Key takeaway
Federal loans usually have better protections, and understanding your repayment options can save money and stress.
Student loans are an investment in future earnings, not free money
Student loans let you borrow money for education expenses, with the expectation that your future earnings will be high enough to repay them. Unlike scholarships or grants, student loans have to be paid back, usually with interest.
The difference between good student debt and overwhelming student debt usually comes down to whether the degree you earn actually increases your income enough to justify the borrowing.
Federal vs private student loans: the key differences
Most student loans fall into two categories: federal loans offered by the government, and private loans offered by banks, credit unions, or online lenders.
Federal loans usually have better terms for borrowers:
- fixed interest rates that don't change over the life of the loan
- income-driven repayment plans that cap payments at a percentage of your income
- loan forgiveness programs for certain careers or after long repayment periods
- deferment and forbearance options when you can't make payments
- no credit check required for most undergraduate federal loans
Private loans typically lack these protections, though they might offer lower rates to borrowers with excellent credit or a cosigner. It usually makes sense to exhaust federal loan options first before turning to private loans.
How student loan interest works
Student loan interest is usually calculated daily using a simple interest formula. That means interest accrues each day based on your current loan balance, rather than compounding monthly.
For subsidized federal loans, the government pays the interest while you're in school at least half-time, during your grace period, and during deferment. For unsubsidized loans, interest starts accruing as soon as the loan is disbursed, even while you're still in school.
If you have unsubsidized loans, you can choose to pay the interest while in school or let it capitalize (be added to your principal balance) when you enter repayment. Paying the interest as it accrues saves you money in the long run because you avoid paying interest on interest.
The grace period and entering repayment
Most federal student loans come with a six-month grace period after you graduate, leave school, or drop below half-time enrollment. This gives you time to get settled before payments start.
The grace period is a good time to:
- understand exactly how much you owe and what your interest rates are
- choose a repayment plan that fits your expected income
- set up automatic payments to qualify for a slight interest rate reduction
- update your contact information with your loan servicer
Private loans might have different grace periods or none at all, so check your loan terms carefully.
Repayment plans: standard vs income-driven
Federal student loans offer several repayment plans:
- Standard repayment: Fixed monthly payments for 10 years. This is usually the fastest and cheapest option overall.
- Graduated repayment: Payments start low and increase every two years, still over 10 years. This can fit if you expect your income to rise significantly.
- Extended repayment: Extends the term to 25 years, lowering monthly payments but increasing total interest paid.
- Income-driven plans (IDR): Caps payments at 10-20% of your discretionary income, with forgiveness of any remaining balance after 20-25 years.
Income-driven plans can be a lifeline if your income is low relative to your debt, but they usually result in paying more total interest over time. They also require recertifying your income annually.
Student loan forgiveness and cancellation
Some federal student loans might be forgiven, canceled, or discharged under certain circumstances:
- Public Service Loan Forgiveness (PSLF): Forgives remaining balance after 10 years of qualifying payments while working full-time for a qualifying employer.
- Teacher Loan Forgiveness: For teachers who work full-time for five consecutive years in certain low-income schools.
- Total and Permanent Disability Discharge: For borrowers who become totally and permanently disabled.
- Closed School Discharge: If your school closes while you're enrolled or soon after you withdraw.
These programs have specific eligibility requirements that are worth understanding early if you think you might qualify.
How to handle multiple student loans
If you have multiple student loans, you have a few options for managing them:
- Keep them separate: Track each loan individually, paying extra toward the highest-interest loan first (the avalanche method).
- Consolidate: Combine federal loans into a Direct Consolidation Loan with one payment. This simplifies things but doesn't lower your interest rate—it averages them.
- Refinance: Replace both federal and private loans with a single private loan at a lower interest rate. This can save money but means losing federal protections like income-driven repayment and forgiveness.
Refinancing federal loans is usually a one-way door, so only consider it if you're confident you won't need the federal protections you're giving up.
Student loans fit into a bigger financial picture
Student debt should be weighed against the earning potential of the degree you're pursuing. Before borrowing heavily, research the typical starting salaries and career paths for your field.
Once you have student loans, they become part of your monthly budget. The goal is to make consistent payments while still building an emergency fund, saving for retirement, and pursuing other financial goals.
Related next steps
Use the Student Loan Calculator to see what your monthly payment might look like and how extra payments could shorten your repayment, then check the Debt-to-Income Ratio Calculator to see how student debt affects your borrowing power for other goals. If you're comparing repayment strategies, try the Debt Payoff Calculator.