5 Things To Know About Student Loans: A Guide to Smarter Borrowing

Student loans are important in making college more accessible, but they also come with long-term financial responsibilities. According to 2024 Federal Reserve data, one-third of adults who attended college borrowed student loans to cover costs. Yet, many borrowers start their education without fully understanding how these loans work or how they'll affect their finances down the road.

Current private student loan rates

This guide breaks down five things you should learn about student loans before you borrow.

1. Start with federal student loans

Many students rely on a mix of federal and private student loans, but it's generally best to prioritize federal loans before considering private options.

Federal student loans, funded by the U.S. Department of Education, offer several advantages: lower interest rates, flexible repayment terms, and robust borrower protections. These protections include income-driven repayment plans, potential loan forgiveness, and options for deferment or forbearance if you face financial hardship.

Private student loans, on the other hand, are issued by banks, credit unions, or online lenders. While they can help fill funding gaps, they often come with higher overall costs and less flexibility. Interest rates can be fixed or variable, and your repayment terms will depend on the lender. Unlike federal loans, private loans require a credit check, and many borrowers need a cosigner to qualify.

Federal loans also don't require a credit history, making them more accessible to students, while private loans may offer higher borrowing limits for those who exceed federal loan caps. However, the long-term cost of private loans tends to be significantly higher due to higher interest rates.

2. Don't borrow more than you need

A common mistake among students is borrowing the full loan amount they're offered without considering their actual needs.

“Many young adults sign on the dotted line without fully considering the impact this debt will have on their future purchasing power,” says William Bevins, certified financial planner and private wealth manager.

“Before taking out any loans, consider exploring grants, work-study programs, or scholarships. Leverage the internet and other online resources to search for alternative ways to finance your college expenses,” he adds.

Learn More: 12 Ways To Pay For College Without Student Loans

Taking on more debt than necessary can lead to overwhelming payments after graduation, making it harder to meet other financial goals. To avoid this, estimate your future income using tools like the U.S. Bureau of Labor Statistics' Occupational Outlook Handbook. Compare your expected salary to your potential loan payments, and create a budget to determine how much you truly need to borrow.

While your school may provide a cost of attendance estimate — including tuition, fees, room and board, and supplies — it's crucial to double-check these numbers. The Government Accountability Office reports that 91% of schools don't give accurate cost estimates, so calculating your own budget ensures you aren't borrowing more than you need.

3. Interest adds up faster than you think

Many borrowers underestimate the impact of interest on their student loans.

“Most people believe that when they stop making payments, the balance stays the same, but that's where they're wrong,” says Bill Townsend, founder and CEO of College Rover. “Interest is cumulative, and debt can add up faster than people expect,” he adds.

Interest accrues daily on most student loans, meaning your balance grows every day your loan is outstanding. If you don't pay off the interest while you're in school or during your grace period, it will be added to your loan's principal. This is known as interest capitalization. Capitalization increases the total amount you owe, making it harder to pay down your loans after graduation.

To avoid this, consider making small, interest-only payments while you're in school. Even a small amount can prevent your balance from growing and help reduce your overall loan costs.

4. Plan your repayment strategy early

It's important to start thinking about repayment before your loan payments start.

“Don't just think you'll sort out repayment someday,” says Townsend. “Take some time now to plan it out. What's your monthly payment going to look like? How does that work with your budget after you graduate? It's smart to think about the long-term effects before you borrow,” he adds.

Here are some practical tips for creating a solid repayment strategy:

• Choose the right repayment plan: Look for a repayment plan that fits with your budget and goals. If you want to pay your loans off as quickly as possible, the standard 10-year repayment plan for federal loans may be a good choice. If you want low monthly payments and the option for loan forgiveness, you may want to look into an income-driven repayment plan.
• Make extra payments: Whenever possible, put extra money toward your loan principal to reduce the total amount you owe. For instance, you can apply tax refunds, bonuses, or other windfalls to your loans. Be sure to instruct your loan servicer to apply extra payments to the principal balance, not just the interest.
• Automate your monthly payments: Setting up automatic payments can help you avoid late payments. Plus, many lenders offer a rate discount of 0.25 percentage points when you enroll in autopay.
• Communicate with your lender: If you run into any problems, be proactive about reaching out to your lender. “They can facilitate measures like deferment or forbearance, and you only worsen the situation by ignoring them,” says Townsend.

5. You can potentially lower your loan costs

If you're looking to reduce or simplify your student loan debt, refinancing and consolidation are two options to consider. While they're often confused, these strategies serve different purposes and have distinct benefits.

• Refinancing: Refinancing involves replacing your existing loan(s) with a new private loan that offers different terms. Borrowers typically refinance to secure a lower interest rate or to adjust their repayment timeline. For example, you might extend your term to lower monthly payments or shorten it to save on interest.
• Consolidation: This option is available for federal student loans. It combines one or more loans into a single Direct Consolidation Loan, simplifying your monthly payments and potentially qualifying you for a longer repayment period, depending on your debt amount. Consolidation can also help you qualify for federal benefits tied to newer loans, such as certain income-driven repayment plans. However, it won't necessarily lower your interest rate. Instead, it averages the rates of your current loans to the nearest one-eighth of a percentage point