Student Loans- How does it work?

This article describes the basic concepts of the student loans, how federal or private student loans works, how you can qualify for these loans. Various repayment options and forgiveness programs related to student loan are listed in this article to give you a clear understanding.

Updated by Rakshitha N on 25th February 2020

Going to college is like an open door of opportunities, this leads you to your career goals. But these opportunities come with a cost and many students cannot afford for their education. Hence comes the picture of student loans.  You must always be aware about concepts of loan, how to apply and how it works. You should know the various options available to you to make smart decisions while choosing the loan. It is important to know how a student loan works. This article answers all your questions about student loans and guides you about how a student loan works.

Table of content

What is a student loan? 

Student loan is the amount of money the students borrow for their education assistance that can be paid later with a certain percent of interest rates. Student loans can be worth when you find yourself marketable for a job after graduating. You should select your student loan upon your financial needs, know the pros and cons and then settle on borrowing the loan.

But the students should first try to be eligible for a scholarship, grant as you don't have to repay them.

How to apply for a student loan? 

Student loans are categorised into two,federal and private loans. The students can borrow loans either from the government or a private lender. You can apply to these loans based on various factors.

How to apply for Federal Student Loan? 

A federal student loan is a government loan offered to students to cover their education.There are different procedures, term to borrow the loans, some ways are listed below:

Fill the FAFSA: 

Free Application for Federal Student Aid - FAFSA is a form to be filled every year to check whether you are eligible for a federal student loan. This gives you access to state grants, scholarship, student loans. You can fill this form online and it would take you 30 minutes.

FAFSA requires you to fill details about the family's income as Estimated Family Contribution(EFC) and Cost of attendance(COA) to estimate the financial aid. Information regarding income tax returns, record of income and investments, etc.

Note that the deadline to fill the FAFSA is:

  • FAFSA application starts from october 1st for the 2020-2021  FAFSA

  • June 30th,2021 is the deadline or 2021 FAFSA

This helps you to borrow an estimate for $5,000-$12,500 every year.

Other financial aid options: (h3)

The financial aids for a student loan are broken down into need based and non-need based.

  • Need-based financial assistance includes the Federal Pell Grant, Federal Supplemental Educational Opportunity Grant (FSEOG), Federal Work-Study Program, Institutional Grants,State Grants. 

To know more about the eligibility criterias and repayment process for various need based financial aids, read Need based financial aid for students. 

  • The non-need based financial aid includes the direct unsubsidized loans, federal PLUS loans, and Teacher Education Access for College and Higher Education (TEACH) Grant. This is the financial aid given with respect to the cost of attendance.

Interest rates on federal student loans

Interest rate is a percent of principal amount to be paid to the lender by the borrower. It may be fixed or variable. The interest is added to the principal amount is paid during the monthly installments. The rates of interest vary according to the type of loan, 

The interest rate for the loans borrowed during July 1st,2019 - July 1st,2020 are:

Type of loan Interest rates
Direct subsidized loan 4.53%(undergraduates)
Direct unsubsidized loan 4.53% (graduate)
Direct PLUS loan 7.08%(parents, graduates and professional)

How to apply for a Private Student Loan?

The student loan borrowed by the private lender is called the Private student loans. Note that the private students loans have a higher rate of interest and the students have to make their monthly installment while they're still in school.

You can apply for private student loans at a credit union, national banks, local bank or even apply online for a loan.

Some information about Private Student loan:

  • Your loan recovery starts while you're still in school.

  • Your credit history and a cosigner is required for loan approval.

  • Most companies quote the rate of interest after you apply for the loan.

  • The interest rates are variable and change according to the changing market. 

Interest rate on private student loans

After exhausting the federal student aid, students opt for private student loans. The private student loan is borrowed by students from a bank or a credit union at a higher rate of interest compared to the federal loans. The interest may be fixed or variable. Your loan could be approved at a lower rate of interest based on your credit score. 

A private student loan can be available for an interest rate of 7.99% which is usually variable.

  • For example, you borrowed a loan of $20,000 with the repayment period of 10 years and the rate of interest is 5%(fixed). The total interest you would be paying for the loan you borrowed is $12,940 and at the end you would pay about $32,940.

What is a Student Promissory Note?

A promissory note is an agreement or a contract to be signed while borrowing the loan to agree to the loan loan terms between both the parties. 

All the details such as the borrower and the lender’s identity , amount borrower, the interest rates, when the payment are to be made and their terms are noted in the agreement.

Federal Loan Promissory notes

The Federal loans such as the direct subsidized and unsubsidized loans have the Master Promissory Note (MPNs). The document is signed to confirm the repayment form the borrowers side.

The single agreement deals with all the details of a number of loans which you take consecutively however, some schools require separate MPNs for each year. The direct PLUS loan requires a separate MPN to be signed to cover all the loan details.

Private Loan Promissory Note

The promissory note is unique for each private lender you borrow a loan. The contract details about the loan being borrowed on a variable rate of interest, the identities of both parties, lenders policy on the repayment plans and other terms. Some private lenders may charge you a prepayment fees before you borrow your loan. The tip here for the borrower is to read the contract before signing and to settle on a fixed rate of interest. 

Worried about student loans? Find the Best Student Loans for you! 

Student Loan Repayment Option 

For better understanding of how the student loan works, the repayment plays an important role.

The Federal loans have flexible repayment plans. Once you graduate, you get six months of grace period till you start paying your loan, however making payments sooner lets you pay lesser as an overall amount. Also, the large payment you make during the monthly installment  lets you pay your loan sooner than paying the interest.

If you borrowed federal student loan, you could be eligible to qualify for the following repayment options,

Standard Repayment plan

According to the Standard Repayment Plan, the federal loan you borrowed is paid back with fixed monthly installment on a schedule of your lender. The standard period for the repayment plan is 10 years for federal loan and it varies for a private loan. This plan helps you save money but cost you as the repayment period is increased.

Graduated Income Repayment plan

The Graduated Income Repayment Plan is for students who have graduated and not in the financial position to repay the amount through monthly payments, so the plan assists them to start paying less amount in the initial stage and increases the payment every two years for 10 years consecutively.

The overall amount paid by the borrower in the graduated repayment plan is greater than a person who repays his loan in standard repayment plan, however the period is 10 years for both. 

Extended Income Repayment plan

Extended Income Repayment Plan is a repayment plan for repaying the loan in a standard or graduated plan over 25 years. This plan is implemented if the student loan borrowed is more than $30,000. This benefits in making lesser monthly payments at a time and also for a longer period.

But we suggest you settle on a loan with a lower period of repayment as a longer period could cost you to pay more interest.

Income-Based Repayment plan

In Income-Based Repayment Plan, the monthly payments are based on your monthly income  and not on how much monthly payment you make. A maximum of 10% of your monthly income you earn is spent on repaying your loan. 

Income Contingent Repayment plan

In Income Contingent Repayment Plan, the period of repayment of this plan is 25years. Your monthly payments are calculated in two ways, first 20% of your monthly income is divided by 12 and the second part is what you pay as a monthly payment for those 12 years, later after 25 years of payment the loan is forgiven.

Pay As You Earn (PAYE)

The Pay As You earn-(PAYE), this repayment plan is you recover the loan borrowed as a part of the income you earn . 10% of the monthly income you earn is repaid to your loan.The loan could be forgiven upon 20 years of monthly fixed payment for undergraduate loan and and 25 years for a graduate loan. 

Revised Pay As You Earn(REPAYE)

Revised Pay As You Earn-(REPAYE) is another repayment plan designed if you are ineligible for PAYE. This plan requires you to pay 10% of your income as the monthly payment. This land is beneficial for a borrower with a large income and large student loan balance.Loan forgiveness is given to undergrad loan after 20 years and graduate loan after 25 years.

Student Loan Forgiveness Options

Some of the student loan forgiveness programs by the government,

Public Service Loan Forgiveness:

It is a government program that forgives 100% student loan to qualifies to work at for a public service job, i.e full-time or part-time service such as a military service, health service or a school-based service. Read to know more about public loan forgiveness programs.

Teacher Loan Forgiveness:

Students who are eligible for the role of the teacher’s job can receive a forgiveness of their loan of upto  $5,000 to $17,500 on their loan. Most of them can qualify for forgiveness after 10 years under the student loan forgiveness program. Read about the teacher loan forgiveness programs see how it works and if  you are eligible for the program..

Nurse Corps Loan Repayment Program:

Nurses can register for a work-study program at the health institution for a repayment program to pay their debts as they work.  Many hospitals pay for eligible nursing students, who are committed to serve at the health program. Read about the Hospitals that pay for nursing schools to know more about the various scholarships and loan forgiveness programs according to states.

Military Student Loan Forgiveness:

Students who graduate with a student loan from U.S. Military College  to serve the nation are eligible for a loan forgiveness program.The program doesn't cover the loan interest but the loan borrowed is forgiven. Know more about the Military Loan Forgiveness program , various repayment programs and its eligibility criteria.

Worried about finding your student loan balances?

If you find it difficult to track your federal and private student loan balances, you can sign in to National Student Loan Data System-NSLDS or the My federal Student Aid account (student loans gov) to track information about your federal student loan.

Once you exhaust your federal student loan, you opt for a private student loan. You can track it by contacting your private service, getting a credit report. 

Read about How to find your student loan balance which guides you about how track of your loan status.


Student loans are given to students for financial assistance, but students must aim at being eligible for the other available options such as a federal grant, scholarship which need not be paid back. You must make a smart decision while choosing the type of loan, interest rate and type of interest rate to have a hassle free repayment process. 

You must be aware about the concepts of how the student loan works to clear off the loan balances soon.