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, and more. The likelihood of college seniors now graduating with student loan debt is pretty high, with over $1.5 trillion in student debt from 42.9 million borrowers.
Taking out student loans may be one of the first major financial commitments you’ll make. And it’s a decision that has the potential to 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.
To help you get started, here’s a quick guide to student loans detailing some need-to-know basics on how student loans work.
What Is a Student Loan?
Student loans are loans that are intended to help a student pay for their education. Like most other types of loans, this money is usually borrowed with the requirement that it will be repaid in the future, with interest.
Student loans can be borrowed by the student pursuing education or in some cases, by their parents. When a student loan is borrowed by a parent to pay for their child’s education, it may be called a parent loan.
The way student loans work is similar to other loans but the application process may be a little different, especially when it comes to borrowing a federal student loan (more on that below). Federal student loans are funded by the federal government and for the most part, do not require a credit check.
When borrowing a private student loan the application process is similar to the process for other types of loans in that potential borrowers will file an application directly with the lender of their choice.
What Can Student Loans Be Used For?
Student loans can be used to pay for a student’s qualified educational expenses. These include things like tuition, room and board, books and supplies for classes, and other fees charged by the school.
They can also be used to pay for expenses related to transportation or the cost of a laptop or computer used for school.
The Two Main Student Loan Categories
The first student loan basic to understand: Student loans fall broadly into two main categories, federal and private. Federal loans, which as mentioned, are funded by the federal government, offer some advantages and borrower protections.
These include interest rates that are fixed and generally lower than private student loans, income-driven repayment plans, and temporary relief to those who are facing unemployment or other challenges.
Federal Student Loans
While federal student loans are backed by the government, the way college loans work is that 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.
There are a few different types of federal student loans. The main federal student loans are:
• Direct Subsidized Loans, available to eligible undergraduates with financial need. The interest that accrues while students are enrolled in school and during the grace period and other times of deferment are covered by the U.S. Department of Education.
• 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 how these student loans work and the distinctions between them.
Private Student Loans
Private student loans are issued by non-government lenders, such as banks, credit unions, or other financial service companies. A potential borrower’s eligibility and terms will depend on their credit history and other factors.
Parents or even family friends can co-sign with a student who may not be able to qualify for a private student loan on their own. Unlike federal loans, repayment on private student loans may start while the borrower is still enrolled in school.
Recommended: Can You Get a Student Loan With No Credit History?
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 be sure to understand the terms before taking a private student loan. Private student loans tend to be the last option for paying for college after all other methods of financial aid have been exhausted.
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.
Understanding How Student Loans Work
Understanding the difference between federal and private student loans is the first step in navigating how college loans work. Here are other essentials:
Student Loan Application Process
Applying for federal student loans, requires students to submit the Free Application for Federal Student Aid (FAFSA®) every year they 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 can be completed online.
Recommended: SoFi’s FAFSA Guide
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 or may not have a fee, depending on the lender.
Most private lenders typically want applicants to provide basic personal and financial details, and may also consider credit history. As we mentioned above, lenders may allow potential borrowers to apply for a private student loan with a co-signer, such as a parent. Adding a co-signer can potentially improve an applicant’s chance of getting approved with a competitive interest rate.
Understanding Student Loan Interest Rates
Interest is a percentage of the unpaid principal loan amount that is paid to the lender in exchange for borrowing money. Federal student loans have fixed interest rates and interest is accrued on a daily basis. Interest rates on federal direct subsidized and unsubsidized loans for undergraduates for the 2021-2022 school year is 3.73%. Interest rates on federal student loans are set annually by Congress.
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.
The way interest on private student loans works is different from federal student loans. Private student loans may have either fixed or variable interest rates. 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 quickly, a variable-rate loan may be an option to consider. 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.
Private student loans 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, borrowers aren’t required to make payments on federal student loans. The exception for federal student loans is PLUS Loans, which require borrowers to start making payments as soon as they receive the entire loan amount. But it is important to note that if on an unsubsidized loan, interest starts accruing while the borrower is enrolled in school.
Recommended: What Is a Federal Direct Subsidized Loan?
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. There are a few different repayment plans available for federal student loans. Borrowers can change their repayment plan at any time without incurring additional fees.
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. Unless the loan is a federal unsubsidized loan, it will likely accrue interest during the grace period.
Private lenders determine when repayment begins on a private student loan, so review your student loan agreement closely before signing.
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: Check out SoFi’s student loan help center for guides, advice, and resources.
The Takeaway
Student loans can make it possible for students to attend college, but just like other types of loans, student-borrowers are charged interest. Federal loans have fixed interest rates and generally have a six-month grace period following a student’s departure from school. They also come with borrower protections and benefits like income-driven repayment plans and deferment or forbearance.
Private student loans can be helpful if a student did not receive enough federal aid in the form of federal student loans, scholarships, grants, and work-study, to pay for college. Lenders determine the rate and terms usually based on factors including the borrower’s credit history. Interest rates may be either fixed or variable, depending on the lender. Private student loans do not carry the same federal borrower benefits.
Students interested in borrowing private student loans may want to shop around to find the best rates and terms for them. SoFi’s private student loans have absolutely no fees and the application process is entirely online.
Check out your interest rate in just a few minutes—with no strings attached.
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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 SoFi.com/eligibility 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.
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Source: sofi.com