A student loan is a lump sum of money that a student receives from the federal government, their state government, or a private company, which they can use toward tuition or other school expenses. However, they must pay that money back after graduation, plus interest.
In addition to scholarships, grants, and work-study programs, many learners use student loans to fund their education.
Student loans can be a helpful tool if you use them responsibly. Student Loan Hero reports that 69% of students in the class of 2019 took out loans to cover college expenses.
Also, Student Loan Hero’s data shows that students in 2019 graduated with an average debt of $29,000.
It’s best to borrow as little as possible to minimize the long-term costs; before committing to a large loan, research starting salaries in your field to determine your ability to pay them back after graduation.
How Student Loans Work
Student loans are unique because they are designed specifically for funding education. But what makes them different from credit cards and other loans?
1. Relatively Low Costs
Student loans are often less expensive than other types of loans that you might currently qualify for. Several factors keep costs low:
Federal student loans, offered through the U.S. government, have borrower-friendly features. Interest rates are relatively low and are fixed for new borrowers, so you don’t have to worry about dramatic changes in your interest costs or payment shock.
Interest costs might be subsidized (or paid by the government) for some students.
Most students don’t have high-paying jobs or high credit scores. As a result, they might not get approved for any loan other than a student loan.
Federal student loans typically don’t require any minimum credit score, but some issues in your credit history can disqualify you.
Student loans can help you establish credit, so it’s critical to pay on time so that you can more easily qualify for other loans in the future.
3. Benefits at Payback Time
Some student loans offer borrower-friendly features that make repayment more manageable. Loans through government programs are best, but private lenders provide flexible terms as well.
In-school deferment: With some loans, you don’t have to make payments until you’re out of school, which allows you to focus on your studies. During that time, interest costs on subsidized loans may even be paid so that your loan balance doesn’t increase.
Unemployment: Some student loans, especially federal student loans, offer unemployment deferment. Under that scenario, you can stop making payments until you find a job.
Limited income: Federal student loans can adjust your required monthly payments when money is tight. If you sign up for income-driven repayment plans, you can avoid the need to make burdensome payments.
Potential tax benefits: Interest you pay on student loans may help reduce your taxes. However, the benefits may be limited due to your income and other factors on your return.
Loan forgiveness: It may even be possible to have your student loans forgiven altogether. Borrowers with federal student loans may qualify for forgiveness after ten years of payment and employment in certain public-service jobs. Others, on income-driven repayment plans, might qualify after 25 years—but forgiven balances may be taxable as income.
Student loans forgiven between Jan. 1, 2021, and Dec. 31, 2025, are tax-free, according to provisions in the American Rescue Plan Act of 2021.
Things to Know About Student Loans
Here are things you need to know about getting your first student loan.
1. Opt For Federal Loans Before Private Ones
There are two main loan types: federal and private. Get federal loans first by completing the FAFSA. They’re preferable because you don’t need credit history to qualify, and federal loans have income-driven repayment plans and forgiveness that private loans don’t.
You may be offered two types of federal loans: unsubsidized and subsidized. Subsidized loans — for students with financial needs — don’t build interest while you’re in school. Unsubsidized loans do.
Take a private loan only after maxing out federal aid.
2. Borrow Only What You Need — And Can Reasonably Repay
Independent undergraduate students can borrow up to $12,500 annually and $57,500 total in federal student loans, while dependent undergraduate students can borrow up to $7,500 annually and $31,000 total.
They limit private loan borrowers to the cost of attendance — tuition, fees, room, board, books, transportation, and personal expenses — minus financial aid that you don’t have to pay back.
Aim to borrow an amount that will keep your payments at around 10% of your projected after-tax monthly income.
If you expect to earn an annual salary of $50,000, your student loan payments shouldn’t be over $279 a month, which means you can borrow about $26,000 at current rates.
Your school should provide instruction on accepting and rejecting financial aid in your award letter. If you’re not sure how to do it, contact your financial aid office.
“We’re not scary people,” says Jill Rayner, director of financial aid at the University of North Georgia in Dahlonega, Georgia. “We really do want students and families to come in and talk with us so we can help strategize with them.”
3. You’ll Pay Fees And Interest On The Loan
You’re going to owe more than the amount you borrowed due to loan fees and interest.
Federal loans all require that you pay a loan fee or a percentage of the total loan amount. The current loan fee for federal direct student loans for undergraduates is 1.057%.
You’ll also pay interest that accrues daily on your loan and will be added to the total amount you owe when repayment begins. The fixed federal undergraduate loan interest rate is currently 3.73%, but it changes each year. Private lenders will use your or your cosigner’s credit history to determine your rate.
4. After You Agree To The Loan, Your School Will Handle The Rest
Your loan will be paid out to the school after you sign a master promissory note agreeing to repay.
“All the money is going to be sent through and processed through the financial aid office — whether it’s a federal loan or a private loan — and applied to the student’s account,” says Joseph Cooper, executive director of the Student Financial Services Center at Michigan Technological University in Houghton, Michigan.
Then, students are refunded leftover money to use for other expenses.
5. You Can Use Loan Money Only For Certain Things
They can use loan money for education-related expenses only.
You can’t use your loan for entertainment, takeout, or vacations, but you should use it for transportation, groceries, study abroad costs, personal supplies, or off-campus housing.
6. Find Out Who Your Servicer Is And When Payments Begin
If you take federal loans, your debt will be turned over to a student loan servicer contracted by the federal government to manage loan payments. If you have private loans, your lender may be your servicer or it may similarly transfer you to another company.
Find your servicer while you’re still in school and ask questions before your first bill arrives, says John Falleroni, senior associate director of financial aid at Duquesne University in Pittsburgh.
They’re also whom you’ll talk to if you have trouble making payments in the future. When you leave school, you have a six-month grace period before the first bill arrives.
Types of Federal Student Loans
The William D. Ford Federal Direct Loan (Direct Loan) Program is a federal student loan program run by the United States Department of Education.
The US Department of Education is your lender under this program. There are four types of Direct Loans available:
Direct Subsidized Loans are loans given to qualifying undergraduate students who show financial need to assist pay for their college or career school education.
Direct Unsubsidized Loans are loans given to eligible undergraduate, graduate, and professional students with no regard for their financial needs.
Also, Direct PLUS Loans are loans given to graduate and professional students, as well as parents of dependent undergraduate students, to help pay for educational expenditures not covered by other sources of funding. Although there is no requirement for financial need, a credit check is required. Borrowers with a poor credit score must complete additional criteria in order to be considered.
You can merge all of your qualified federal student loans into a single loan with a single servicer using Direct Consolidation Loans.
The FAFSA asks a series of questions about the student’s and parents’ income and investments, as well as other relevant matters such as whether the family will have more than one child in college at the same time.
Based on the information you supply, the FAFSA will calculate your Expected Family Contribution (EFC). That’s the amount of money the government believes you should be able to pay for college for the coming school year out of your own financial resources.
You can complete the FAFSA online at the office of the Federal Student Aid website. To save time, round up all of your account information before you sit down to start work on it.
You must not only complete the FAFSA when you first apply for aid but every year after that if you hope to continue receiving aid.
Step 2: Compare Your Financial Aid Offers
The financial aid offices at the colleges you apply to will use the information from your FAFSA to determine how much aid to make available to you.
They compute your need by subtracting your EFC from their cost of attendance (COA). The cost of attendance includes tuition, mandatory fees, room and board, and some other expenses. It can be found on most colleges’ websites.
In order to bridge the gap between your EFC and their COA, colleges will put together an aid package that may include federal Pell Grants and paid work-study, as well as loans.
Grants, unlike loans, do not need to be paid back, except in rare instances. They are intended for students with what the government considers “exceptional financial need.”
Award letters can differ from college to college, so it’s important to compare them side by side. In terms of loans, you’ll want to look at how much money each school offers and whether the loans are subsidized or unsubsidized.
Step 3: Consider Private Student Loans
Another option if you need to borrow more money than federal student loans can provide is to apply for a private loan from a bank, credit union, or other financial institution.
Private loans are available regardless of need, and you apply for them using the financial institution’s own forms rather than the FAFSA.
To obtain a private loan, you will need to have a good credit rating or get someone who does have one, such as a parent or other relative, to cosign on the loan. Having less-than-stellar credit can make it difficult to qualify for student loans.
Generally, private loans carry higher interest rates than federal loans, and their rate is variable rather than fixed, which adds some uncertainty to the question of how much you’ll eventually owe.
Private loans also lack the flexible repayment plans available to federal loans and are not eligible for loan consolidation under the Federal Direct Consolidation Loan program.
However, you can refinance your private loans after you graduate, possibly at a lower interest rate.
Each college will notify you of how much aid it is offering around the same time that you receive your official acceptance.
This is often referred to as an award letter. In addition to federal aid, colleges may make money available out of their own funds, such as merit or athletic scholarships.
Step 4: Choose Your School
How much you’ll have to borrow to attend one college versus another may not be the most important factor in choosing a college.
But it should definitely be high on the list. Graduating from college with an unmanageable amount of debt—or, worse still, taking on debt and not graduating—is not only a burden that might keep you up at night; it can limit—or even derail—your career and life choices for years to come.
Also, factor in the future careers you are considering when you choose to pay more for college. A career with a high entry-level salary will put you in a better position to repay your loans and justify taking on more debt.
Before applying for any loan, you need to know how its benefits and disadvantages affect you as a student.
Pros of Student Loans
Of course, student loans have a lot of advantages which we will list:
1. Student Loans Give You The Chance To Afford An Excellent College Education
Firstly, acquiring a college degree is necessary to earn more in any environment, but the college costs can be quite expensive.
Even when you lump in help from parents, it’s a really small percentage of Americans that can afford college costs without taking out any student loans at all.
For this reason, student loans are very vital to helping you achieve that degree of your choice.
2. Student Loans Can Help You Build Your Credit Score
Yep, very true. Student loans help college students build their credit scores significantly. So, having an excellent credit score will come in handy throughout the rest of your life as you apply for apartments, look for credit cards, and even while applying for jobs.
Hence, you must make sure you are using your student loan responsibly and always making your monthly payments.
3. Student Loans Are The Difference Between Your Going To That Ideal School And Going To Any Other School
Just imagine that you applied to that Ivy League school of your choice and they accepted. But, your parents couldn’t afford to take care of those college expenses.
Basically, if you didn’t have access to student loans, you would be forced to go to the college that your savings could afford. But because student loans exist, you have the ability to choose which school you want to go to.
The feeling of having a choice rather than just one option is really heartwarming.
Cons of Student Loans
It’s also important to note the disadvantages of obtaining student loans.
1. Student Loans Can Be Expensive
When you pick a student loan, you have to pay it back with interest. This ranges anywhere from 4.45–7% for federal student loans (in 2018) to a high of 11–15% for private student loans. Hence, this is one of the major disadvantages of taking school loans.
So, it’s important to accept federal student loans first, before turning to private student loans, because they are cheaper.
2. It Becomes A Burden When You Can’t Pay Off Student Loans
It might look like your world is coming to an end when you can’t pay off your student loans. Also, you can’t declare bankruptcy to get rid of the loans taken.
Just imagine having to service a mortgage loan while still paying off your student loan. This can really take a hit on your credit score. And a bad credit score can follow you throughout your life.
So, this is one major disadvantage of taking a student loan while in college. That’s why it’s important to pick loans you can easily pay back after graduation.
3. Student Loans Cause You To Start Life With Debt
Honestly, if you rely on student loans to pay off college costs, your adult life starts out in debt.
Truly, a college education might give you the chance to earn more money than someone with only a high school diploma.
But, depending on your debt, you might have a hard time finding a job that pays enough money to allow you to live a decent life and repay the loans as well.
Pros and Cons of a Federal student Loan
We all know that these government student loans are cheaper and easier to get than private student loans. But, is a federal student loan right for you? Let’s find out together.
Pros of Federal Student loans
Here are a few advantages of student loans provided by the government.
1. You don’t need a cosigner to get this loan
Federal loans are not credit-based. For this reason, you don’t really need a co-signer to be concerned with covering the loan payment in any case you can’t repay.
As opposed to private student loans that prefer to know that the student on the loan has experience borrowing and repaying with good credit history.
So, you don’t need a good credit score to determine what interest rate you’ll get.
2. There is less interest on subsidized loans
When you qualify for a federal direct subsidized loan, the government pays the interest on the subsidized loans, while you are in school at least half the time or in your grace period.
So, this is advantageous for students with high financial needs because acquiring alternative student loans doesn’t have this option.
3. You don’t need good credit to consolidate this student loan and also get it forgiven.
So, if you find yourself having multiple federal loans, you can easily consolidate student loans into one payment. You can easily do this without a credit check.
This consolidation would also make some of your loans eligible for Public service Loan Forgiveness and income-driven repayment plans.
In Federal loan forgiveness, loans are generally forgiven after 10 years, while working in a non-profit or for the government can also get your loans to be dissolved.
This option does not really appear in private loans.
While acquiring a federal loan might be cheap, there are financial needs that exceed the limits you can borrow and college students are forced to supplement these loans with other funding avenues like Private student loans which charge higher interest rates.
Also, those who are currently defaulting on any federal loan are automatically denied from applying for another. Well, until they get their loan to the default status.
2. Not Available to all schools
Federal Direct Loans can only be used at colleges that release Title IV student financial aids.
So, if you plan to go to a school that is not eligible for this category, you will have to find some other source of student loans to help you cover the college expenses.
That can be disadvantageous if your dream school was not eligible for that category and you planned of applying for federal loans.
3. Graduate Students are eligible for some favorable options in this loan
This is a bummer, really! As a graduate student, you are not eligible for some options available to undergraduates, such as getting a Direct Subsidized Loan.
Also, graduate students are charged a higher interest rate on their loans than undergraduates. According to Federal Student Aid, the graduate-student rate for the 2021 school year was 6.08% compared to 4.53% for undergrads.
Students who borrow and cannot repay their federal loans will also not be able to escape them when they declare bankruptcy. They may have a slim chance if they fall under “undue hardship” but, it is very difficult to qualify for that category.
Pros and Cons of a Private Student Loan
Should you choose to take a private student loan? Let’s discuss its advantages as well as its disadvantages.
Pros of Taking a Private Student Loan
There are always a few merits to applying for a student loan as we will discuss here.
1. They fill the funding gap when needed
When federal loans set limits on how much to be borrowed, students with bigger financial needs can rely on private student loans to help them cover their tuition expenses.
So, these loans fill in the gap when federal loan options have been exhausted.
2. They have Higher Borrowing Limit
Unlike federal loans, with alternative loans, students can qualify to take higher loans. You can even borrow up to 100% of your cost of attendance with little or no restriction, depending on your degree level and credit history.
3. The Statute of Limitation
Because your credit score will take a bad hit, it’s rarely advisable to default on a private student loan. But, it is comforting to know that your student loan has an expiry date. Well, that’s if the worst happens.
However, the statute of limitations when you default may vary, from 3 to 10 years. So, this can be very advantageous, if you consider taking a private student loan.
Major Cons of Taking Private Student Loans
Although the advantages of alternative student loans can be enticing, there are major drawbacks you should consider before making a decision.
1. You need a Co-signer to get one
Many financial institutions require you to provide a cosigner for you to take a student loan. So, you can’t just bring anyone to qualify to get a loan.
Your cosigner must meet the credit standards required to get the student loan.
Worse still, if you qualify without a cosigner, as a young college student with limited credit history, you still pay a higher interest rate than federal loans. You then graduate from college neck-deep in debts you can barely repay.
2. There are little or no repayment or Forgiveness options
As regards federal loans, loan defaulters can engage in income-driven repayment programs or are eligible for Public service Loan Forgiveness.
But for private student loans, defaulters are rarely lucky to find any student loan repayment assistance. Hence, this can lead to their credit being destroyed more quickly than in federal loans’ cases.
3. There are little or no subsidized student loans
Yo! Forget it. Private student loans are rarely subsidized. Also, in the case of an unsubsidized loan, you will be responsible for all the interest on your loan regardless of the loan status.
4. Loans cannot be consolidated
Unlike federal loans, private student loans cannot be consolidated into a Direct Consolidation Loan. But, they can be refinanced with a private lender to give you a new interest rate.
Loan Forgiveness & Differences between Forgiveness, Cancellation, and Discharge
The terms forgiveness, cancellation, and discharge mean nearly the same thing, but they’re used in different ways.
If you’re no longer required to make payments on your loans due to your job, this is generally called forgiveness or cancellation.
If you’re no longer required to make payments on your loans due to other circumstances, such as a total and permanent disability or the closure of the school where you received your loans, this is generally called discharge.
Types of Forgiveness, Cancellation, and Discharge
The summaries below offer a quick view of the types of forgiveness, cancellation, and discharge available for the different types of federal student loans.
If you teach full-time for five complete and consecutive academic years in a low-income elementary school, secondary school, or educational service agency, you may be eligible for forgiveness of up to $17,500 on your Direct Loan or FFEL Program loans.
Note: You may not receive a benefit for the same qualifying payments or period of service for Teacher Loan Forgiveness and Public Service Loan Forgiveness.
3. Closed School Discharge
Available for Direct Loans, FFEL Program loans, and Perkins Loans.
If your school closes while you’re enrolled or soon after you withdraw, you may be eligible for discharge of your federal student loan.
4. Perkins Loan Cancellation and Discharge
Available only for Federal Perkins Loans.
You may be eligible to have all or a portion of your Perkins Loan canceled (based on your employment or volunteer service) or discharged (under certain conditions). This includes Perkins Loan Teacher Cancellation.
5. Total and Permanent Disability Discharge
Available for Direct Loans, FFEL Program loans, and Perkins Loans.
If you’re totally and permanently disabled, you may qualify for a discharge of your federal student loans and/or Teacher Education Assistance for College and Higher Education (TEACH) Grant service obligation.
6. Discharge Due to Death
Available for Direct Loans, FFEL Program loans, and Perkins Loans.
Federal student loans will be discharged due to the death of the borrower or of the student on whose behalf a PLUS loan was taken out.
In some cases, you can have your federal student loan discharged after declaring bankruptcy. However, discharge in bankruptcy is not an automatic process.
8. Borrower Defense to Repayment
Available for Direct Loans.*
You may be eligible for discharge of your federal student loans based on borrower defense to repayment if you took out the loans to attend a school and the school did something or failed to do something related to your loan or to the educational services that the loan was intended to pay for.
The specific requirements to qualify for borrower defense to repayment discharge vary depending on when you received your loan.
9. False Certification Discharge
Available for Direct Loans and FFEL Program loans.
You might be eligible for a discharge of your federal student loan if your school falsely certified your eligibility to receive a loan.
10. Unpaid Refund Discharge
Available for Direct Loans and FFEL Program loans.
If you withdrew from school and the school didn’t make a required return of loan funds to the loan servicer, you might be eligible for a discharge of the portion of your federal student loan(s) that the school failed to return.
What are the Pros and Cons of Allowing Student Loans to be Discharged in Bankruptcy?
Because your credit score will take a bad hit, it’s rarely advisable to discharge student loans in bankruptcy. But, it is comforting to know that your student loan has an expiry date. Well, that’s if the worst happens.
In conclusion, Student loans are among the resources available to help families pay college bills. Private and federal loans have advantages and disadvantages depending on your situation.
Private loans, administered by banks and credit unions, are much like any other kind of loan meaning a credit check will be required.
Federal loans are often needs-based with lower interest rates and flexibility in repayment. Those who do the required legwork will find options that best meet their needs. Please find the best option for you.
If this article was helpful, do well to share it with others. And also, you should subscribe to our mailing list to get notified each time we publish a new article.