How Do Federal and Private Student Loans Work?


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Since most students don’t have enough cash on hand to pay for their college education out of pocket, many turn to student loans to cover their education costs.

If you are planning to get a student loan, it is advisable to first learn how student loans work. This way, you will be prepared before you take out a student loan.

Here’s how student loans work:

What are student loans?

Student loans are loans made specifically to help cover tuition, room and board, and other expenses related to college education.

Remember that you must be enrolled in an accredited educational program to be eligible for student loans.

There are two main types of student loans:

  • Federal student loans are supported by the US government. These loans have fixed interest rates and come with federal benefits and protections. This includes access to deferral and forbearance options, income-based repayment plans, and student loan cancellation programs.
  • Private student loans are issued by private lenders. Unlike federal student loans, private student loans require a credit check and verifiable income. You will also need to meet all the other requirements set by the lender.

Learn more: Federal or private student loans

Types of student loans

Many students find themselves with a mix of federal and private student loans to help pay for their education.

It’s generally a good idea to start with federal student loans because they offer more benefits and protections for borrowers. Then you can consider using private student loans to fill the financial gaps.

Here’s how the two types of student loans work:

Federal student loans

Federal student loans are guaranteed by the US government and have interest rates set by Congress. They also come with several refund options.

To apply for federal student loans, you will need to complete the Free Application for Federal Student Assistance (FAFSA).

There are three main types of federal student loans:

  • Direct subsidized loans: These loans are offered to undergraduate students with financial need. The government pays all interest on subsidized loans while you are in school at least part-time.
  • Direct unsubsidized loans: These loans are available to undergraduate and graduate students regardless of their financial needs. Unlike subsidized loans, you are responsible for all interest charges on unsubsidized loans.
  • Direct PLUS Loans: There are two types of PLUS loans: Graduate PLUS Loans and Parent PLUS Loans. Grad PLUS loans are for graduate students, while Parent PLUS loans are taken out by parents paying for their child’s education. PLUS loans also require a credit check.
Federal student loan repayment: Federal student loans offer several repayment plans, including Income-Based Repayment Plans (IDRs) and a student loan forgiveness.

If you subscribe to an IDR plan, your monthly payment will be based on your income. After 20 to 25 years of payments (depending on the IDR plan you choose), any remaining balance will be forfeited.

There are also other student loan exemption programs available for federal student loans.

Learn more: How to take out a student loan

Private student loans

Private student loans are offered by private lenders. If you are applying for a private student loan, your interest rate will depend on the lender as well as your credit score and income.

You also have the option of applying with a student loan co-signer, which may make approval easier.

Unlike federal student loans, private student loans do not have built-in deferral and forbearance programs if you are in financial difficulty. Instead, the help is at the discretion of the lender.

Private student loans also do not offer forgiveness programs.

Borrow wisely! Getting a private student loan might be a smart move, but remember that you will need to pay it back.

Make sure you borrow only what you need to keep your monthly payments and interest charges as low as possible while you’re paying off.

Learn more: Average cost of college in USA

How much can you borrow?

There are student loan limits that could affect the amount you can borrow, depending on the type of student loan you have:

  • Federal student loans: The borrowing limits for both subsidized and unsubsidized federal student loans depend on your year of study and your dependency status. Typically, independent graduate and graduate students can borrow more than dependent undergraduates. With PLUS Loans, you can borrow up to tuition fees less any other financial assistance received.
  • Private student loans: With private student loans, you may be able to borrow up to the cost of tuition, but the exact limits will depend on the individual lender.
Type of loan Loan limits
Direct subsidized loans $ 3,500 to $ 5,500 per year
Direct unsubsidized loans Baccalaureate dependent: $ 5,500 to $ 7,500 per year (total limit of $ 31,000)

Independent baccalaureate: $ 9,500 to $ 12,500 per school year (total limit of $ 57,500)

Graduated and Professional: $ 20,500 per year
(total limit of $ 138,500)

Direct PLUS loans Up to the attendance fee less any other financial assistance received
Private student loans Up to attendance fees
(depending on the lender)

See: Use Your Student Loans Wisely: Take Only What You Need

How to apply for a student loan

The application process is a little different for federal and private student loans. Here’s how to apply for both types:

Federal student loans

  1. Submit the FAFSA: The FAFSA is used to determine which federal student loans you are eligible for. To complete it, you will need the financial information from your tax returns. You might also need information from your parents if you are a dependent student.
  2. Review your financial aid award letter: Your school’s financial aid office will send a letter detailing your financial aid program. This will include all federal student loans, bursaries, and work-study programs for which you are eligible.
  3. Accept your loans: After considering your reward options, you can accept any federal student loans you want. These loans are usually disbursed at the start of the term. Any funds left over after paying your tuition should be refunded to you within a few weeks.

Learn more: When to apply for a student loan

Private student loans

  1. Take the tour and compare the prices: Before taking out a private student loan, be sure to consider as many lenders as possible to find the loan that’s right for you. You can easily compare your rates from several lenders with Credible.
  2. Complete the loan application: Once you have considered your options, you can fill out a complete application with the lender. You will likely be subject to a credit check at this point.
  3. Accept your student loan: If your application is successful, you will receive a final student loan offer. Once you accept the loan, you will need to sign your loan documents. Most private student loans will need to be certified by your school before funds are sent to your school’s financial aid office. The remaining money will then be returned to you. Keep in mind that this process usually takes around three weeks, but can take up to two months if there are any delays. So make sure you give yourself plenty of time to get a student loan.

If you decide to take out a private student loan, it’s important to take the time to consider as many lenders as possible. Credible makes it easy for you: you can compare your rates with multiple lenders in two minutes.

Find your student loan

How Does Student Loan Interest Work?

Depending on the type of student loan you get, you will have a fixed or variable interest rate. Your interest rate will affect both your monthly payment and the total cost of your loan.

  • Federal student loans: Federal student loans have fixed interest rates. A fixed rate will stay the same for the life of the loan, which also means your payment will not change (unless you change your payment plan). However, your payments and interest charges may vary depending on whether your loan is subsidized or unsubsidized, as well as whether you have an IDR plan.
  • Private student loans: With a private student loan, you could have a fixed or variable rate. While fixed rates remain the same, variable rates can change with the market. This means that your payment could go up or down in the future with an adjustable rate loan.

If you decide that a private student loan is right for you, be sure to consider whether a fixed or variable rate would be better for your situation. With Credible, you can easily compare the fixed and variable rates of several private student lenders in two minutes.

Compare student loan rates from the best lenders
  • Several lenders compete to get you the best rate
  • Get real rates, not estimates
  • Fund almost all degrees

See your rates
Checking rates will not affect your credit

About the Author

Eric Rosenberg

Eric Rosenberg is an expert in personal finance. His work has been featured in Business Insider, Investopedia, The Balance, The Huffington Post, MSN Money, Yahoo Finance, Mint.com and more.

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