# How do student loans work?

> Know which loans are federal and which are private, then pick a repayment plan you can keep up with.

Source: https://www.walletprep.com/learn/student-loans/ · Updated 2026-10-04 · Debt

Student loans are either federal, from the US Department of Education, or private, from a bank, credit union or online lender. Federal loans come with repayment options and protections that private loans usually lack, so the type of loan shapes every choice you make about it.

## Key facts
- **Two kinds of loans.** Federal student loans come from the US Department of Education, and you apply with the FAFSA. Private student loans come from banks, credit unions and online lenders and usually depend on your credit or a cosigner.
- **Interest starts early.** Interest on most loans builds from the day the money is paid out, even while you are in school. Subsidized federal loans are the exception: the government pays that interest while you are enrolled at least half-time.
- **More than one way to repay.** Federal loans offer fixed-payment plans and income-driven plans that tie the payment to your income. If any loan was first paid out on or after July 1, 2026, your choices are the Repayment Assistance Plan or the Tiered Standard Plan.
- **Refinancing has a cost.** Refinancing federal loans with a private lender can lower your rate, but it ends federal protections like income-driven repayment, federal forgiveness programs and federal deferment.

## Federal and private loans
Federal loans have fixed interest rates set by law for each school year, and most don't require a credit check. They also come with a set of borrower protections written into federal rules.
Private loans are made by lenders under their own terms. The rate can be fixed or variable, it often depends on your credit score, and many students need a cosigner. Options if you lose your job or your income drops are up to the lender and are often more limited.
Most guidance, including StudentAid.gov, suggests using federal loans before private ones for that reason.

## How the interest adds up
Student loan interest is usually simple daily interest on the balance. A $20,000 loan at 6% builds $20,000 × 6% ÷ 365, or about $3.29 a day, which is about $100 a month.
If you don't pay that interest while you are in school or in a grace period, it piles up. In some situations, unpaid interest can be added to your balance, which is called capitalization. After that, you pay interest on the old interest too.

## Repayment plans
A fixed plan has a set monthly payment over a set term. It usually costs the least in total interest because you pay the loan off fastest. For Direct Loans first paid out on or after July 1, 2026, the fixed option is the Tiered Standard Plan, which runs 10 to 25 years depending on how much you owe.
Income-driven plans set your payment from your income and family size. The payment can be much lower, which helps when money is tight, but a lower payment over more years usually means more total interest. Some of these plans forgive a remaining balance after many years of payments. The newest one, the Repayment Assistance Plan (RAP), charges 1% to 10% of your income.
Which plans you can use depends on your loan dates. If even one loan, including a new Direct Consolidation Loan, is first paid out on or after July 1, 2026, all your Direct Loans must go on RAP or Tiered Standard. If every loan came before that date, older plans like IBR stay open, and PAYE and ICR close no later than July 1, 2028. Parent PLUS loans can't use RAP.
The SAVE Plan was blocked by a federal court on March 10, 2026, so borrowers in SAVE forbearance must choose another plan. Our lesson on student loan repayment plans walks through each option, and StudentAid.gov has the current rules.

## When refinancing makes sense
Refinancing means a private lender pays off your loans and gives you a new loan, ideally at a lower rate. For private loans, it can save money with little downside.
For federal loans, weigh it carefully. You give up income-driven plans, federal deferment and forbearance, and programs like Public Service Loan Forgiveness. If your income is steady, your savings are healthy and you won't need those options, a lower rate may be worth it. If your job is uncertain, keeping them is usually safer.
A federal Direct Consolidation Loan is different. It combines federal loans into one federal loan and keeps them federal. One made on or after July 1, 2026 counts as a new loan, though, so it limits all your Direct Loans to RAP or Tiered Standard.

## A worked example: a lower payment over more years
Jordan owes $20,000 in student loans. Assume a 6% rate. She compares a 10-year fixed payment of $223 with a smaller $144 payment over about 20 years.

- Borrowed: $20,000
- Interest at $223/mo, 120 months: $6,603
- Total paid, 10 years: = $26,603
- Borrowed: $20,000
- Interest at $144/mo, 238 months: $14,231
- Total paid, about 20 years: = $34,231
- Minus the 10-year total: −$26,603
- Extra cost of the lower payment: = $7,628

1. At $223 a month, Jordan is done in 120 months and pays $6,603 in interest, for $26,603 in total.
2. At $144 a month, it takes 238 months and $14,231 in interest, for $34,231 in total.
3. The lower payment frees up $79 a month but costs $34,231 − $26,603 = $7,628 more over the life of the loan.
4. Jordan picks the $223 payment. If her income drops, she can ask her servicer about lower federal options.

## Common mistakes
- **Ignoring interest during school.** Unsubsidized and private loans build interest while you study. Even small payments toward that interest keep the balance you start repayment with closer to what you borrowed.
- **Refinancing federal loans too quickly.** A lower rate looks good, but federal protections are gone once you refinance privately. Check that you won't need an income-driven plan or forgiveness first.
- **Going silent when payments get hard.** Missed payments add late fees and can damage your credit. Federal loans that go unpaid long enough go into default. Your servicer can often lower or pause payments if you ask.

## Questions people ask
### How do I find out what student loans I have?
Log in to StudentAid.gov with your FSA ID to see your federal loans and who services them. Private loans won't show there, so check your credit report from free weekly from each of the three bureaus at AnnualCreditReport.com to find them.

### Should I pay off student loans or invest?
It depends on the rate. Paying off a loan saves its interest rate for certain, while investment returns vary and can be negative. Many people take any employer retirement match first, then pay down loans with higher rates faster.

### Can student loans be forgiven?
Some federal loans can be forgiven through programs for public service work, for teachers, for borrowers with a total and permanent disability, or after many years on an income-driven plan. Rules are specific, so check StudentAid.gov. Private loans rarely offer forgiveness.

### Does a federal consolidation loan lower my rate?
Usually not. A Direct Consolidation Loan uses a weighted average of your current rates, rounded up to the nearest one-eighth of a percent. It keeps your loans federal, but one made on or after July 1, 2026 also limits you to RAP or the Tiered Standard Plan.

## Do this today
Log in at StudentAid.gov and write down each federal loan's balance, rate, servicer and first disbursement date. Add any private loans from your credit report. Then run the Repayment Calculator to see your payment on each plan you qualify for.

## Sources
- [StudentAid.gov: Federal versus private loans](https://studentaid.gov/understand-aid/types/loans/federal-vs-private)
- [StudentAid.gov: Repayment plans](https://studentaid.gov/manage-loans/repayment/plans)
- [StudentAid.gov: Interest rates and fees](https://studentaid.gov/understand-aid/types/loans/interest-rates)
- [CFPB: Repay student debt](https://www.consumerfinance.gov/paying-for-college/repay-student-debt/)
- [StudentAid.gov: One Big Beautiful Bill Act updates](https://studentaid.gov/announcements-events/big-updates)
- [StudentAid.gov: IDR plan court actions](https://studentaid.gov/announcements-events/idr-court-actions)

_General education, not personalized financial, tax or legal advice. Figures are examples. Check current rates and limits before you act._