for students & cosigners with strong credit histories and scores. |
| Borrowing Limits | For undergraduates: between $5,500-$12,500 maximum with the Direct Subsidized and Direct Unsubsidized Loan per academic year. For parents: Varies on the cost of attendance and financial aid award received for the Direct PLUS Loan. For graduate/professional students: Varies on the cost of attendance and financial aid award received for the Direct PLUS Loan. | High borrowing limit, up to 100% of the cost of attendance. |
| Repayment Plans | Direct Subsidized Loans and Direct Unsubsidized Loans have a six-month grace period where you do not pay to make regular loan payments after graduation, after dropping out, or enrolling less than half-time. Interest accrues during the grace period for the Direct Unsubsidized Loans and not for the Direct Subsidized Loans. The federal government offers eight different types of repayment options: the Standard Repayment Plan, Graduated Repayment Plan, Extended Repayment Plan, Pay As You Earn Repayment Plan (PAYE), Revised Pay As You Earn Repayment Plan (REPAYE), Income-Based Repayment Plan (IBR), Income-Sensitive Repayment Plan (ISR), and the Income-Contingent Repayment Plan (ICRP). | Private student loans tend to have fewer repayment options in comparison to federal student loans. |
How Much Can You Borrow in Student Loans?
Your borrowing limit depends on the type of student loan that you take out.
Federal Student Loans
For federal loans, your borrowing limit depends on your year in school, dependency status, and your Estimated Family Contribution (EFC), which is calculated through your FAFSA application. The maximum borrowing limits, however, are as follows:
| Direct Subsidized Loan | Dependent Undergraduate: $3,500 – $7,500 per year ($31,000 aggregate loan limit) Independent Undergraduate: $3,500 – $12,500 per year ($57,500 aggregate loan limit) |
| Direct Unsubsidized Loan | Dependent Undergraduate: $5,500 – $7,500 per year ($31,000 in total) Independent Undergraduate: $9,500 – $12,500 per year ($57,500 in total) Graduate/Professional Student Limit: $20,500 per year ($138,500 in total) |
| Direct PLUS Loan | Covers the difference between the cost of attendance and any received financial assistance. |
Private Student Loans
For private loans, the lender you work with determines how much you can borrow. Most private lenders cover the entire cost of attendance, though others have a cap of up to $500,000.
When You Borrow a Student Loan, Where Does the Money Actually Go?
When you borrow a student loan, the money is disbursed to your school directly. The lender handles the process of getting the money to your school, and any remaining funds are distributed to you based on your school’s policy.
When Do I Need to Pay Back My Student Loans?
When you begin paying back your student loans depends on the type of student loan you borrowed and the repayment plan that you choose.
Federal Student Loan Repayment
For all federal student loans, you will have a grace period where you do not have to make payments on your student loan. The grace period begins after leaving school or graduating and ends after six months.
It’s important to note that interest accrues during the grace period for Direct PLUS Loans and Direct Unsubsidized Loans, however, but not for Direct Subsidized Loans.
After this grace period is over, your loan payments will start. Depending on loan type, you may have a choice between one of the eight repayment options offered for federal student loans:
| Standard Repayment Plan | Payments are made at a fixed amount for up to 10 years. All federal student loan borrowers are eligible for this plan. |
| Graduated Repayment Plan | Payments are lower at first and increase every two years so that the loan is paid off within 10 years. All federal student loan borrowers are eligible for this plan. |
| Extended Repayment Plan | Payments can be fixed (set amount) or graduated (increasing amounts per every two years) and are made for up to 25 years. Only Direct Loan borrowers with more than $30,000 in debt are eligible for this plan. |
| Pay As You Earn Repayment Plan (PAYE) | Payments will be 10% of your discretionary income and will be recalculated based on annually updated family and income information. To qualify for a PAYE repayment plan, borrowers must have borrowed a loan after October 1st, 2007 and received a disbursement on or after October 1st, 2011. |
| Revised Pay As You Earn Repayment Plan (REPAYE) | Payments will be 10% of your discretionary income and will be recalculated based on annually updated family and income information. Any amount that has not been paid off 20 years after your undergraduate study or 25 years after your graduate or professional study will be forgiven. Any Direct Loan borrowers with certain loans are eligible for this plan. |
| Income-Based Repayment Plan (IBR) | Payments will be 10-15% of your discretionary income and will be recalculated based on annually updated family and income information. Any amount that has not been paid off after 20 years or 25 years will be forgiven. Borrowers must have high debt in comparison to their income. |
| Income-Sensitive Repayment Plan (ISR) | Your monthly payment will be based off of your annual income and will remain as such for up to 15 years. Borrowers must have FFEL Program loans to qualify for an ISR repayment plan. |
| Income-Contingent Repayment Plan (ICRP) | Your monthly payment will be either 20% of your discretionary income or the amount that you pay on a 12-year repayment plan adjusted to your income. Any Direct Loan borrower with specific loans are eligible for this plan. |
Private Student Loan Repayment
With private student loans, there are four common repayment plans across the industry:
| Immediate Repayment | You begin making loan payments as soon as the loan is disbursed, meaning you begin making payments while you are in school. |
| Interest-Only Repayment | You begin making interest loan payments, or paying for only the interest of the loan, as soon as the loan is disbursed. |
| Partial Repayment | You begin making partial loan payments, or paying for only a portion of the interest that is accrued for the loan, as soon as the loan is disbursed. |
| Deferred Repayment | Similar to the grace period that is offered by federal student loans, you do not start making loan payments until six months after leaving school. |
Closing Thoughts From the Nest
Student loans may not be the world’s most fascinating or enjoyable topic in the world, so we commend you for taking the time to do your research. Informing yourself as a borrower is key to managing your finances without being bogged down by student loan debt.
If you want to see which private student loans you qualify for, consider using Sparrow’s free online tool. If you submit an application with us today, you can compare all of your private loan options across 15+ lenders.