How Student Loans Work: A Simple Guide

If you don’t have a clue on how student loans work, you’re in the right place! I’ll try to keep it simple as much as possible to help you get the basics.

Terms To Get You Started:

  • Principal– the total amount of money you are borrowing (for tuition, supplies, living expenses etc.)
  • Disbursement – fancy term for the principal ($$) actually given to you and/or your school for your education
  • Deferment – the amount of time allowed before you have to start paying back the money. Typically the period of time you are in school plus a few months after to let you get a job and get on your feet, but this can vary.
  • Interest– the amount of money you will be paying back in addition to paying back the principal. This is a percentage number, not a flat fee, and the total amount that you will pay in interest over time depends on a number of factors not limited to 1) the percentage rate 2) how much principal you still owe 3) how fast you pay off the loan. Keeping it super simple, if you borrow $100 with a 5% annual interest rate, after 1 year you will owe $105. Someone has to make money in order to have a reason to give it to you!
    • Fixed rate- the annual percentage does not change over time. If you start at 5%, you end at 5%
    • Variable rate- the percentage rate changes over time. You may start out low at 2% but up high at 11%. More likely to occur on private loans
  • Loan Fee– similar to interest, but instead of adding up and being paid off later, the “fee” is immediately deducted from the amount of money you receive.  So if you borrow $100 with a $1 fee, you will only get $99, but still have to pay back $100 (not even considering interest yet). Most federal loans have loan fees and they are taken out of each disbursement
  • Loan Servicer– the company that you will make loan re-payments to once you are ready. Read here if you want a more detailed dive.
  • Repayment Plan– schedule of how the principal + interest will be paid back over time, it’s not just a free-for-all, pay us back whenever you feel like it! There are tons of different options from a “standard” fixed monthly payment over 10 years, to plans which allow you to pay less initially and more later (as your income presumably grows) and other plans which are tied to the amount of money you make.  Check this site out for more details
  • Federal vs. Private – federal loans are backed by the government, private loans are made by private companies who set their own rates and general terms
  • Subsidized vs. Unsubsidized – Subsidized loans are “better” because the government pays the interest on your principal while you are attending school and you do not have to pay it back (woooo free money).  Unsubsidized loans accumulate interest during the time period you are in school and you must pay the ~4 years worth of interest back.  You might have to start paying this during the time you are in school, and if not, you will certainly pay for it afterward.
Fun fact! Interest Rates on Federal Loans are set by... CONGRESS!
So if you're 18+, pay attention and vote because it will affect you.

Things to consider before borrowing:

      • What fields are you generally interested in? No one expects you to know what you want to do before you even have a chance to try some hats on for size, but you probably have a general idea.  Are you interested in high powered, cut throat, corporate ladder climbing roles like finance, law or business?  Or perhaps you are more interested in community organizing or social welfare? Maybe you land somewhere in the middle and want a comfortable, but not overly demanding job dealing with banking, customer service, etc.
      • Once you’ve gotten a general idea of 3-5 potential fields you may be interested in, make a note of those salary levels and keep in mind that as a new hire you will likely be making even less… so if the range is $30,000 – $45,000, err on the side of caution and assume you will be on the lower, not higher end, of the scale. If you turn out to make more, great! But better to be safe than sorry.

TL:DR- A Simple Chart to Break It Down!

Breakdown 2 Year Community College 2 Year CC + 2 Year Transfer 4 Year Public University  4 Year Private Uni
Estimated Annual Cost of Tuition/ Room & Board  $      7,500  $       16,250  $      25,000  $       50,000
Total Cost after 4 years (2 for CC) = Principal  $   15,000  $       65,000  $    100,000  $     200,000
Interest Rate (No Loan Fees for Simplification) 4% 4% 4% 4%
10 Year Standard Monthly Payment  $         151  $            658  $        1,012  $         2,204
Annual Salary Needed to Make Monthly Payment*  $   18,224  $      78,970  $   121,494  $    242,988
Total Amount Paid after 10 Years  $   18,224  $      78,971  $   121,494  $    242,988
Total Interest Paid after 10 Years (cost to borrow the $)  $     3,224  $      13,971  $     21,494  $      42,988
30 Year Standard Monthly Payment  N/A  $           310  $          477  $           954
Annual Salary Needed to Make Monthly Payment*  ONLY AVAILABLE  $     37,238  $    57,290  $   114,579
Total Amount Paid after 30 Years  TO DEBTS OVER  $   111,715  $  171,867  $   343,739
Total Amount Interest Paid after 30 years $33,000  $     46,715  $    71,867  $   143,739

*Note on the “Annual Salary Needed to Make Monthly Payment” – this is a number that figures you set aside about 10% of each paycheck toward paying your student loans (i.e. $10 out of every $100 you make for 10 years).  If you live in an area with low cost of living, you can probably set aside a higher percentage of your check to go toward paying off your student loans (another way to think of it, is that you don’t have to make as much as the chart shows in order to pay off your debt. If you put $20 out of $100 toward paying your debt, but don’t pay much in rent because you live at home or anywhere besides LA, SF, NYC, you can get by with a lower salary than what it shows on the chart).

As you can see, the more money you take out, the money you will owe (in both principal & interest).  If you extend the time frame to pay back the loan (or pay less now and more later) you will end up paying more over time.  And certainly, if your interest rate is higher than 4% these numbers will look even worse.  The bigger this debt payment is, the less money you’ll have to put into savings for fun things like going to dinner, vacation, and grownupthangs like rent, cell phone bills and eventually buying a home. So use this as a general guide- plug in numbers for your own colleges here to see a simple look at what repayment can look like.  Here is the government calculator too, based on their own “average” costs for various types of schools/lengths.

Regardless of what option you choose- remember to do whatever you can to make those payments on time and in full, so you can build good credit!

I know this is a lot to take in, but better to put the effort into learning it now than learning the hard way and literally paying for it. If you plan to be educated this is a good place to start that education! This is not meant to discourage anyone from taking loans, but rather to make sure that you consider if it is right for you before committing from something that you cannot (typically) walk away from.

One thought on “How Student Loans Work: A Simple Guide

Leave a Reply

Your email address will not be published. Required fields are marked *