With the costs of education rising, many students are turning to student loans to help cover tuition and expenses. Student loans are often considered good debt — but they’re a big financial commitment and should be used carefully.

What is a student loan?

A student loan is a form of financial assistance created to help students afford the costs of education after high school. The lender provides money to help cover the cost of tuition and expenses and the borrower pays back the loan principal and any interest accrued when he or she leaves school (regardless of whether or not he or she graduates).

What kind of student loan you take out and how much you borrow depends on your personal goals, financial needs and your ability to repay those loans in the future. You can apply for student loans through the federal government’s Free Application for Federal Student Aid (FAFSA) or through private lenders.

• FAFSA: www.fafsa.ed.gov

Most student loans fall into two main types — federal student loans and private loans. These loans vary according to their loan terms, their interest rates and their repayment arrangements. Before you take out a student loan, it’s important to understand which loans will best fit your personal goals and financial needs and how to be a savvy borrower.

• See also: Continuing your education, Going to graduate school

Student loan funding applies to a broad range of educational institutions — community colleges, four-year colleges and universities; and career, trade or technical schools. Different types of student loans have different loan terms and interest rates, but have one important thing in common — when your education is finished, you have to pay them back. That means you are on the hook to make regular (usually monthly) payments until the loan is paid off — often for 10 or more years.

• Financial Aid Resource Publications:
  studentaid.ed.gov/students/publications/student_guide/index.html

What are the types of student loans?

There are two types of student loans: federal student loans and private education loans.

Federal student loans

The federal government provides and guarantees three main types of loans for students and their parents:

Direct Stafford Loans

William D. Ford Federal Direct Loans, or Direct Stafford Loans, are the most common federal student loans available to borrowers. They are low-interest loans that the U.S. Department of Education provides to qualified borrowers through participating schools. The schools determine how much in loans the student is able to borrow — this amount is reflected on the financial aid award letter. Direct Stafford Loans come in two forms: subsidized and unsubsidized.

• Direct Stafford Subsidized Loans

When a Direct Stafford Loan is subsidized, it means no interest is charged on the loan as long as the borrower is enrolled in school at least half time or is in a grace period or deferment period. The government awards subsidized loans based on financial need — to qualify for a subsidized loan, the borrower must meet certain income restrictions.

• Direct Stafford Unsubsidized Loans

When a Direct Stafford Loan is unsubsidized, it means that interest starts accumulating on the loan as soon as the borrower receives the initial payment. Interest also accrues during grace and deferment periods. As a borrower, you can choose to pay interest as it accrues — while you are in school or in grace and deferment periods — or you can wait and pay it when you enter into re-payment. If you wait to pay interest until re-payment, you will end up paying more in interest because the interest capitalizes — it is added to the principal and accrues interest. Unsubsidized loans are not based on financial need and are available to most students.

• Student Aid Stafford Loans:
  studentaid.ed.gov/PORTALSWebApp/students/english/studentloans.jsp

Direct PLUS Loans

Direct PLUS Loans are available to parents of undergraduate student that are defined by the Department of Education to be a dependent. Please note the definition of dependent student is different than the IRS rules for claiming a dependent on your taxes. Graduate and professional students also can qualify for PLUS loans. To apply for a Direct PLUS Loan, parents or graduate students must complete a Direct PLUS Loan application and a Master Promissory Note (MPN). The Direct PLUS Loan program limits the amount that a borrower can take out to the cost of education expenses minus any other financial aid received. The Direct PLUS Loan interest rate is fixed, and interest is charged from the first day the loan is paid out.

• Student Aid Parent Loans section: studentaid.ed.gov/PORTALSWebApp/students/english/parentloans.jsp

• Federal Student Aid: studentloans.gov/myDirectLoan/index.action

Federal Perkins Loans

Federal Perkins Loans are low-interest loans available to students with financial need. Borrowers apply for Federal Perkins Loans through the FAFSA application, and the participating school determines whether and how much to award the applicant in Federal Perkins Loans. In order to determine eligibility, a student’s FAFSA application is reviewed for: the student’s income and assets, his or her parents’ income and assets (if applicable), the household size and the number of immediate family members attending post-secondary school—community college, college or university, trade, technical or career school.

• U.S. Department of Education Federal Perkins Loans: www2.ed.gov/programs/fpl/index.html

Private education loans

In addition to student loans offered by the federal government, students also can borrow private education loans. However, because the federal government does not sponsor these loans, many have high origination fees, shifting interest rates and a lack of options if you find yourself unable to pay. These loans cost more than education loans offered by the federal government but often cost less than credit card debt. Before you apply for a private loan, make sure you understand the costs and loan terms. Don’t take out more in loans than you will be able to repay after leaving school.

• FinAid private loans: www.finaid.org/loans/privateloan.phtml

Federal loans also offer a number of types of repayment plans, including those that may reduce your payments based on your income. For income-contingent plans and income-based plans, your payment amount is based on how much you earn, helping to keep your education costs less than 15% of your income.

What are the parts of a student loan?

When you borrow a student loan, several terms will appear on your documents and statements that will help you know more about the details of your loan.

Loan principal

The loan principal is the amount of money you borrow from the lender that you are required to pay back. Your remaining principal gradually goes down over the term of the loan, as you make payments each month. When you receive your financial aid offer letter from your educational institution, the letter will include any student loans you have been awarded and how much you can borrow in loan principal. You do not have to take the whole loan principal — borrow only what you need to cover your education and the amount you know you will be able to pay back.

Interest rate

The loan interest rate is the amount of interest the borrower will pay to the lender. Most federal student loans offer fixed interest rates, which means the interest rates remain the same over time. Most private education loans offer variable interest rates, which means the interest rate changes over time.

Origination fees

An origination fee is a fee that you sometimes have to pay when you open an account with a financial institution or service provider. You may have to pay an origination fee when you take out a student loan, particularly if you borrow from a private lender.

Payoff and late payment fees

When you take out a student loan, you agree to pay the lender back based on the loan terms. Often, lenders will charge you fees for late payments on your loan once you are in repayment. Late payments also may increase your interest rate.

Because lenders make money on interest, they sometimes charge you a payoff fee if you pay off the entire loan in one lump sum before the final payment date. This fee can run anywhere from $15 to 6% of the loan. Paying the loan off early might not save you any money if your lender requires a high payoff fee. Before you take out a loan, read the loan terms very carefully so you understand any fees you might have to pay.

How do I pay back my student loans?

Once you’re out of school, you want to set a goal to pay off your student loan debt as quickly as possible. Your loan terms will include information about:

• Any grace periods you may have before you have to start payment

• Options for payment relief like deferment or forbearance — temporary suspension or reduction in loan payments for a set period of time

• How long you’ll have to pay the loan off

• What your interest rate will be and how much you’ll pay in interest.

• Federal Student Aid repayment information:
  studentaid.ed.gov/PORTALSWebApp/students/english/repaying.jsp

• Federal Student Aid Postponing repayment:
  studentaid.ed.gov/PORTALSWebApp/students/english/difficulty.jsp

Know what you owe and don’t miss payments. 

Keep a handy list of all loans you've taken out that includes amount owed, contact information, interest rate, monthly payment, start date and end date.

Set up automatic payments. 

Set up an automatic payment each month so you don't forget to pay your loan on time. Repaying student loan debt is the same as all other debt — being late with payments will reflect poorly on your credit report and can easily snowball into a bad situation. Some lenders will offer discounts if you pay through automatic debit or if you pay on time for several years.

Take your tax deduction. 

When you’re paying back your student loans, you may qualify for a tax deduction up to $2,500 per year on qualified student loan interest that you paid depending on your income level. If you paid $600 or more on any qualified student loan interest in any year, you will receive a Form 1098-E, Student Loan Interest Statement, from the lender. To claim the deduction, you must file federal tax Form 1040 or 1040-A, although you don’t have to itemize deductions to qualify for a student loan interest deduction.

If you find yourself unemployed or unable to make your student loan payments for any reason, the good news is that there are a variety of options to assist you. Depending on your individual situation, you may elect to choose one repayment option over the other.

• Graduated repayment schedule

This repayment schedule assumes that borrowers should make more money as they progress in their careers. Payments are initially lower and then increase later in the repayment schedule.

• Income-based or income-contigent repayment

The monthly payment amount will be established based on your gross monthly income and student loan debt.

• Hardship-related repayment

These next options allow you to make changes to the original repayment plan. When circumstances cause repayment to become difficult, sometimes a change in the terms of the loan can solve the repayment challenge.

• Change of due date

If you fall behind because your student loan is due the same week as the rent or mortgage, car payment or other significant bills, contact your lender to see whether you can change the due date and thus stagger your bill payments.

• Deferment and forbearance

A deferment is when the lender grants a temporary suspension of monthly payments. Generally, deferments are a better option than forbearance because interest is suspended for subsidized loans the duration of the deferment. Like a deferment, a forbearance is a loan policy that allows you to temporarily suspend or reduce loan payments for a set period of time or to extend the period of time you have to repay a loan. However, you will still be responsible for paying the interest that accumulates during the period of delay. When considering a deferment or forbearance, try to get a deferment first.

Some of the reasons to qualify for either a deferment or forbearance may include:

• Unemployment
• Temporary disability
• Return to school
• Economic hardship
• Military service

In addition to the options discussed above, your lender may be able to work out other accommodations to assist you in your repayment. It is important to contact your lender and be proactive if you have a financial challenge and can’t repay your loans. Ignoring the situation will not make it go away — it usually only makes the situation worse. Never make the assumption that your lender cannot help.

How can I consolidate multiple loans?

One thing that quickly comes up for anyone trying to pay back multiple student loans is the topic of loan consolidation. Consolidation is a way for you to take all your loans (it’s very common to have multiple loans) and wrap them into a single new loan through the process of refinancing.

Refinancing your loan may help lower your monthly payment, but chances are it also will extend the life of your loan. So while you may see a little bit in savings every month, the final amount you end up paying is more than what you would have paid if you did not consolidate. Before you consolidate, read the fine print — particularly with private lenders who make consolidation sound good, while often resulting in higher fees and interest rates.

Consolidating federal student loans

For federal student loans, the U.S. Department of Education oversees the consolidation program. Reasons you might consider consolidating your federal loans include:

• The convenience of having all of your loans rolled into one

• Extending the repayment period (which likely lowers your monthly payment, but may increase your total interest paid)

• You may be able to reduce your interest rate.

When you consolidate, the federal program calculates a weighted average of the interest rates of all your federal loans rounding up to the nearest 1/8th of a percent up to a maximum rate of 8.25%. Depending on how much you owe and at what interest rate you owe it, this may or may not save you money.

To calculate the impact of consolidation on your monthly payments, you can use a few online calculators:

• Federal Student Aid calculators: www.direct.ed.gov/calc.html

• FinAid consolidation calendar:
  www.finaid.org/calculators/loanconsolidation.phtml

Consolidating private education loans

When considering consolidating private student loans, terms can vary wildly. These loans often are set at variable rates, and it can be hard to determine what your payment will be over the long term. Consolidate only when it makes sense financially.

What is student loan default?

Default is when a borrower fails to make payment on the interest and principal of a loan within the agreed contractual time frame. Defaulting on a student loan can seriously hurt your credit score. If you default on federal student loans, you won't be able to get approved for a mortgage insured by the Federal Housing Administration (FHA) or Veterans Administration (VA). You might not be able to get an occupational license and your income could be garnished or withheld from your paycheck, just like taxes. You also will be subjected to hefty late fees and collection charges, which can make your financial situation worse.

For most federal loans, you’re in default if you have fallen at least nine months behind in your payments. With private loans, default can come sooner. If you fall more than a month behind on your student loan payments, you'll need to call the servicer to work out a repayment agreement. You won't be able to keep your promises until you know how much you can afford for a monthly payment. And for that, you'll need to devise a solid budget plan.

When you call the loan servicer or collection agency, you'll be asked to pay the past-due amount and late fees immediately. You want to do that as quickly as possible. If you can't cover your overdue payments all at once, describe your budget and explain how much you can afford to pay each month. Work with your lender to come up with an affordable payment plan.

If you go into deferment, you probably will be asked to fill out a financial disclosure form and to send copies of pay stubs, bills and bank statements to document your financial situation. When negotiating, don’t agree to a monthly payment that you can't afford — the point is to get ahead, not fall behind again.

If you need help, visit:

• Department of Education: www.fsahelp.ed.gov

How can I recover from student loan default?

If you fall into default, negotiate a rehabilitation plan and stick with it. If you make good on your loan under a rehabilitation program, it can remove the default status of previously defaulted loans once you complete the process.

Rehabilitating a defaulted federal loan means that you agree on a reasonable and affordable payment plan for a specific number of payments over a specific amount of time. A loan is rehabilitated after you have voluntarily made the payments on time and the loan has been purchased by a lender.

• Federal Student Aid loan rehabilitation:
  www2.ed.gov/offices/OSFAP/DCS/rehabilitation.html

Words to know

Unsure about something you read? Many of the financial terms you came across in this article are defined in our financial glossary. A-Z Glossary

Links we like

Here are a few online resources you might find useful:

• National Student Loan Data System: www.nslds.ed.gov/nslds_SA

• FAFSA: www.fafsa.ed.gov

• FinAid: www.finaid.org

• Federal Student Loans: www.studentloans.gov

• Direct Loans: www.direct.ed.gov