How student loans move from application to money in your account
A student loan begins when you complete the Free Application for Federal Student Aid (FAFSA) or a private lender's application. The FAFSA tells federal loan programs how much aid you may receive based on your family's income, assets, and other factors. Once you submit it, your school's financial aid office receives the results and builds a financial aid package — which may include federal loans, grants, work-study, and scholarships. You then accept or decline each loan offer. If you accept, the lender disburses the money directly to your school, which applies it to tuition, fees, and room and board. Any leftover amount is sent to you, usually by check or direct deposit.
Private student loans work differently. You borrow directly from a bank or online lender, not through a federal program. The lender approves you based on your credit score and income (or a cosigner's), sets the interest rate, and sends the money to your school or to you, depending on the lender's rules. Private loans have no income-based repayment options and no forgiveness programs, so the terms are set when you sign.
Key Takeaways
- Federal student loans require the FAFSA, which your school uses to determine how much you can borrow and what grants you may receive.
- Your school receives the loan money first and pays your bill; you get any remainder as a refund.
- Federal loans offer income-based repayment plans and forgiveness programs; private loans do not.
- Interest rates on federal loans are set by Congress and are the same for all borrowers; private rates depend on your credit and the lender.
- You do not begin repaying federal loans until after you leave school or drop below half-time enrollment, but interest may accrue during that time.
The difference between federal and private loans
Federal student loans are funded by the U.S. Department of Education. They include Direct Subsidized Loans (the government pays interest while you are in school), Direct Unsubsidized Loans (interest accrues from day one), and Direct PLUS Loans (for parents or graduate students). Federal loans have fixed interest rates set by Congress, which change each year for new loans but stay the same for loans you already have. You repay them on a standard 10-year schedule unless you choose a different plan.
Private student loans come from banks, credit unions, and online lenders. They typically require a credit check and often a cosigner if you have no credit history. Interest rates are variable or fixed depending on the lender and your agreement. Private loans begin accruing interest immediately and do not pause when you are in school. They also do not offer income-based repayment or forgiveness, so your monthly payment is locked in from the start.
Most students borrow federal loans first because they offer more flexibility and protection. Private loans fill the gap when federal loans do not cover the full cost of school.
Interest rates and how they affect what you owe
Federal loan interest rates are set by Congress and announced each year. For the 2024–2025 school year, the rate on Direct Subsidized and Unsubsidized Loans is 6.53 percent; the rate on Direct PLUS Loans is 7.53 percent. These rates apply only to loans you take out that year. Loans you borrowed in previous years keep their original rates. Interest accrues (builds up) daily on unsubsidized loans and PLUS loans, even while you are in school. On subsidized loans, the government covers the interest while you are enrolled at least half-time.
Private loan rates vary widely. A borrower with excellent credit might get 4 percent; another with fair credit might pay 10 percent or more. Some lenders offer variable rates that change with market conditions, which means your payment could go up or down over time. Fixed-rate private loans keep the same rate for the life of the loan.
The interest you pay is added to your principal (the amount you borrowed). The longer you take to repay, the more interest you pay overall. A $30,000 federal loan at 6.53 percent costs roughly $10,000 in interest over 10 years; the same loan over 20 years costs roughly $18,000 in interest.
When you start repaying and what your options are
Federal loans enter repayment six months after you graduate, leave school, or drop below half-time enrollment. This period is called the grace period. During the grace period, interest continues to accrue on unsubsidized and PLUS loans, but you do not have to make payments. If you do not pay the accrued interest, it gets added to your principal when repayment begins — a process called capitalization.
Once repayment starts, you choose a repayment plan. The Standard Repayment Plan is 10 years with a fixed monthly payment. Income-Driven Repayment Plans calculate your payment based on your current income and family size; your payment may be as low as $0 per month if your income is very low. Income-driven plans last 20 to 25 years. After that time, any remaining balance may be forgiven, though you may owe taxes on the forgiven amount. Public Service Loan Forgiveness (PSLF) forgives remaining balances after 10 years of payments if you work for a government agency or nonprofit.
Private loans have no grace period and no income-based options. You begin repaying as soon as the lender disburses the money, though some lenders allow you to defer payments while in school. Once repayment starts, your payment stays the same unless your rate is variable.
How much you can borrow each year
Federal loan limits depend on your year in school and whether you are a dependent or independent student. For the 2024–2025 school year, a dependent freshman can borrow up to $5,500 in Direct Loans (of which no more than $3,500 can be subsidized). A dependent senior can borrow up to $7,000. Independent students and graduate students have higher limits. Parents can borrow up to the full cost of attendance through Direct PLUS Loans, with no annual cap.
Private lenders set their own limits based on your credit and income. Some cap loans at the cost of attendance; others allow you to borrow more. Most require you to be a U.S. citizen or permanent resident and to be enrolled at least half-time at an accredited school.
Your school's financial aid office can tell you exactly how much you can borrow in federal loans. If you need more, private loans are the next step, though they come with higher interest rates and fewer protections.
What happens if you cannot pay
Federal loans offer several options if you fall behind or cannot afford your payment. Deferment and forbearance pause your payments temporarily — usually for up to three years. During deferment on subsidized loans, the government covers the interest; during forbearance, interest accrues and gets added to your balance. You can also switch to an income-driven repayment plan, which may lower your payment to $0 if your income is low enough.
If you do not pay for 270 days, your loan goes into default. The entire remaining balance becomes due immediately, your credit score drops, and the government can garnish your wages or tax refunds. However, you can rehabilitate a defaulted loan by making nine on-time payments over 10 months, which removes the default from your credit report and stops the garnishment.
Private loans have no deferment or forbearance options and no income-based relief. If you miss payments, the lender can sue you, garnish your wages, or sell the debt to a collection agency. Your only option is to contact the lender and negotiate a new payment plan or settlement.
Cosigners and how they affect your loan
A cosigner is someone who signs the loan with you and agrees to repay it if you do not. Cosigners are common on private loans because they help borrowers with no credit history or low income get approved and receive a better interest rate. Federal loans do not require cosigners for undergraduate students, though parents can take out PLUS Loans in their own name.
If you have a cosigner, they are legally responsible for the debt. If you miss a payment, the lender can pursue the cosigner for the full amount. The loan also appears on the cosigner's credit report, which can affect their ability to borrow money themselves. Some private lenders allow you to release a cosigner after you have made a certain number of on-time payments and meet income or credit requirements, but this is not may provide.
Frequently Asked Questions
Do I have to take out the full amount my school offers?
No. Your financial aid package shows the maximum you can borrow, but you can accept less. Borrowing only what you need keeps your total debt lower and reduces the interest you pay. You can also decline loans entirely and use grants, scholarships, or work-study instead.
What is the difference between subsidized and unsubsidized federal loans?
On subsidized loans, the government pays the interest while you are in school at least half-time. On unsubsidized loans, interest accrues from the day you borrow, even while you are in school. Unsubsidized loans cost more over time because the interest compounds. Subsidized loans are harder to get because they are based on financial need.
Can I pay off my student loans early without a penalty?
Federal loans have no prepayment penalty, so you can pay extra or pay off the entire balance whenever you want. Private loans vary — some allow early repayment without penalty, while others charge a fee. Check your loan agreement or contact your lender to confirm.
What happens to my student loans if I do not finish school?
Your loans enter repayment six months after you leave school, regardless of whether you finished your degree. The grace period still applies. If you plan to return to school later, you can request a deferment based on enrollment status, which pauses payments while you are enrolled at least half-time.
Can I transfer my student loans to someone else?
No. Student loans are personal debt and cannot be transferred or discharged in bankruptcy except in rare cases of extreme hardship. Only the borrower can repay the loan, though a cosigner is responsible if the borrower does not pay.