The Basics of Loans

All loans are not the same, but they are all constructed using the same basic building blocks. Understand these building blocks so you know what to look for when you're exploring options.


"Eligibility" refers to the minimum requirements you must meet in order to qualify for a loan.

For federal loans—Eligibility for federal student aid is usually based on financial need, as determined by the information you provide on the Free Application for Federal Student Aid (FAFSA®). For more details on eligibility, visit Student Aid on the Web.

For alternative (private) loans—Alternative loans are made by private lenders. Eligibility varies by lender and may be based on:

  • Your credit score
  • Your enrollment status (full time, part time, etc)
  • Your age
  • Other factors

Why do I need to know about eligibility?
Become familiar with each loan's eligibility criteria. If there are criteria you do not meet, can you do anything to qualify? For example, if your credit score is low or if you do not have a credit score, you may be required to have a co-signer. Make sure you know all of the eligibility requirements before you pursue any loan.

Who Pays

The person who takes out the loan (the student or the parent) is usually the person responsible for paying it back.

For federal loans—The person who takes out the loan (signs the promissory note) is responsible for paying the principal. In the case of a subsidized federal loan, the government pays the interest during certain approved periods. For an unsubsidized loan, the borrower can either:

  • Pay the interest while in school, during the grace period, or during any deferment
  • Capitalize (add) the accrued balance to the principal

For alternative (private) loans—Generally, the person who signed the promissory note is responsible for paying both the principal and the interest.

Why do I need to know who pays?
Know what you are responsible for paying so there are no surprises.

Interest Rates

Interest is the amount that a lender charges for lending you money.

For federal loans—Federal loans have a "fixed" interest rate, meaning the rate stays the same throughout the life of the loan.

For alternative (private) loans—Alternative loans frequently have a "variable" interest rate, meaning that the interest rate will fluctuate throughout the life of the loan, and the amount of your monthly payments may change.

Why do I need to know about interest rates?
The interest rate is very important to consider when searching for a loan. If you are comparing loans with fixed interest rates, choose the loan with the lower interest rate, because you'll have less interest to pay during the life of the loan. If you are comparing a fixed interest rate loan and a variable interest rate loan, the fixed rate loan may be a better choice if you expect interest rates to increase, whereas the variable rate loan may be a better choice if you expect interest rates to decrease.

Origination Fees

An origination fee is nothing more than a processing fee.

For both federal and alternative (private) loans—When you apply for a loan, someone must process the application. So the government, bank, or lending institution may charge a fee to cover this expense.

Why do I need to know about origination fees?
Check into the origination fees before you apply for any loan (not all loans have them). If the loan that you select has an origination fee (for example, 3%), the fee is an added cost for the loan.

Repayment Terms

"Repayment" is the word the lenders use to refer to the way in which you will pay back your loan.

For federal loans—Your promissory note states that you will repay the loan according to specific repayment terms. The repayment terms of your loan—the start date, the duration of repayment, and the repayment plan—may vary according to the type of loan you receive.

For alternative (private) loans—The repayment terms for an alternative loan may be less flexible than those for a federal loan.

Why do I need to know about repayment terms?
Read your promissory note so you know when repayment begins and how long it will last. And start out on the right financial foot by selecting a repayment plan that works for you.

Sometimes the right repayment plan makes all the difference in your ability to pay your student loan back.

Promissory Notes

The promissory note is a "promise to pay" contract between you and the lender that is providing your loan money.

For federal loans—Before you receive your federal student loan, you must sign a promissory note This legally binding document specifies your responsibilities (called the "terms and conditions") for paying back the loan. Because you may borrow federal loans under the same promissory note for up to 10 years, the federal government calls it a "master promissory note" or "MPN."

For alternative (private) loans—You must sign a promissory note before you receive an alternative loan as well. This document, which outlines your responsibilities, may vary from lender to lender.

Why do I need to know about promissory notes?
Because your responsibilities may vary according to the type of loan you receive, be sure to read any promissory note before you sign it, so you know what is expected of you. By signing the promissory note, you promise to repay your loan money, and you will be held accountable for doing so.

Borrower Incentive Programs

Some lenders may offer incentive programs that reward you for paying your loan on time.

For federal loans—Your lender may offer you a lower interest rate if you make payments through Direct Debit, in which payments are automatically withdrawn from your checking or savings account. If you have a direct federal loan, meaning your lender is the U.S. Department of Education, the interest rate reduction for using Direct Debit is 0.25%.

For alternative (private) loans—Incentive programs vary by lender and/or servicer. For example, you may be able to reduce your interest rate if you make timely payments for a number of consecutive months. Or you may get additional discounts if you pay your bill using Direct Debit.

Why do I need to know about borrower incentive programs?
Know the incentive programs available on any student loans that you borrow and take advantage of these available rewards.

Loan Limits

Loan limits refer to the maximum amount of money you are eligible to receive under a loan program.

For federal loans—Federal loan programs base their annual loan limits on your year in school. The loan limits are lower for freshmen than for upper classmen and graduate students. In the case of PLUS loans (for parents and graduate students), the loan limits are determined by the cost of attendance minus any other aid you are expected to receive (for example, in the form of grants or scholarships).

View federal loan limits at Student Aid on the Web.

For alternative (private) loans—Loan limits generally depend on the borrower's credit score in addition to the student's cost of attendance minus any other aid that the student may be receiving.

Why do I need to understand loan limits?
Loan limits determine the maximum amount that you may borrow. However, you may be eligible for less than the maximum amount based on your cost of attendance, your expected family contribution, and any other aid you may be receiving.

Never borrow more than you need for your education, even if you are eligible to receive a larger loan amount.

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