How Do Student Loans Work?

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Attending college is expensive and most families simply cannot afford to fund their children’s higher education without some form of financial assistance. While scholarships and grants can help greatly, they are not often enough to cover all the expenses involved. There are the tuition fees, rent and boarding, text books, transportation, miscellaneous college fees, and other personal expenses. It all adds up to an amount that personal finances together with scholarships may not always be able to cover.

The majority of students have no other option but to take out loans to pay for college. So what exactly is a “student loan”? How do student loans work and how are they different from other types of loans?

Knowing how student loans work, how the interest is calculated, and how you have to pay back the loan will help make informed decisions. Every choice you make affects your future.

What is a Student Loan?

A student loan is fundamentally much like any other loan. You are borrowing money from a bank or financial service with the understanding that you are going to pay it back over time, with interest.

The major difference between student loans and all other types of loans is that student loans attract a significantly lower rate of interest, along with the benefit of deferred payments options and other advantages.

One of the many benefits of a student loan is that the service provider or bank does not expect you to have a stellar credit rating or maybe even a credit rating at all. They understand you are just starting out and are willing to loan money to you, with interest of course.


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What Exactly is Interest?

In the most simple of terms, interest is the price of borrowing money. When financial institutions loan you money, they have to get something out of it too. So they charge you to borrow it. These additional charged are the ‘interest’.

When applying for a student loan, it behooves you to look for a financial institution that has a lower interest rate. The lower the interest rate, the lower the overall total will be for repayment.

Who Loans Money to Students? How Does it Work?

There are two types of student loans—federal loans, which are funded by the government and private loans, which are offered by private lenders. Federal loans are the preferred option as they offer the lowest interest rates along with several other benefits.

FAFSA (Free Application For Federal Student Aid) is one of the most used service providers for students loans. The application is free and is backed by the government. It typically has the lowest interest rates and better plans for repayment as compared to other private financial services.

When you submit FAFSA, they use a formula based on your family finances to determine your financial need. Based on that, you are awarded a specific amount. You can choose to borrow some, all or none of the offered amount.

Very often, students are approved for more than they really need. It can be tempting to take it for “miscellaneous expenses”. However, this can get you into trouble when it is time to pay it back. It is best to only borrow what you need each semester. Remember, you have to repay this money. Taking more than is needed only causes more interest and larger payments down the road.

Each school year, you re-apply for the student loan for the upcoming school year. The loans from year to year stack onto each other.

In addition to federal student loans, there are many other banks and financial institutions that also provide student loans. However, their interest rate is usually much higher and they do not offer as many benefits.

It is always advisable to start with FAFSA to see how much they are willing to loan you before checking into other financial options.

What You Should Know About Paying Back Your Student Loan

Most student loans do not require any payments until after you graduate or stop attending school. This is called deferment.

The financial provider does not charge any interest until after a set period of time, which is typically your graduation year. Of course, you can make payments while you are in school, but there is no penalty if you choose to wait until you are required to do so.

Once you graduate, you are expected to start making payments on the loan. The payments are often divided into monthly payments for 10 years. The monthly payment amount depends on the total amount you borrowed, plus the interest.

Most financial institutions have an auto-debit system. This allows you to set up monthly payments on a date of your choosing. The money will be automatically withdrawn from your account, and you won’t have to stress about due dates, checks, and stamps.

What If I Can’t Pay?

First, look into loan forgiveness. There are several forgiveness programs available with varying terms depending on your career choice. Forgiveness programs are a great way to wipe out your loans, provided you choose a career that fits into this category and meet all of the requirements.

If you do not eligible for loan forgiveness and are struggling to pay back your student loan, it is important to contact the financial institution and let them know. They may be able to reduce the monthly payments or defer the payments a little longer.

It is always better to talk to them and let them know your situation rather than just ignoring the payments as if they don’t exist. If you simply just do not pay the payments, the consequences will simply escalate from bad to worse. Some lenders may increase the interest rates or add fee to your balance. The loans do not go away, so even if you chip away at them little by little, it is better than not making a payment at all.

Don’t let the finances of college give you stress or deter you from attending. Think of student loans as an investment. Yes, it will cost you a little, but it will pay out in the long run. Borrow only what you need and make the best out of each of your classes to ensure the money you are borrowing is going to good use and not being wasted.

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