Alert Message
Thanks for signing up! We hope you enjoy our newsletter, The Teller.
how do student loans work

How Do Student Loans Work? Everything You Need to Know

Conquer your student debt. Refinance now.

Get My Rate

A college degree paves the way for employment, increased income, and financial stability. It also leaves nearly 62% of graduates with student loan debt.

Loans are the only way many students can afford a college education. Americans owe a collective $1.75 trillion in student loan debt, with the average debt hovering at just under $30,000.

Applying for different types of student loans, or even knowing where to start, can be a confusing process. We’ve broken down the types of loans, programs, and repayment options to help you get the most out of your money and your education.

What is a student loan and what can you use it for?

A student loan is money you can borrow specifically for education costs. College students can get loans from the federal government or from private entities, such as credit unions or student loan lenders, which focus on education loans. You can use this money to pay for tuition and room and board.

Federal loans are generally paid directly to your school. However, depending on the terms of the loan you take out and how it’s distributed, you may also be able to access some of the funding as cash to use for books or living expenses.

Loans are different from scholarships and financial aid grants because you have to pay them back, regardless of whether you finish your degree.

How student loans work

The best way to fund your college education without going into debt is to get the maximum amount of financial aid and free scholarships as possible. Once you’ve exhausted all the options available to you, and accounted for all the cash you and/or your family can afford to spend, you can cover the remainder with loans.

If you’re going to school at least half-time, there are several types of federal student loans available to you, including Parent Plus Loans and Direct Subsidized and Unsubsidized Loans. Once you fill out your FAFSA, you’ll find out how much federal assistance you’re eligible for, and you’ll be able to accept or reject the loans offered to you.

  • If you decide to accept, you’ll be offered the standard federal student loan interest rate. While the government changes the rate each year for disbursements of new loans, the interest rate you receive will remain the same for the life of the loan you’ve taken out.
  • On the other hand, if you don’t like the terms of the loan or you need more loan money, you may decide to explore private student loan options. These have different terms, repayment options, interest rates, and types. But they don’t come with the same protections offered by the federal government, like deferment, forgiveness, or income-based repayment.

Once you’ve signed your promissory note, which documents all the terms of the loan and your obligation to pay, you won’t be required to make payments on principal or interest until after you graduate. New grads receive a six-month grace period to get settled into new careers and start making payments. Once that six-month grace period has elapsed, the student will make monthly payments to the lender over the agreed-upon term until all the principal, plus interest, is paid back.

Filling out your FAFSA

The first step for every student, whether or not they think they will need a loan, is to fill out the Free Application for Federal Student Aid, more commonly known as the FAFSA, from the US Department of Education. This will allow you to apply for federal aid, including grants, loan programs, and work-study programs to cover the cost of attendance.

Once the application process is complete, you and your potential schools will be sent a Student Aid Report, or a SAR, that includes your Expected Family Contribution, or EFC, which will determine your eligibility for a Federal Pell Grant.

Colleges will also use the EFC to determine what other types of aid you may be eligible to receive, including additional federal aid, school scholarships, work-study, or other types of student financial aid. Make sure to max out any gift aid options for financial aid before looking into your loan options for the school year.

Experts say that all students should fill out the FAFSA, whether or not they think they need or qualify for federal financial assistance for higher education. Not only does it give you a safety net if your financial need or college costs change at any point during your college career, but it also puts you in line for school-subsidized financial gifts for all income brackets. Filling out the FAFSA can even boost your enrollment chances because it shows schools you listed them as a potential choice, and that you are committed to your education.

Completing entrance counseling

Both undergrad and graduate students who have never taken out a federal loan will need to complete entrance counseling, which is required by the federal government to ensure you understand your responsibilities and repayment term obligations.

Your school may have its own entrance counseling. Check with your school’s financial aid office to make sure the entrance counseling you complete satisfies the government’s requirements.

Evaluating federal student loans

Federal student loans are always the best place to start if you’re looking for student loan options. The government offers protections to borrowers in the event they don’t make enough money to make payments for the standard repayment plan, and also offers forgiveness for people in some public service careers (called Public Service Loan Forgiveness).

Taking out loans from the federal government doesn’t require a credit check. Anyone going to college can receive them as the primary signer. Your parents may also take out Direct PLUS Loans—either on their own or with the help of a cosigner—to fill in any remaining gaps for the cost of attendance, such as for books or other essential materials.

All government loans have fixed interest rates that are set before the beginning of each academic year. They also have generous repayment options to help you make sure you don’t enter default even if you’re not making enough money to make your payments for an extended period of time.

Here are the different types of federal loans and which student loan borrower they apply to:

Loan Type Borrower Fixed Interest Rate
Direct Subsidized Loans and Direct Unsubsidized Loans Undergraduate students 4.99%
Direct Unsubsidized Loans Graduate or professional students 6.54%
Direct PLUS Loans Parents and graduate or professional students 7.54%

These are the limits on federal loans, depending on the borrower and loan type.

Year Dependent Students Independent Students (and parents of dependent undergrad unable to obtain PLUS Loans)
First-Year Undergraduate Annual Loan Limit $5,500 – No more than $3,500 of this amount may be in subsidized loans. $9,500 – No more than $3,500 of this amount may be in subsidized loans.
Second-Year Undergraduate Annual Loan Limit $6,500 – No more than $4,500 of this amount may be in subsidized loans. $10,500 – No more than $4,500 of this amount may be in subsidized loans.
Third Year and Beyond  Undergraduate Annual Loan Limit $7,500 – No more than $5,500 of this amount may be in subsidized loans. $12,500 – No more than $5,500 of this amount may be in subsidized loans.
Graduate or Professional Student Annual Loan Limit Not Applicable $20,500 (unsubsidized only)
Subsidized and Unsubsidized Aggregate Loan Limit $31,000 – No more than $23,000 of this amount may be in subsidized loans.

$57,500 for undergraduates – No more than $23,000 of this amount may be in subsidized loans.

$138,500 for graduate or professional students – No more than $65,500 of this amount may be in subsidized loans.

*The graduate aggregate limit includes all federal loans received for undergraduate study.

You can apply for federal loans simply by filling out your FAFSA forms and accepting what’s offered to you based on your family’s financial situation. You may be offered both subsidized and unsubsidized loans, and you’ll get information from your school about how to accept them. Subsidized loans do not accrue interest while you’re in school, while unsubsidized loans do. Your parents may also be offered a Direct PLUS loan, which they can apply for to cover any remaining educational costs as determined by your school.

Evaluating private student loans

When federal assistance isn’t enough to pay for college — whether you weren’t approved for what you need or you need more than the federal limit on how much you can borrow — private student loans can help you cover the gaps in funding.

While many lenders will look at your credit score to determine the loan amount and terms, you may be able to get a quote without a credit check. Bad credit score or no credit history? You may have to take on a higher interest rate, or you can ask a parent or other financially responsible adult with a good credit score to be a cosigner on your loan. Having a cosigner may also help you get a lower interest rate than you could have when applying on your own.

Just make sure you will be able to stick to your repayment plan so your cosigner doesn’t get stuck with the tab and the interest.

You’ll have to choose between getting a loan with either a fixed or variable interest rate. What you choose is completely up to you. Fixed-rate loans will stay the same throughout the duration of your repayment period—they won’t go up or down if federal interest rates change.

You’ll generally be offered lower rates for variable loans, though they come with a risk that the rate may increase significantly over time. Earnest allows borrowers in good standing to apply to refinance their loans in-house to switch from a fixed-rate loan to a variable rate loan and vice versa once every six months. Be aware, though, a hard credit pull will be conducted every time you apply to refinance.

When you’re choosing which lender to sign with, make sure you understand everything they’re offering to you. Check to see if their loans have any unexpected fees, like origination fees to take out the loan (Earnest doesn’t charge these), or if they offer any kind of flexibility to take some of the stress out of repaying your debt. You can generally check your interest rate from multiple lenders without a hard credit pull to compare and make sure you’re getting the best rate possible.

Private lenders work directly with your school and, just like federal loans, student loan payments are made to the financial aid office.

Repaying student loans

Thinking about loan payments should begin before you sign your loan agreement. Ask the lender when repayment begins so you can be prepared to tackle the loan balance.

Repayment for federal student loans typically begins after graduation (or after you drop below half-time enrollment), while private lenders may require monthly payments while you are still in school. Federal loan holders typically get a grace period of six months between the time they graduate and the date repayment begins.

How does interest work?

Interest typically starts accruing on the loan before you begin repayment, including during the grace period, but making payments while you are still in school can lessen the impact and make repayment seem less daunting. If you have a subsidized federal loan, the government will cover your interest payments until the end of your grace period.

The balance of unpaid debt excluding accrued interest is called your principal. If you ever end up consolidating your federal loans or refinancing private ones with another lender, any outstanding interest at that time will be capitalized, meaning it will be tacked on to your new principal balance and will start accruing interest as well.

Interest is essentially the cost of your loan – how much you agreed to pay to borrow the funds. Your payments will be broken down into interest and principal so you can see where your money is going.

You do not generally have to pay interest on top of interest, except in circumstances where the interest becomes part of your principal balance, such as if you refinance your loans and your new lender pays the outstanding interest on your behalf.

Over the course of your repayment term, which is the number of years you’re allotted to repay the full amount of the loan, you may notice that the percentage of your payment that goes toward interest will start to decrease as you pay off your principal.

You can figure out how much interest you can expect to pay over time using a simple loan calculator. Your interest payments will always be higher in the early days of your loan, as that’s when your principal balance is highest and so interest accrues more quickly.

What will my monthly payment be?

The minimum required payment you’ll have to make every month is the bare minimum you’ll have to pay to your lender to keep your account in good standing. Whenever possible, it’s best to pay more than your minimum amount. This is because any money you pay on top of the minimum will go directly to the principal balance—and the faster you pay down your principal, the less interest will accrue, which in turn makes it faster to pay down your loan.

Even if all you can add is an extra $5 a month or $100 of birthday money one time, it can make a difference. The more you can do to chip away at that principal balance, the less money you’ll end up paying over time—and the faster you’ll be debt-free.

Your monthly payment will vary based on the amount of your loan, the length of your repayment term and the interest rate you borrowed at. Longer loan terms generally result in lower monthly payments, but higher overall costs—because there’s more time for interest to accrue.

You can calculate your potential monthly payments with Earnest’s student loan calculator, which will also help you understand what range of rates you may be offered if you apply for a loan.

Federal student loan repayment options

Your federal loan will be transferred to a company called a loan servicer, which handles the billing, sending the loan disbursements to your school, and answering questions about repayment or loan terms. You can also reach out to your loan servicers for information on student loan forgiveness.

Graduates who are in repayment can find out who their loan services are — each loan might have multiple servicers — by logging into My Federal Student Aid.

Once you’re ready to start making payments, you have quite a few options for structuring your payment plan:

  • Standard Repayment Plan—the plan you’re offered by default, which spreads out your payments into equal pieces over the span of 10 years or 120 payments.
  • Income-Based Repayment—this plan has payments that are typically 10-15% of your take-home pay after taxes, depending on when you took out your loans and whether you’re a new borrower.
  • Income-Contingent Repayment—this plan is based on either 20% of your discretionary income or the amount you’d have to pay monthly if your plan was spread out into fixed payments over 12 years—whichever is less.
  • Revised Pay As You Earn—typically 10% of your discretionary income
  • Pay As You Earn—typically 10% of your discretionary income, as long as that amount is less than your minimum payment under the standard repayment plan.
  • Extended Repayment—if you have more than $30,000 in outstanding Direct Loans, you may be eligible to extend your repayment plan to 25 years.
  • Graduated Repayment—this plan starts out with lower payments and gradually increases the amount you have to pay each month.

Private student loan repayment options

Private lenders and financial institutions may also use loan servicers, while others — including Earnest — take care of all your loan information in-house. In that case, you can reach out directly to your lender to get information on your repayment plan or get help managing your loan debt.

Private student loan repayment terms are not standardized. They’re an agreement between you and the lender. That means that each company will offer you different benefits and possibly even significantly different interest rates.

Earnest allows borrowers some flexibility over repayment to help you meet your financial goals faster. You can calculate how paying a few dollars more each month or extending or decreasing your total repayment period can affect the total cost of the loan. Based on those numbers, you can set automatic payments either once a month or once every two weeks—and as a bonus for setting up autopay, you’ll get a .25% interest rate reduction1 on loans with either fixed or variable interest rates.

Earnest also allows borrowers in good standing to request to skip a payment2 once a year if they fall on hard times or have an unexpected financial emergency. That payment will be redistributed evenly over the rest of your loan term.

What if I can’t make payments?

If you find yourself unable to make your monthly payments, you will need to check in with your loan servicers about whether you qualify for deferment or forbearance to temporarily pause your payments. If you hold a federal student loan, you may qualify for student loan forgiveness.


Deferment can pause your loans for up to three years during loan repayment and is generally a better financial choice if your federal loans are subsidized, because you may not accrue additional interest payments during your deferment period. Deferment qualifications are based on unemployment or significant financial hardship, such as homelessness, military deployment, or major medical treatments.


A forbearance may be approved for those who do not qualify for deferment. During forbearance, loans are either paused or reduced for up to 12 months. The glaring financial difference between the two options is that interest will continue to accrue on the original loan amount in forbearance.

If at all possible, an income-based repayment plan is likely a better option than deferment or forbearance because you can continue making payments without letting interest pile up

Student loan forgiveness

If you work in a job designated as a public service career, you may be eligible for student loan forgiveness. This is called Public Service Loan Forgiveness, or PSLF, and is for people who work in certain non-profit or government roles, such as some teachers. If you’re eligible for PSLF, your remaining debt may be canceled—as in, you won’t have to make any unpaid payments—if you make 120 consecutive, on-time payments.

Only federal student loans are eligible for forgiveness. If you refinance your loans with a private lender, you won’t be able to ask for them to be forgiven by the government, no matter how many payments you’ve made. If you’ve consolidated your loans through the federal government, however, you’ll still be eligible, though your progress toward making 120 payments will start over and the counter will be reset to zero.


Default happens when a borrower misses nine months’ worth of student loan payments. During the process, your student loan servicer will report your missed payments to the three credit bureaus—which can have a devastating impact on your credit score. Eventually the debt will be turned over to collections.

Even worse, if your federal loans enter default, up to 15 percent of your disposable wages can be garnished, meaning it’ll go straight to the government to pay off your debt without ever landing in your account. You may also have to pay additional penalties on top of any unpaid principal and interest.

You can avoid default by making on-time payments, or by contacting your student loan servicer to ask for your payment plan to be restructured. The federal government offers many ways for borrowers to temporarily decrease or pause their monthly payments when they’re experiencing financial distress, such as Income-Based Repayment and Income-Contingent Repayment.

Both of these programs take a borrower’s earnings into account when restructuring monthly payments. You may even be granted a full (but temporary) hiatus from payments, so you can focus on other essentials until you’re making more money. Just keep in mind that you’ll still accrue interest on your loan balances even if you’re not required to make payments, so you’ll ultimately owe more money.

Recovering from default and rebuilding your credit can take time and can be a stressful and frustrating process. It’s important to do whatever you can to avoid it altogether.

Find out why Earnest is a top choice for student borrowers

Navigating student loans can seem overwhelming at first. That said, the good part of having a lot of options is that you can find a loan and lender that may work really well for your specific needs.

Earnest offers some of the lowest interest rates around for new student loans as well as student loan refinancing, and offers flexibility many other lenders don’t have. Check out how Earnest might be able to help you finance your education for less money and less stress.




Disclaimer: This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.

1 You can take advantage of the Auto Pay interest rate reduction by setting up and maintaining active and automatic ACH withdrawal of your loan payment from a checking or savings account. The interest rate reduction for Auto Pay will be available only while your loan is enrolled in Auto Pay. Interest rate incentives for utilizing Auto Pay may not be combined with certain private student loan repayment programs that also offer an interest rate reduction. For multi-party loans, only one party may enroll in Auto Pay. It is important to note that the 0.25% Auto Pay discount is not available while loan payments are deferred.    

2 Earnest clients may skip one payment every 12 months. Your first request to skip a payment can be made once you’ve made at least 6 months of consecutive on-time payments, and your loan is in good standing. The interest accrued during the skipped month will result in an increase in your remaining minimum payment. The final payoff date on your loan will be extended by the length of the skipped payment periods. Please be aware that a skipped payment does count toward the forbearance limits. Please note that skipping a payment is not guaranteed and is at Earnest’s discretion. Your monthly payment and total loan cost may increase as a result of postponing your payment and extending your term.

Before applying for private student loans, it’s best to maximize your other sources of financial aid first. It’s recommended to use a 3-step approach to assembling the funds you need: 1) Look for funds you don’t have to pay back, like scholarships, grant and work-study opportunities. 2) Next, fill out a FAFSA® form to apply for federal student loans. Federal student loans do not require a credit check or cosigner, and offer various protections if you’re struggling with payments. 3) Finally, consider a private student loan to cover any difference between your total cost of attendance and the amount not covered in steps 1 and 2. For more information, visit the Department of Education website at

Loan Eligibility criteria for student loans: Eligible students must: 1) For college Freshmen, Sophomores and Juniors, attend, or be enrolled to attend, a Title IV school full-time. For college Seniors and Graduate students, attend, or be enrolled to attend, a Title IV school at least half-time; and 2) be pursuing a Bachelor’s or Graduate degree. Earnest private student loans are subject to credit qualification, completion of a loan application, verification of application information, self-certification of loan amount, and school certification.

Loan Eligibility criteria for refinancing: Your debt is from paying for education at a Title IV accredited school. The debt is from your education or your child’s. The debt you’re refinancing is for a completed degree or one that will be completed at the end of this semester. You are currently the primary borrower on the student loans you would like to refinance, and you will remain the primary borrower after refinancing. You must reside in the District of Columbia or one of the 48 states Earnest Operations LLC is authorized to lend in (all but Kentucky and Nevada). This is strictly a student loan refinance product. There is no opportunity to borrow more than your outstanding qualifying student loan amount. You must be the age of majority in your state or older at the time you apply, as well as be a United States citizen or Permanent Resident Alien without conditions. Refinancing is subject to credit qualifications. Please note, we are not able to offer variable rate loans in AK, IL, MN, NH, OH, TN, and TX.

You may lose benefits associated with your underlying federal and/or private loans if you refinance such as federal Income-driven Repayment Plans, Economic Hardship Deferment, Public Service Loan Forgiveness, or other deferment and forbearance options. If you file for bankruptcy, you may still be required to pay back this loan.

Earnest Loans are made by Earnest Operations LLC or One American Bank, Member FDIC. Earnest Operations LLC, NMLS #1204917. 535 Mission St., Suite 1663, San Francisco, CA 94105. California Financing Law License 6054788. Visit for a full list of licensed states. For California residents: Loans will be arranged or made pursuant to a California Financing Law License. One American Bank, 515 S. Minnesota Ave, Sioux Falls, SD 57104.

Earnest loans are serviced by Earnest Operations LLC with support from Navient Solutions LLC (NMLS #212430). One American Bank and Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by agencies of the United States of America.  

 © 2022 Earnest LLC. All rights reserved.

Conquer your student debt. Refinance now.

Get My Rate
Disclaimer: This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.