Understanding Student Loans 101

Laura Shin

1. Student loans are great, but grants and scholarships are better.
Grants and scholarships are free money … which means you don’t need to pay them back. Grants are awarded mostly on a needs basis and can come from the federal or state government. Scholarships are awarded on need or merit by any number of sources, such as a nonprofit, or, if your grades are stellar, the school you’re planning to attend. If you’re worried about the costs of college, try to get grants and scholarships to reduce the amount you have to take out in loans.

2. Decide whether an education at this university is worth the amount of debt you’ll have to take on.
When doing this calculation, take into account not just the loan but the amount you’ll pay in interest. So, for instance, if you take out the full amount in federal loans ($31,000) and pay it off over 10 years, you’ll also pay $11,800 in interest. Use this calculator to see how much your loan will cost you based on how quickly you pay it back. If you end up deciding it’s not worth it to take on that much debt, you could opt for a less expensive school, your parents could take out PLUS loans to help you, or you could decrease your college costs by spending a year or two at a community college to accumulate credits and then transfer to your school of choice for the remaining years.

3. Don’t borrow more than you need.
Only borrow as much as you need for your tuition and living expenses while in college. If you’re not sure how much you’ll need, use our checklist.

4. Do your best to avoid a private loan.
Only pursue a private loan after you’ve gotten the maximum you could have gotten from the government. And if you decide you need to take one, make sure you understand its terms inside out.

Remember …

Student loans are an important and worthy investment in your future, but taking out too much in loans or choosing loans from a private lender without looking into the fine print can quickly turn a good investment bad. If you do it right, however, the returns will make this debt entirely worth it.

RELATED: Out of School, Now What? 6 Things New Grads Should Do About Their Student Loans

This story was updated on February 16, 2017.

Update, October 31, 2012: We initially reported that private loans can charge fees but federal loans can’t. However, federal loans do charge a processing fee.

Paul Sisolak of GoBankingRates.com contributed some reporting to this story. 

  • Tony

    We were offered a Parent Plus Federal loan in my son award letter from the college he decided to attend. The rate on this loan is 7.9% and it has a 4% loan fee. The loans from the private institutions are half (for a fixed rate) and no fees. Is it still worth it to get the federal loan vs the private loan? Thanks.

  • Lauren

    Where do I go to obtain a college loan?