Understanding How Student Loans Work

February 5, 2019 by Comerica Bank

Student loans rank among the dominant themes of personal finance today. Rising tuition costs across the nation and increased debt carried by graduates has rocketed student loans to the top of the priorities list for many consumers. Indeed, there are several macro factors influencing the discussion: generational shifts in the population, the overall economic recovery and job creation post-Great Recession, for example. 

Yet these overarching factors can sometimes cloud what is already a complex concept. Student loans themselves, while seemingly essential to the financing of higher education, can be difficult to get one's head around. There are a number of variables to become familiar with, from what terms you receive to how you plan for repayment.

Understanding how student loans from a bank work versus how a government loan works is a critical differentiation to make. Finding the right financing for your education depends on what you know about student loans. Consumers considering college or university can talk to their local bank to learn more about getting a loan, but to start, here's a guide to the most important points.

Quick facts about student loans

According to Federal Reserve statistics, U.S. consumers owed more than $1.5 trillion in student loan debt at the end of 2018, which is more than double the amount just a decade earlier. The share of debt held by younger students has rapidly inflated: Of adults with student loan debt, nearly 40 percent are ages 18 - 29. Tuition cost increases have fed this rise in part. U.S. News and World Report®️ data showed the average annual cost of attending a public, in-state school in 2007 was $6,468 (that's including tuition and room and board). By 2017, that figure reached $10,691. For private college, the increase is even more extreme, with average tuition and fees climbing from nearly $28,000 in 2007 to above $41,000 in 2017. 

The average bachelor's degree holder owes $27,000 by the time he or she completes school, Pew Research Center®️ said. Seeking more education costs more money, as postgraduate students owe on average $45,000.

How a private student loan works

Private student loans only enter the equation after a student has filled out the Free Application for Student Aid (FAFSA). Upon completing this form, borrowers will receive a letter stating how much in grants and federal loans a student can expect. If this aid does not meet all costs concerned, students can then apply for a private loan from a bank or other financial institution.

Application process

While many students seek private loans from a bank or other financial institution as a supplement to federal financial aid to help pay tuition, that's not the only direct cost of education private loans can help with. Other items include textbooks and other living costs. It all starts with the application process, which is a key stage of the loan process. Applicants must:

  • Gather documentation: This includes readying your driver's license, Social Security number, school information and any other materials needed to establish identity or personal history.
  • Decide on how much to borrow: Since federal loans are tied to financial need, their amounts are limited. Private loans, however, are not capped and students can request what they want (even if they only get a portion of that initial figure). It's crucial here to budget and plan out what you need from a private loan. You don't want to get stuck with debt you don't actually need, but now must pay interest back on.
  • Get a cosigner: Loan applicants without a credit history (as most students about to enter college are) need to get a cosigner for their loan to satisfy lender demands. More on this below.

Credit-based decision

A key differentiator between private loans and government loans is that those in the former category are based on creditworthiness. That means the amount you receive and the rates you borrow at are influenced by credit history. This is what makes a cosigner so important. Students don't often have the employment history and established credit that qualifies them for beneficial rates and terms, so most use a relative or close relation to act as a cosigner to their loan. Another alternative is a parent loan, where a credit-worthy parent or guardian takes out a loan on behalf of their college-bound child, which can mitigate the latter's potential lack of credit. This means that even if you have no credit or bad credit as a student, there are still opportunities to get a private loan under the right circumstances.

Fixed and variable rates available

One of the bigger draws to a private loan is the borrower's ability to benefit from a variable rate arrangement. Private loans generally come in two formats: the fixed rate and the variable rate. Both are fairly self-evident, but a fixed rate loan is one with a locked-in interest rate from the beginning, while variable rate loans come with adjustable terms that may fluctuate with the greater economy and open students to the possibility of reduced costs. However, many variable rate plans also come with low introductory rates that can increase dramatically later on. Students must be sure to talk through the loan offering with their bank to be totally clear on the variables offered. 

Repayment plan

It is vitally important to understand your private loan repayment terms. While federal loans across the board do not require payment until after graduation (and even then, offer flexible repayment strategies), some private loans may require payment while you're still in school. Lenders may expect timely repayment upon disbursal of funds without a grace period. At other times, there may be penalties for earlier repayment that students and any cosigners have to be aware of. Also, it's less likely that a private loan will be forgiven if the borrower cannot make payments. While the government does forgive student debt in certain cases, private lenders typically maintain much more stringent criteria. In such cases, however, working with your bank or financial partner to find a pathway to repayment is possible and may lead to more flexible terms.

What separates government loans from private loans

While the differences between federal and private loans seem clear, the details are always the deciding factor:

  • Interest rates: As mentioned, federal student loans come at only fixed rates, whereas private loans allow for fixed or variable interest rates. Also, if a student qualifies for a subsidized federal loan, the government will pay interest for him or her throughout the duration of schooling, or at least on a short-term basis. Interest paid on federal loans is always tax-deductible up to a maximum cap, while students will have to check their tax-exempt status with their private lender.
  • Repayment options: Federal student loans don't have to be repaid until a student graduates, leaves school or becomes less than a half-time student. Even then, students have a number of deferment options they can take advantage of if personal economic difficulty makes full payments a challenge. The government, for instance, allows students to tie payments to monthly income. Consumers with multiple loans from the government may also consolidate their accounts under the U.S. Department of Education and its partners, something that those with a private loan might not be able to do.
  • Credit impact: Federal loans are not made on the basis of credit and thus don't require a cosigner or credit checks. However, federal loans are reported to national credit bureaus, so taking out such loans can help students build first-time credit by establishing an account, history and track record of payments once they begin.

Student loan refinancing

Yet another distinction to be made between the two types of student loans is the possibility of refinancing. Since the federal government disperses loans on a fixed-rate basis, students can only refinance their loans into a new federal loan called a Federal Consolidation Loan. Students can, on the other hand, refinance their private loans into a new private loan. Refinancing is an attractive option for many young consumers because it allows them to take advantage of current economic conditions. If the opportunity for a lower rate arises thanks to market movements or policy decisions, students can work with their bank to explore refinancing options. Student loans are a big decision in the life of any student or parent. Finding the right financing from the best partners means all the difference in getting a loan with the right terms and repayment options. Reach out to Comerica Bank today to talk to our qualified professionals on any of the private student loan products. These offerings include parent loans that can limit the effect a student's lack of credit or financial means may have on the loan. 


This information is provided for general awareness purposes only and is not intended to be relied upon as legal or compliance advice. 

This article is provided for informational purposes only. While the information contained within has been compiled from source[s] which are believed to be reliable and accurate, Comerica Bank does not guarantee its accuracy. Consequently, it should not be considered a comprehensive statement on any matter nor be relied upon as such.

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