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How Do Student Loans Work? Here’s What You Need to Know

Posted by MoneyKey on August 16, 2019
crowd of college grads wondering "how do student loans work?"

A college diploma doesn’t come cheap, so it makes sense that some people take out student loans for help. The problem is, it all has to be paid back with interest.

That’s a huge responsibility when you’re just out of school and learning how to go at it alone. Not only do you have to cover your student loan payments, but you also may have to pay for all the other trappings of adult life — like rent, groceries, utilities, and more!

If you’re worried about how you’ll pay for school on- and off-campus, you’re not alone. More than 44 million borrowers owe a collective $1.5 trillion. That’s one in five Americans who shoulder a debt after graduation. 

This blog is usually a place where you can learn more about cash loan options. But today, you’ll find some of the ins and outs of the average student loan, so you can make better borrowing decisions. Better yet, you’ll see some tips on how to manage your student loans after you graduate to potentially help you pay them off faster.

What Are Student Loans?

A student loan is a special kind of unsecured personal loan used to cover your education. You can apply for one regardless of your schooling — whether you’re pursuing a trades degree or college diploma.

Like any personal loan, a student loan is:

  • Borrowed money
  • Due back with interest

What Kinds of Student Loans Are There?

Generally speaking, student loans fall under two major categories:

  1. Federal student loans
  2. Private student loans

What Are Federal Student Loans?

A federal student loan is money backed by the government, so the U.S. federal government is your lender.

The federal loan system was first introduced in 1958 as a way to offset the financial burden of private loans. Federal law regulates these loans, so they may have better terms and conditions than private alternatives — whether it’s a student loan or other types of personal loans. 

A federal student loan comes with the following benefits:

  • It may be easier to borrow: Federal loans don’t need as much underwriting as the average personal loan, so it improves your chances of approval even if you don’t have credit or a co-signer. In fact, credit checks are not necessary for many federal student loans. You will need to prove that you’re enrolled in and actively attending a qualifying educational institution.

  • It may be easier to repay: Typically, federal loans may come with fixed interest rates and flexible repayment plans.

How Much Federal Money Can You Borrow?

Like any personal loan, federal financial aid comes with strict borrowing limits.

Your school, academic year, and whether you’re dependent on your parents affects how much money you can borrow. To see how much you may be eligible for, visit this resource to learn more about these limits.

Sometimes, you’re eligible for less than what you need in a single school year. Ideally, your savings and income will cover the rest. But, as the cost of tuition continues to rise, this may not be realistic for your finances.

For this reason, some undergrads turn to private loans to make up the difference.

What Are Private Student Loans?

A private student loan is a type of personal loan. It may come from private institutions like banks, credit unions, or other financial organizations, including your school or state agency.

So do online loans, but don’t confuse an online cash advance for a private student loan. Online loans are designed to be temporary stopgaps for paying unexpected bills — not a way to finance your education. Before you apply for an online cash advance, you should get more info on potential lenders and when it’s appropriate to use them.

Private student loans, on the other hand, are meant to cover education costs.

Since they take the federal government out of the equation, individual lenders can set unique terms and conditions.

As a result, you may be expected to:

  • Prove you have good credit or have a co-signer
  • Make payments against your principal and/or interest payments while you’re still in school

woman writing in a notebook at a table with friends

How Does Student Loan Interest Work?

As with an online cash advance or online installment loan, you are required to pay interest on a student loan. This is additional money you owe on top of your principal (the amount you borrow).

The amount of interest owed on a student loan is typically calculated based on your outstanding principal.

The amount you owe in interest is typically calculated based on a percentage of your outstanding principal balance. This percentage is called your interest rate.

Your interest rate is an important number to know whenever you borrow money. It changes how much you ultimately owe on anything, in total — from a student loan, to an online cash advance, or an online installment loan.

Fixed vs variable interest rates

Beyond these basics, lenders may calculate interest rates differently.

Federal student loans usually apply a fixed interest rate, which means it generally won’t change.

The same might go for a personal loan, including an online cash advance or online installment loan. Typically, these online loans have fixed interest rates.

black computer screen showing fluctuating line graph in yellow and blue

Private student loans may apply a fixed interest rate on your loan, but they may also use a variable interest rate. Variable interest means the rate may fluctuate, going up and down as the market does.

If you find yourself choosing between one or the other, take the time to weigh your options carefully. While fixed rates tend to be the better option, it all depends on the market.

How much interest do I accrue?

The answer to this depends on the type of loan.

For the last 13 years, the average federal student loan interest rates have been:

  • 79% for undergraduates
  • 36% for graduate students
  • 41% for parents and graduate students taking out PLUS loans

These interest rates are relatively low — especially compared to the average online installment loan or online cash advance. A low interest rate is one of the perks of a federal loan.

Interest rates for private student loans are much harder to pin down, as they typically depend on:

  • The lender
  • The loan amount
  • Your credit score
  • Fixed vs. variable interest rates

The people at ValuePenguin analyzed five different private lenders, and their analysis showed interest rates could be as low as 3.27 percent or as high as 12.94 percent.

What is the Average Student Loan Payment?

Your payments, and how long it takes to pay off your loan completely, depend on a lot of factors — including your loan type and interest rate. Your student loan repayment option will also impact what you pay and when.

In general, there are two main types of payment plans:

  1. A standard repayment plan. This option involves 120 fixed payments split over 10 years. This is an ideal plan for this type of loan, as you’ll be paying the least interest and paying off your debt faster.

  2. An income-driven payment plan. There are four income-driven options available if you can’t meet the terms above. In these cases, your monthly payments required are lowered to fit your income. Some of these plans have strict eligibility criteria, so make sure you double check if you meet these requirements before you apply.

Depending on the type of income-driven payment plan you have, you may extend your loan term to as many as 25 years. If you still have a remaining balance at the end of this time, the balance will typically be forgiven.

Should I Use Online Loans to Pay off Student Loans?

Short answer: no. You shouldn’t use online loans to pay off student loans.

Generally, taking out a personal loan to pay off another one is a bad idea — whether you’re paying down a student loan, online cash advance, or online installment loan.

Online loans aren’t designed to pay off existing debt. They’re meant for emergencies, like when you don’t have enough savings to cover an emergency car repair or an unexpected medical bill. While an online cash advance may help you get your transmission fixed without delay, it isn’t the best option to cover your next student loan payment. 

How to Pay off Student Loans Fast

It takes the average person with a bachelor’s degree 21 years to pay off their loans. That’s a lot of time to be carrying around your student debt. If you don’t want to spend the next two decades making payments, try the following tips to chip away at your student debt. But don’t forget them as soon as you pay off your debt — some of this advice works for any personal loan you take out in the future!

curly-haired man leaning against wooden coffee counter in a café with POS system

1. Earn as much as you can during school

While using a student loan may be a necessity, you don’t have to rely entirely on borrowed money to earn your degree. If you can put more of your own money towards your expenses during your academic career, you may not have to rely on student loans as much to get by.

Learn how to prioritize your time on campus, so that you can take on a part-time or full-time job in addition to your studies.

You should also look into scholarships, bursaries, and other financial aid that you won’t have to pay back. There are plenty of options available, including MoneyKey’s own Key Thinkers Scholarship.

2. Use a student loan repayment calculator

To find out approximately how much your individual monthly payments may be, input your information into a student loan repayment calculator like this one. If you have an account with the Federal Student Aid, you’ll see an accurate breakdown of your payments.

For a more basic option, check out Bankrate’s student loan calculator. All you need is your loan amount, term length, and interest rate to get started.

3. Trim the fat

Don’t panic if your monthly payments put a squeeze on your budget. You can take some of the pressure off by trimming the fat.

blonde woman looking over her shoulder holding green wallet paying for drinks with cash

For plenty of people, the wants in their budget form the worst of their bad spending habits. Things like takeout, online shopping, or your growing book collection eat into how much cash you have left to spare.

If you manage to limit how much you spend on your wants — or attempt to cut them out entirely — you may be in a better position to afford your living expenses and monthly loan payments simultaneously.

But what if you’re already careful with how much you spend on takeout and other wants? There are still ways to save even if you don’t have a lot of extras to cut from your budget. You just have to try to switch gears from spending most of your money on your wants to focusing on spending mainly on your needs.

You can try to reduce how much you spend on the necessities like groceries, rent, and other bills by:

  • Using meal plans and coupon apps
  • Learning how to cook nutritious meals on a dime
  • Moving back home with your parents
  • Splitting rent with multiple roommates
  • Cutting out unnecessary bills like cable — you won’t have to give up on tv if you check out these cable alternatives once you cut the cord

4. Make as many extra payments as possible

If possible, cut enough unnecessary expenses until you’re able to make additional or larger payments on your student loan each month. If this isn’t possible, put any windfall towards your student loans — whether it’s a bonus at work, birthday present, or cash winnings.

This is a good rule of thumb regardless of what type of loan you’re repaying — whether it’s an online cash advance or an online installment loan. Making additional payments may reduce how much you pay in interest on any personal loan. It could also help you pay off an online cash advance or online installment loan faster.

5. Go online for help

curly-haired woman looking at an iPhone

If money is still tight, your phone may offer a different way that may help you to stay on top of your payments. There’s a growing world of apps designed to help students cover their loans, including:

  • ChangEd: Shark Tank star Mark Cuban backs ChangEd, a savings app helping graduates tackle their student loan debts. It syncs with your bank account to round up every purchase you make to the nearest dollar and invests the spare change in your student loans.
  • Givling: If you’re a fan of Jeopardy, you’ll want to check out Givling, a trivia-based app that puts your general knowledge to good use. It randomly places you on a trivia team with whom you answer true or false questions. If you win, your team splits a cash prize that may be as big as $50,000.

Bottom Line: Know Your Options

Leaving for college may be one of the most exciting times in your life, so don’t let the thought of student loans dampen your spirits. Although it can be daunting to think about what you you’ll owe once you leave campus, it’s possible to pay down your debt more quickly than you think.

The most important step towards managing your student loans is understanding how they work. Financial literacy helps you make responsible money management decisions at every stage of your academic career — from your freshman year, to your first year as a grad, and beyond!

Check in with these financial literacy tips, and remember the student loan repayment tricks we shared today. They can help you tackle your student loans with greater confidence.

Let us know your plans for college, and how you intend to keep on top of your student personal loan debt.


Disclaimer: This article provides general information only and does not constitute financial, legal or other professional advice. For full details, see MoneyKey's Terms of Use.

Posted in: Financial Tips

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