What a student loan is and how the money reaches you

A student loan is money borrowed from a lender — usually the federal government or a private bank — that you use to pay for college, graduate school, or trade school. Unlike a grant or scholarship, you have to repay it, with interest. The lender gives the money directly to your school, which applies it to tuition, fees, room and board, and books. Any leftover amount is sent to you.

The school's financial aid office handles the paperwork. They tell the lender how much you need, the lender sends the funds to the school, and the school disburses what's left after covering your bill. This process happens once or twice per year, depending on your school's term schedule.

You don't start repaying while you're in school at least half-time. This period is called in-school deferment. Interest still accrues on unsubsidized loans during this time, but on subsidized federal loans, the government pays the interest for you.

Key Takeaways

  • Federal student loans come from the U.S. Department of Education and have fixed interest rates set by Congress; private loans come from banks and have rates that vary by lender and your credit.
  • Subsidized federal loans don't accrue interest while you're in school; unsubsidized loans do, and that interest gets added to what you owe.
  • You begin repaying six months after you graduate, leave school, or drop below half-time enrollment — a period called the grace period.
  • Federal loans offer income-driven repayment plans that cap your monthly payment based on what you earn; private loans typically require a fixed payment regardless of income.
  • Interest rates on federal loans are set by law and the same for all borrowers; private rates depend on your credit score and the lender's terms.

Federal loans versus private loans

Federal student loans are issued by the U.S. Department of Education. The interest rate is set by Congress and is the same for every borrower in a given year. For the 2024–2025 school year, the rate is fixed. Federal loans do not require a credit check, and they come with protections like income-driven repayment plans, deferment options, and loan forgiveness programs.

Private student loans come from banks, credit unions, and online lenders. The interest rate depends on your credit score, income, and the lender's policies. A borrower with excellent credit may get a lower rate than the federal rate; a borrower with poor credit will pay more. Private loans typically require a cosigner if you have no credit history. They do not offer income-driven repayment or forgiveness programs.

Most students borrow federal loans first because the rates are predictable and the repayment terms are flexible. Private loans are often used to cover costs that federal loans don't, or by graduate students who have exhausted federal borrowing limits.

Types of federal loans and how interest works

Subsidized loans (also called Direct Subsidized Loans) are available to undergraduate students based on financial need. The government pays the interest while you're in school at least half-time, during your grace period, and during deferment. You only pay interest after repayment begins.

Unsubsidized loans (Direct Unsubsidized Loans) are available to undergraduates and graduate students regardless of need. Interest accrues from the moment the loan is disbursed. If you don't pay the interest while in school, it gets added to your principal — a process called capitalization — and you end up paying interest on interest.

PLUS loans are federal loans for graduate students and parents of undergraduates. They have a higher interest rate than subsidized or unsubsidized loans and require a credit check. Parents who take out PLUS loans are responsible for repayment; the student is not.

Interest on all federal loans is simple interest, meaning it's calculated only on the amount you borrowed, not on previously accrued interest. The interest rate is fixed for the life of the loan.

How repayment plans work

Federal loans offer four main repayment plans. The Standard Repayment Plan requires a fixed payment over ten years. The Income-Driven Repayment Plans — which include PAYE (Pay As You Earn), REPAYE (Revised Pay As You Earn), IBR (Income-Based Repayment), and ICR (Income-Contingent Repayment) — cap your monthly payment at a percentage of your discretionary income, usually between 10 and 20 percent. Your payment recalculates each year based on your current income.

Income-driven plans can stretch repayment over 20 to 25 years. If you still owe money after that period, the remaining balance may be forgiven, though you may owe income tax on the forgiven amount. These plans are useful if your income is low or variable when you graduate.

Private loans typically offer only a standard fixed-payment plan, though some lenders allow you to defer payments while in school or to switch between fixed and variable interest rates. The terms vary widely by lender.

What happens after you graduate or leave school

Your grace period begins when you graduate, leave school, or drop below half-time enrollment. For most federal loans, this is six months. During the grace period, you don't have to make payments, but interest still accrues on unsubsidized loans. Some private loans have a grace period; others require payments to begin immediately.

Before your grace period ends, you'll receive a disclosure statement from your loan servicer — the company that collects your payments. This statement shows your loan balance, interest rate, servicer contact information, and the date your first payment is due. You can choose your repayment plan at this time or stick with the default (usually the Standard Plan).

If you don't make a payment when it's due, your loan enters delinquency. After 270 days of missed payments on federal loans, the loan goes into default. Defaulted loans can result in wage garnishment, tax refund seizure, and damage to your credit score. Private loans may go into default sooner, depending on the lender's terms.

Interest rates and how they're set

Federal student loan interest rates are set by Congress and change each year. The rate for loans disbursed in a given academic year stays fixed for the life of that loan. For example, a loan disbursed in 2024–2025 will have the 2024–2025 rate even if rates change in future years.

Private loan rates are set by the lender and depend on market conditions, your credit score, and whether you choose a fixed or variable rate. A fixed-rate private loan has the same rate for the entire repayment period. A variable-rate loan's rate can change, usually once per year, based on an index like the prime rate. Variable rates start lower but can increase significantly over time.

Federal rates are generally lower than private rates for borrowers with average credit, but private rates can be competitive for borrowers with excellent credit. It's worth comparing both before deciding where to borrow.

Deferment, forbearance, and what to do if you can't pay

Deferment and forbearance are both ways to pause or reduce your federal loan payments if you're facing financial hardship. In deferment, you don't make payments and interest doesn't accrue on subsidized loans (though it does on unsubsidized loans). Deferment is available if you're unemployed, in school, serving in the military, or facing other specific circumstances.

Forbearance is more flexible — you can request it for almost any reason — but interest accrues on all loans during forbearance, and that interest is capitalized when forbearance ends. Forbearance periods are typically three to six months and can be renewed.

Private loans rarely offer deferment or forbearance. If you can't pay a private loan, contact your lender immediately to discuss options; many will work with you to avoid default, but there's no legal requirement for them to do so.

Frequently Asked Questions

Do I have to repay student loans if I don't finish my degree?

Yes. Repayment begins six months after you leave school, regardless of whether you completed your degree. The grace period applies whether you graduated, dropped out, or transferred. If you're considering leaving school, contact your loan servicer before you go to understand your obligations.

What's the difference between my loan balance and what I actually owe?

Your loan balance is the principal — the amount you originally borrowed. What you owe includes the principal plus accrued interest. On unsubsidized loans, interest accrues while you're in school, so your balance grows before you ever make a payment. On subsidized loans, interest doesn't accrue until after the grace period ends.

Can I pay off my student loans early without a penalty?

Federal student loans have no prepayment penalty, so you can pay extra or pay off the entire loan whenever you want. Private loans vary — some allow early repayment without penalty, while others charge a fee. Check your loan documents or contact your lender to confirm.

What happens to my student loans if I die or become permanently disabled?

Federal student loans can be discharged (forgiven) if you become permanently and totally disabled or if you die. Your family should contact your loan servicer with documentation. Private loans do not automatically discharge upon death or disability, though some lenders offer optional disability insurance.

How do income-driven repayment plans affect my credit score?

Using an income-driven plan does not hurt your credit score. Making on-time payments — whether under a standard plan or an income-driven plan — helps your credit. Missing payments damages your credit regardless of which plan you're on.