How Do Student Loans Work? - Earnest | Earnest

How Do Student Loans Work? Everything You Need to Know

By Kassondra Cloos | Published on March 6, 2026

)

Earning a college degree can open doors to a fulfilling career, financial stability, and significantly higher lifetime earnings. But it also leaves nearly 61% of graduates with student loan debt.

Loans are extremely common. For many students, they’re the only way to afford a college education. That said, they can be unduly expensive if you don’t do your research and calculate the best funding strategy for your needs. According to the Education Data Initiative, Americans currently owe a collective $1.73 trillion in student loan debt, with the average debt hovering at just under $40,000 per graduate.

Applying for different types of student loans, finding the most affordable options—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 a loan you borrow specifically to cover education costs. College students can get loans from the federal government or from private entities¹, such as credit unions, banks, or student loan lenders. You can use this money to pay for tuition, room and board, and other educational costs.

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 private student loans work

Student loans work similarly to other loans: You find a lender — like a bank, credit union or online lender — that you’d like to work with. The lender agrees to extend you a lump sum of money with the stipulation that it can only be used for tuition, fees, and school-related expenses. The lender typically sends your loan funds directly to your school, which uses it to pay your tuition and fees. Your school will then send any extra money to you for other expenses.

With some student loans, you don’t have to start repayments until after you graduate. Most lenders also give you six to nine months to get your bearings post-graduation before they start sending you bills. Once this grace period ends, you’ll pay off the loan balance and accumulated interest in monthly installments until it’s completely paid off.

That’s a pretty high-level overview. But how do student loans work from a student’s perspective? The steps below will give you a better sense of what this process looks like on the ground.

1. Fill out your FAFSA

The first step for every student, whether or not you think you 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 make you eligible for federal aid, including grants, loan programs, and work-study programs to cover the cost of attendance.

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 the running for school-subsidized financial gifts for all income brackets.

2. Receive your student aid report (SAR)

Once the application process is complete, you and your potential schools will be sent a Student Aid Report, or a SAR, that includes your student aid index (SAI). Your SAI is the amount your family can be expected to contribute toward your college education based on their finances.

This SAI will determine your eligibility for types of federal aid institutional scholarships, work-study, and federal student loans.

3. Max out gift aid

Loans are just one type of funding you can use to pay for college. The other type is called “gift aid” and includes grants and scholarships. Unlike loans, you never have to pay gift aid back. Because gifted funds don’t leave you in debt — or on the hook for interest payments — it’s best to explore all your avenues for this kind of aid before you start taking out loans. Once you’ve maxed out your gift aid, subtract this amount from the sticker price of your school. You’ll be left with your true cost of college: the amount you’ll have to figure out how to pay for yourself.

4. Evaluate 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). These options are usually not available when you borrow from a private lender.

Do federal loans require a credit check?

Taking out loans from the federal government usually doesn’t require a credit check. Anyone going to college can receive them as the primary borrower, no matter what kind of credit history they have.

Your parents may also take out Direct Parent PLUS Loans — either on their own or with the help of a cosigner (PLUS loans do require a credit check) — to fill in any remaining gaps for the cost of attendance.

What interest rates will I be eligible for?

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 student loans and which student loan borrower they apply to:

Applying for federal loans is as simple as 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. It’s important to know that subsidized loans do not accrue interest during school, your grace period, or in periods of deferment, while unsubsidized loans do during all these periods.

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. PLUS loans do not have limits like other types of loans do. But be careful with these. Without limits, it’s easy for parents and grad students to over borrow and accrue excessive debt.

5. Complete entrance counseling

Both undergrad and graduate students who have never taken out a federal loan will need to complete entrance counseling before the school year starts. Entrance counseling 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.

6. Evaluate private student loans

Federal assistance isn’t always enough to pay for college. Maybe you didn’t get approved for the full amount you need, or maybe the cost of your school exceeds the amount that federal loan limits will let you borrow. Regardless, private student loans can help you cover the gaps in funding.

Private lenders typically offer higher loan limits than the federal government. Many offer you a choice between fixed and variable interest rates, as well as a wider variety of loan terms than you’d get with federal loans. There are tons of private lenders out there, so make sure to do a robust online search, ask friends and family for lender recommendations, and thoroughly evaluate each one. Look for a lender that has:

7. Defer your loans during school

When you enroll at least half-time at an accredited college or university, your loans (whether federal or private) will be put into deferment. During periods of deferment, you don’t have to make loan payments. In-school deferment happens automatically; there’s nothing special you need to do to make this happen.

Unless you have federal Direct Subsidized Loans or Perkins Loans, your deferred loans will accrue interest during your in-school deferment period. So, if you borrow $10,000* in student loans with a 5% Fixed interest rate for a term of 15 years, and you take four years to complete your degree as a full-time student, those loans will accrue $2,375 in interest over those four years and your monthly payment will be $97.86 per month.

While you aren’t required to make interest payments while you’re in school, it’s often recommended. That’s because at the end of the deferment period, any accrued interest will be “capitalized,” or added to the principal amount of your loan. In the above example, after capitalization, your effective total loan balance after graduating will be $12,375, rather than just that $10,000*. You’ll have to pay interest on that higher amount going forward. That will cost you more money over the lifetime of the loan. You will likely pay a total of $17,614 over the life of the loan.

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

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.

8. Repay student loans after you graduate

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 if you drop below half-time enrollment (though this policy may vary with some private lenders).

Federal loan holders typically get a six-month grace period between the time they graduate and the date repayment begins. For private borrowers, the length of your grace period will vary by lender. Earnest** offers borrowers 9 months².

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 programs.

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, your loans will be automatically enrolled into the standard repayment plan. you have quite a few options for structuring your payment plan:

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.

What will my monthly payment be?

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. Try Earnest’s student loan calculator to see what your monthly payment might look like.

Longer loan terms generally result in lower monthly payments, but higher overall costs — because there’s more time for interest to accrue. On the other hand, shorter terms mean higher monthly payments, but usually less interest because there’s less time for it to accrue.

What is the minimum due?

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. This includes interest, fees, and principal.

Whenever possible, it’s best to pay more than your minimum amount. This is because any money you pay on top of the minimum should go directly to the principal balance (make sure to tell your lender you want your overpayment to apply to the loan’s principal, not next month’s bill) — 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 chip away at that principal balance, the less money you’ll end up paying over time — and the faster you’ll be debt-free.

How much will I pay in interest?

Your lender will typically set your student loan interest rate at the time you take out your loan. If you have a fixed interest rate, your rate will remain the same over the full duration of the loan. If your interest rate is variable, however, it will fluctuate depending on national interest rate trends and could go up over time.

The actual amount of interest you’ll pay over the life of the loan will also depend on the principal, or the amount you borrowed, and on the repayment period. The higher your principal and the longer your repayment period, the more you’ll pay in interest over the life of the loan.

You can use Earnest’s online loan calculator to see what your interest payments will look like for your particular loan amount.

Can I change my monthly payments?

Federal loans offer various repayment options that you can apply for at any time. These make it relatively easy to extend your loan term, which will shorten your monthly payment but cost you more in interest charges over the long run. The only way to change the payments on your private loans, however, is to refinance them.

9. Consider refinancing and/or consolidation

If national interest rates have dropped or if your personal finances have improved since you first took out your loans, you may want to consider student loan refinancing. Refinancing⁴ is a tool you can use to trade in your old loans for a single new loan with new terms. If you qualify for a lower interest rate, refinancing could save you hundreds if not thousands of dollars in interest charges over the life of your loan⁵.

Refinancing is available to both federal and private student loan borrowers. That said, refinancing federal loans turns them into private debt, and this can’t be reversed. So if you think you might qualify for a student loan forgiveness program or hope to take advantage of other federal borrower protections, consolidation might be a better option for you.

Student loan consolidation is a federal program that allows you to exchange your existing federal loans for a single new federal loan called a Direct Consolidation Loan. Since your debt stays federal, you remain eligible for federal forbearance, deferment, and other programs. However, you cannot get a lower interest rate by consolidating; the only path to a lower interest rate is refinancing.

10. Take advantage of hardship options when you 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 certain types of student loan forgiveness.

Deferment

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.

Forbearance

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.

Income-driven repayment

If at all possible, an income-driven repayment plan is likely a better option than deferment or forbearance because you can continue making payments without letting interest pile up. This is a type of hardship payment plan that calculates your monthly payments based on a percentage of your income. It’s designed to make sure your payments never get so high that they become a burden.

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.

PSLF isn’t the only type of forgiveness available for federal student loans. There are several circumstances, especially for students facing hardship, when forgiveness may be an option for federal loans.

Private student loans, on the other hand, are rarely eligible for forgiveness outside of extreme circumstances. These circumstances are different for every private lender.