Student Loans 101: How Do Student Loans Work?

Student Loans 101: How Do Student Loans Work?

If you’re thinking about taking out a student loan to help pay for college, you might be navigating the loan process for the first time and encountering a lot of questions, number one on your list being: How do student loans work?

Student loans are a very common and oftentimes necessary way to cover the costs of college. The Institute for College Access and Success has reported that nearly 70 percent of college students nationwide borrow money to help pay for school-related expenses. Student loans make it possible for many people to attend college, which can open doors and opportunities for years to come.

Whether you’re a student or the parent of a student, you’ll want to understand exactly how student loans work, so you can find the student loan that’s right for you.

What is a Student Loan?

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A student loan is money that you borrow to help pay for school with the expectation that you will pay that money back in the future.

Student loans don’t differ all that much from other types of loans. However, the process of obtaining and repaying a student loan does have some unique attributes.

How Do Student Loans Work?

Your student loan might be the first loan you’ve ever pursued or received, so keep in mind that it’s not just how much you borrow it’s how much that amount costs in the long term.

Student Loan Interest Rates

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One of the most important components of any loan that directly affects its long-term cost is the loan’s interest rate. An interest rate is, essentially, the cost of taking out your loan. It is calculated as a percentage of the amount you borrow and added on to your loan.

A fixed interest rate will not change for the life of a loan, while a variable interest rate can change.

Interest rates for federal student loans, which are issued by the government, are currently set once per year and are fixed. Private student loans, which are issued by banks, credit unions, private lenders, and other types of financial institutions, tend to have interest rates that are higher than federal direct student loans, and those rates can be fixed or variable.

Interest rates will differ depending upon the lender, so this should be a key question as you shop around for private student loans.

Student Loan Origination Fees

You’ll also want to be aware of loan origination fees, which are one-time fees charged when you initially take out your loan. The percentage will vary based on the type of student loan and lender. For federal student loans, the origination fee ranges from 1.057% to 4.228% of the amount you’re borrowing. Many private student loans don’t have origination fees, but that’s not a hard and fast rule.

When charged, an origination fee is usually added to the loan amount, so you typically pay the fee as part of the loan.

Student Loan Repayment Term

Your student loan repayment term is the amount of time you will take to repay the loan. It can vary greatly depending on what type of student loan you take out. Typical repayment terms range from 5 years to 15 years. Be sure you understand what your loan term is before taking out a student loan.

The 2 Types of Student Loans

Students have two main options when it comes to student loans: federal student loans, which are issued by the government, and private student loans, which are issued by nongovernment entities, like banks and other financial institutions.

1. Federal Loan Options

  • Direct Subsidized Loans are available to undergraduate students whose families can demonstrate financial need. These are the only federal student loans in which interest does not accrue while the student is enrolled in school at least half-time (or during the grace period following graduation typically six months).