There’s no hiding the truth. Going to college in America can be incredibly expensive.

We created Scholly to address this very problem, and we’re proud of the more than $100 million dollar in scholarships students have won over the years. But we know scholarships are just one of the ways students pay for college, and that for many students, loans are essential for making the college dream a reality.

Since you’re here, we’re gonna guess you’re thinking about taking out one or more student loans to help cover the costs. Right?

Okay. Now, we’re gonna take one more guess. You don’t want to end up like the 69% of millennials who recently reported feeling moderately to extremely regretful over taking out student loans, right? 

You surely said yes to that one. Didn’t you? At least, we hope you did! If so, we made this guide just for you! 

By the end of reading this guide, you’ll have learned everything you need to know to make an informed decision on student loans. To get you there, we’ll cover these questions: 

  • What are student loans? 
  • What’s the difference between federal and private student loans?
  • What is the maximum amount of student loans you can get? 
  • How do student loan interest rates work? 
  • When do you have to pay back student loans?
  • How can you find the best private student loans? 

Feel free to click on the question that interests you most to skip ahead to that section of the guide! 

Or, you can follow along as we start with general questions you may have about student loans and then gradually work our way down to the stuff that tends to cause the most confusion.

Ready? Let’s go! 

What are student loans?

At the most basic level, student loans are a form of financial aid

You can use student loans to help pay for things like tuition, accommodation in a student dorm, health insurance, books, and whatever else is included in your school’s cost of attendance. 

But you wouldn’t be alone if you think of student loans as the type of financial aid you’re going to like the least… Why’s that?  

Well, because unlike other forms of financial aid, like scholarships and grants, you’re gonna have to pay these ones back. And, on top of that, you’ll also have to pay interest and fees as well as navigate a bunch of other terms.

Luckily, not all student loans are bad. 

You just have to make sure you have a strategic game plan for finding a good student loan – especially when it comes to private loans. We’re going to cover that later in this guide. But before we can get to that, it’s important you know the answers to these next few questions. 

Federal vs. private student loans. What’s the difference?   

You’ll have two major options when it comes to getting student loans:

  1. Federal student loans (i.e. money you borrow from the government)
  2. Private student loans (i.e. money you borrow from a private lender, like a bank, credit union, or private financial organization)

But there’s more to it than that. So, let’s go into a bit more detail into how those two options differ.

Federal Student Loans: The Basic Info 

Since taking out a federal student loan means borrowing money from the government, it only makes sense that it’s also the government who decides on the terms and conditions of the loan. Generally, this makes federal student loans the best options for students.

For example, with federal loans, interest rates are fixed and relatively low. The loans are available to you if you need them, regardless of your credit score (except for PLUS loans). And, you don’t need to worry about paying the loans back until after you’re done with school. 

There are 3 types of federal student loans.

  • Direct Subsidized Stafford Loans 
  • Direct Unsubsidized Stafford Loans 
  • Direct PLUS Loans 

Federal Student Loan Eligibility

Type of Loan  Basic Eligibility Requirements 
Direct Subsidized Stafford Loans Undergraduate students with demonstrated financial need 
Direct Unsubsidized Stafford Loans Undergraduate, graduate and professional students regardless of financial need 
Direct PLUS Loans Graduate and professional students; Parents of dependent undergraduate students 

Source

So, if there are 3 types, why not just take out federal student loans? 

Well, for one thing, as you might have noticed, you may not meet the eligibility requirements for all types of federal student loans. And, for another, there’s a limit to how much money you can borrow.

We’ll go into more detail on those two limitations of federal student loans in a bit. But let’s first take a look at your other option for getting a student loan. 

Private Student Loans: The Basic Info 

Private student loans are a bit trickier to understand. That’s because the terms and conditions of private student loans depend on who you choose as your private lender. And there are many to choose from! 

But, generally, compared to federal student loans, interest rates on private student loans tend to be a bit higher. How much you can borrow does depend on your credit score or the credit score of your co-signer. And, in some cases, you may have to make payments while you’re still in school. 

Does that mean you should avoid private student loans at all costs? Not exactly. Why? Because not all private student loans are bad and can still be great options when you need more support in covering the costs of school. 

Remember, later in this guide, we’re going to show you how to find the best private student loans! 

What is the maximum amount of student loans you can get? 

Alright, now that you know the difference between federal vs. private student loans, let’s look at how much money you can borrow for each. 

Federal Student Loans: Borrowing Limits 

As we just briefly mentioned, there’s a limit to how much money you can borrow with federal student loans. But what exactly determines the limit? 

The limit to how much you can borrow for federal student loans depends on the information you input while filling out the Free Application for Federal Student Aid (FAFSA®). 

Your school’s financial aid department will use your FAFSA to determine the amount and type of loans to offer you based on: 

  • Your demonstrated financial need
  • Whether you’re an undergraduate or graduate student
  • What year you are in school 
  • Your “dependency status” (i.e. whether you need to include information about your parents on your FAFSA)

Take a look at this table from the Federal Student Aid Department to get a general idea of how much you can borrow with direct subsidized and unsubsidized federal student loans: 

 

Year Dependent Students (except students whose parents are unable to obtain PLUS Loans) Independent Students (and dependent undergraduate students whose parents are 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 (all graduate and professional students are considered independent) $20,500 (unsubsidized only)

Source

Notice the table didn’t really include any information on PLUS loans. That’s because PLUS loans are a little different from subsidized and unsubsidized loans in that they are only available to graduate students and parents who want to help their son or daughter pay for school.

If that’s you, with a Grad PLUS or Parent Plus, you can take out as much money as you need to cover the total cost of attendance minus the amount of other forms of financial aid (e.g. grants, work study, scholarships, etc.).  

But if you’re an undergraduate that still needs to borrow more than what you can get from federal student loans, then that’s when you may want to consider getting a private student loan. 

Private Student Loans: Borrowing Limits 

Unlike federal student loans, each private lender gets to set their own limits on how much money you can borrow.

Generally, the amount will depend on things like how confident the private lender is in your ability to pay them back, how much you’ve received in other forms of financial aid, and the total cost of attendance for your school. 

Before deciding how much money you can borrow, private lenders will want to know information like: 

  • Your credit score
  • Your employment history 
  • The credit score and employment history of a co-signer (e.g. a parent or trusted adult) 
  • The type of degree you plan to get 
  • The total cost of attendance 

To give you an idea of some private student loan limits, take a look at this table created by NerdWallet

Now that you have an understanding of how much you may be able to borrow, let’s move on to the most confusing topic when it comes to student loans. Yep, it’s time to discuss interest rates! 

How do student loan interest rates work? 

Interests rates… well… they suck! We mean, they’re arguably the scariest part about federal and private student loans. 

And here’s why: interest rates are what can make a small, reasonable loan turn into a scary, overwhelming headache of debt. At least if you don’t understand how they work.

So, if you’ve been skimming, now is a good time to slow down your pace. Because this part is important. Ready? 

What is an interest rate? 

Bankrate defines interest rates as: 

 “the proportion of an amount loaned which a lender charges as interest to the borrower, normally expressed as an annual percentage. It is the rate a bank or other lender charges to borrow its money

If you’re rereading that for the third time and still feel confused, don’t worry! We got you. Let’s look at some examples based on federal and private student loans. 

Federal Student Loans: Interest Rates 

Let’s imagine you’re an undergraduate whose FAFSA results have determined you will need financial assistance to pay for college. You’re looking to take out a federal subsidized student loan with a principal amount of $3000 for the 2020/21 academic year. 

Since it’s a federal student loan, we know three things: 

  1. The interest rate is fixed, meaning the interest rate will remain the same throughout the duration of the loan.
  2. The loan will follow a simple daily interest formula, meaning the interest is calculated daily.
  3. With this year’s record low interest rates on federal student loans, your interest rate will be 2.75%.

2020/21 Federal Student Loan Interest Rates 

Type of Loan Interest Rate
Undergraduate Direct Loans (Subsidized and Unsubsidized) 2.75%
Graduate Direct Loans (Unsubsidized) 4.30%
Graduate and Parent PLUS Loans 5.30% 

Alright, now let’s take a look at how you would calculate the interest on that $3000 subsidized student loan. 

  1. First, divide the interest rate by 365 to get the daily interest rate. (.0275 ÷ 365 = .00007534) 
  2. Next, multiply that daily interest rate by your principal amount. (.00007534 x 3000 = .22602) This means you’ll be charged about $0.226 in interest per day on the loan. 
  3. Then you’ll want to multiply the daily interest amount ($0.226) by the number of days in a month. (0.226 x 30 = 6.78). This means you’ll pay around $6.78 per month in interest.
  4. Finally, to get the amount of interest accrued per year, simply multiply that monthly amount by 12. ($6.78 x 12 = 81.36) So, you’ll pay about $81.36 per year in interest. 

Luckily, that amount per year continues to go down as you pay off the principal balance.  

Also, since in our example, you got a subsidized federal loan, you don’t need to worry about the interest accruing while you’re in school at least half-time, for 6 months after you graduate, or during a deferment period. 

But that’s not the case for the other types of federal loans. For example, interest will accrue on unsubsidized federal loans while you’re still in school.

Private Student Loans: Interest Rates 

Interest rates on private student loans can get a bit more complex. That’s because, unlike federal loans, private lenders let you choose between a variable APR or fixed APR. 

With a variable APR, the interest rate can go up or down throughout the term of the loan. And with a fixed APR, the interest rate is fixed throughout the term of the loan.

In general, it’s safer to go with a fixed APR. But, in some cases, you may consider a variable APR due to the rates generally being lower at the start of the loan.

With some private student loans, you may also need to pay compound interest. If you’re not  sure what that means either, no problem. Let’s see a definition and then go through another example. 

According to Investopedia, having a compound interest rate means: 

“the daily interest isn’t being multiplied by the principal amount at the beginning of the billing cycle—it’s being multiplied by the outstanding principal plus any unpaid interest that’s accrued”

To give you an even better idea of what that means, in this next example, let’s say you’re an undergraduate student looking to take out a private student loan of $17,000 for the upcoming academic year. 

After looking around at a couple of different private lenders, you decide to get a private student loan whose current interest rates range from 1.49%-10.49% (variable APR) and 3.49%-14.39% (fixed APR). You decide to go with a fixed APR, and the lender offers you a daily compound interest rate of 8.5%.

Now, let’s look at how to calculate your compound interest. 

  1. Find the daily interest rate by dividing your APR (8.5%) by 365. (.085 ÷ 365 = .00023288)
  2. Next, we multiply your daily interest rate by your principal balance. (.00023288 x 17,000 = 3.958). So, your daily interest is $3.958.
  3. Here’s where it differs from fixed interest. The next day, you’re not multiplying your daily interest rate by your principal balance anymore. You’re multiplying it by the new sum of your principal and yesterday’s daily interest (17,000 + 3.958 = 17,003.958). 

And then day by day, year by year, it continues to grow exponentially. 

  • Day 2: (.00023288 x 17,003.958 = 3.959) → new loan balance: $17,003.958 + $3.959 = $17,007.917
  • Day 3: (.00023288 x 17,007.917 = 3.96) → new loan balance: $17,007.917 + $3.96 = $17,011.87
  • Day 4: (.00023288 x 17,011.87 = 3.961) → new loan balance: $17,011.87 +  $3.961 = $17,015.831 

Now just imagine the new balance on day 365 or day 1825 (5 years)! 

A bit scary, but remember if you do your research, you can get better rates and terms than the loan we used in this example. We’ll show you how soon, but first let’s look at when you have to pay back your student loans. 

When do you have to pay back student loans? 

A conversation about paying back student loans is one that many people would choose to avoid. 

But, if you’d rather avoid all of that student loan regret we were talking about earlier, it’s a good idea that we do have this conversation right now. We promise it won’t be so bad  

Federal Loans: Paying Them Back 

For federal student loans, you should expect to see your first bill about 6 months after you graduate, drop below half-time enrollment, or leave school. 

But how much you have to pay will depend entirely on your repayment plan, of which you have 8 different options:

  • Standard Repayment Plan
  • Graduated Repayment Plan
  • Extended Repayment Plan
  • Revised Pay As You Earn Repayment Plan (REPAYE)
  • Pay As You Earn Repayment Plan (PAYE)
  • Income-Based Repayment Plan (IBR)
  • Income-Contingent Repayment Plan (ICR)
  • Income-Sensitive Repayment Plan

As we’re sure you can imagine, each of those plans has its own eligibility requirements that would take quite a bit of time for us to sift through individually. But we don’t want to overwhelm you with all of that information just yet. So, here’s the gist. 

Depending on the type of federal loan and your chosen repayment plan, you’ll be paying anywhere from 10% of your discretionary income per month to high monthly payments that make sure you pay off the loan within ten years. 

To pay the loan off faster, you can also make payments while you’re still in school and pay more than the minimum amount of your monthly repayment plan. 

In fact, both of these are good ideas and apply to private loans as well. 

Private Student Loans: Paying Them Back 

As you’ve probably come to expect by now, paying back private student loans isn’t as easy to generalize as federal student loans.

That’s because when you begin paying back the loan and the options for repayment are determined by the private lender

For some, you will need to make monthly payments immediately. For others, you’ll have a similar 6-month deferment plan as you’d have federal student loans. And for others, you’ll need to make monthly payments while in school to cover all or part of the interest. 

It can definitely be confusing and costly if you don’t know what you’re getting yourself into. 

Which is definitely another reason why you’ll want to compare private student loans and make sure to find the best one for you before you sign any loan agreements.

How can you find the best private student loans? 

The best private student loans are the ones that have the best terms and rates. Which seems simple enough, right? Well, yes, but also… no.  

You see, with so many different lenders to choose from and each having their own terms and rates, it can be difficult to really get a clear idea of how each loan stacks up against the other.

That’s why instead of spending hours sifting through the terms and fine print on the websites of every single private lender there is, we’ve setup a private student loan comparison tool. Plus, for a limited time, we’re entering all students who use the student loan comparison tool into our $5,000 Close the Gap Scholarship. Apply for the instant scholarship and compare student loan options today!

It will help you easily compare things like interests rates, the lender’s reputation and more. 

That way you don’t have to feel uneasy about your decision to take out a private student loan when you need one. Because you’ll know that you did your research and got the best one for you! 

Final thoughts

Taking out student loans to help pay for school is definitely a big decision. But it doesn’t have to be a scary one that you regret later on! 

By planning ahead and understanding exactly how student loans work, you’ll be able to make a more informed decision and know how to find the best student loans for you.