Student debt works by borrowing money to pay for college or graduate school, then repaying it with interest after you leave school. Most student loans come from the federal government, though private lenders also offer them. The two types differ significantly in how interest is set, what protections you get, and how flexible repayment can be. Understanding these mechanics helps you borrow smarter and pay less over the life of your loans.
Federal vs. Private Loans
Federal student loans are issued by the U.S. government with terms set by law. You don’t need a credit check to qualify for most of them (the exception is PLUS loans, which do involve a credit review). Interest rates are fixed, meaning they stay the same for the life of the loan. For loans first disbursed between July 1, 2025, and July 1, 2026, undergraduate rates are 6.39%, graduate rates are 7.94%, and Parent PLUS loans carry an 8.94% rate. These rates are set annually by Congress based on the 10-year Treasury note yield, so they change each academic year but lock in once your loan is disbursed.
Private student loans come from banks, credit unions, and online lenders. They typically require an established credit history or a cosigner. Interest rates can be fixed or variable and may be higher or lower than federal rates depending on your creditworthiness. The key tradeoff: private loans sometimes offer competitive rates for borrowers with strong credit, but they lack the built-in safety nets federal loans provide, like income-driven repayment and forgiveness programs.
How Interest Accrues
Interest on student loans accrues daily. The calculation is straightforward: your loan balance is multiplied by your annual interest rate, then divided by 365 to get a daily interest charge. On a $10,000 loan at 6.8%, that works out to about $1.86 per day. Over a full year of not making payments, roughly $680 in interest builds up on that balance alone.
Federal loans come in two flavors that matter here. Subsidized loans are available to undergraduates who demonstrate financial need, and the government pays the interest while you’re enrolled at least half-time, during your grace period, and during certain deferment periods. Unsubsidized loans start accruing interest the moment the money is disbursed, even while you’re still in school. Private loans are never subsidized, so you’re responsible for all the interest from day one.
Capitalization
Capitalization is what happens when unpaid interest gets added to your principal balance. If you have a $10,000 loan and $2,000 in unpaid interest capitalizes, your new balance becomes $12,000, and future interest accrues on that larger amount. This is how balances can grow even when you haven’t borrowed another dollar.
Capitalization typically triggers after periods when you weren’t making payments: your post-graduation grace period, a forbearance, or a deferment. On unsubsidized and private loans, interest accumulates during these stretches and rolls into your principal once regular payments resume. Making interest-only payments during school or grace periods, even small ones, prevents capitalization from inflating your balance.
When Repayment Starts
Most federal student loans include a six-month grace period after you graduate, leave school, or drop below half-time enrollment. During that window, no payments are required (though interest still accrues on unsubsidized loans). Once the grace period ends, you enter repayment automatically under the Standard Repayment Plan unless you choose something else.
Private loan terms vary by lender. Some offer a grace period similar to federal loans, while others require payments while you’re still enrolled. Check your loan agreement for the specifics.
Federal Repayment Plans
The federal system offers several repayment structures, and you can switch between them at any time without a fee.
The Standard Repayment Plan sets fixed monthly payments over 10 years. This is the default and the fastest way to pay off your loans, meaning you’ll pay the least total interest. The Graduated Repayment Plan also uses a 10-year timeline, but payments start lower and increase every two years, which can help if your income is modest right after graduation but expected to rise. The Extended Repayment Plan stretches your timeline to 25 years with either fixed or graduated payments, but you need more than $30,000 in outstanding Direct Loans to qualify. Longer timelines mean lower monthly payments but significantly more interest paid over the life of the loan.
Income-Driven Repayment
Income-driven repayment (IDR) plans tie your monthly payment to how much you earn rather than how much you owe. There are several versions:
- Income-Based Repayment (IBR) caps payments at 10% or 15% of your discretionary income (the gap between what you earn and a poverty-line threshold), depending on when you first borrowed. Your payment will never exceed what you’d pay under the Standard Plan.
- Pay As You Earn (PAYE) caps payments at 10% of discretionary income for borrowers who meet specific eligibility criteria.
- Income-Contingent Repayment (ICR) sets payments at the lesser of 20% of discretionary income or what you’d pay on a 12-year fixed plan, adjusted for income.
IDR plans recalculate your payment annually based on your income and family size. If your income is low enough, your payment can drop to $0 for that year, and that still counts as a qualifying payment. After 20 or 25 years of payments (depending on the plan), any remaining balance is forgiven. That forgiven amount may be treated as taxable income, though rules on this have shifted in recent years.
How Forgiveness Works
Public Service Loan Forgiveness (PSLF) is the most well-known path to having your balance erased. It requires 120 qualifying monthly payments (essentially 10 years) made under an accepted repayment plan while working full-time for an eligible employer. Eligible employers include federal, state, and local government agencies, as well as qualifying nonprofits. The forgiven balance under PSLF is not taxed as income.
Loan discharge is different from forgiveness and applies in specific circumstances. If your school closes while you’re enrolled or shortly after you withdraw, you may qualify for a closed school discharge, which cancels your federal loans related to that school. If you become totally and permanently disabled and can no longer work, you can apply for a total and permanent disability discharge covering your federal loans. In both cases, you generally won’t owe anything further on the discharged amount.
What Happens If You Can’t Pay
Federal loans offer options if you hit a rough patch. Deferment lets you temporarily stop making payments, and on subsidized loans, the government continues covering interest during that time. Forbearance also pauses or reduces your payments, but interest accrues on all loan types and capitalizes when the forbearance ends.
If you stop paying federal loans entirely, they become delinquent immediately and go into default after about 270 days of missed payments. Default triggers serious consequences: your credit score drops, the entire balance becomes due immediately, the government can garnish your wages and tax refunds, and you lose eligibility for future federal financial aid. Private loan default timelines and consequences vary by lender but can be similarly damaging to your credit.
How to Reduce What You Owe
There’s no prepayment penalty on federal or most private student loans, so paying more than your minimum each month goes directly toward reducing your principal. Even an extra $50 a month can shave years off your repayment timeline and save thousands in interest. When making extra payments, contact your servicer to ensure the overpayment is applied to principal rather than being counted as an early payment for the next month.
Refinancing is an option primarily through private lenders. You take out a new loan at a lower interest rate and use it to pay off your existing loans. This can save money if your credit has improved since you originally borrowed, but refinancing federal loans into a private loan means permanently giving up access to income-driven repayment, PSLF, deferment, and forbearance. For borrowers who plan to use those protections, refinancing federal loans is rarely worth the tradeoff.
Employer student loan repayment assistance has grown more common, with some companies contributing toward employees’ loan balances as a workplace benefit. If your employer offers this, it effectively acts as free money toward your debt.