By now you are most likely aware that you can take out loans to pay for college. But what does it mean to take out a loan? How do you actually do it?

First and foremost, federal student loans fall under the heading of Title IV funds and thus the first step in taking out a loan is completing the FAFSA. If you are considering taking out a loan for the coming school year and have not yet completed the FAFSA, you should contact your school’s financial aid office to ask for guidance.

A student may have a loan included in their financial aid package. If that’s the case, the student simply accepts the aid package and the loan will be applied. Otherwise, accessing loans can vary from school to school. My son’s school, for example, offers a direct student loan when you go online to pay your tuition bill—it’s just a checkbox. My daughter’s school requires you to contact financial aid to access a loan. If you’re unsure, just ask the school.

There are two components to student loan disbursement that families should understand:

  • Federal loans are disbursed equally for each academic term. If you’re a first year student borrowing the entire direct student loan ($5,500) attending a school that’s on semesters, you will get $2,750 per semester. If the school were on quarters, you would get $1,833.33 per quarter. (Scholarships work the same way, including outside scholarships.)
  • Loans are disbursed directly to the school, not to the student. Only after the school’s entire bill has been satisfied are any remaining dollars disbursed by the school to the student. For example, a student borrower with a bill of $1,000 net of scholarships and other payments would have the loan applied to that $1,000, then wait to receive the remaining $1,750 (or $833.33 as the case may be) from the school. This can be challenging for a student who intends to use their loan to pay for off-campus housing or books; if this is your situation, contact your financial aid office to find out when to expect the balance of your loan.

The above applies to all federal loans including Parent PLUS loans. Most private loans work the same way but there may be exceptions.

The other important piece of loans is repaying them. Student loans are automatically in deferment while the student is in school and through the six month grace period following graduation (or otherwise leaving school or attending less than half time). Loans that are unsubsidized will accrue interest during this time, which can increase the loan balance considerably. Subsidized loans do not accrue interest until they go into repayment. Students wanting to make payments while in school can look up their loans here to get instructions for doing so.

Parent PLUS loans can also be deferred while the student is in school; however, interest will accrue on the entire balance during the entire term of the student’s education. Parent borrowers will be given repayment options once the loan is fully disbursed for the year, i.e. after you are billed for the last academic term of the year. Parents who defer also receive the six month grace period following graduation or exit from at least half-time schooling.

After graduation, the borrower has a six month grace period before they enter repayment and payments are due. When the loan converts to repayment, all accrued interest is capitalized, or added to the loan balance. In English that means that while you are in school, you are only accruing interest on your original loan amount but once you enter repayment, the unpaid interest is added to the loan balance and therefore you pay interest on it as well. This year’s freshmen will accrue 2.75% of $5,500 each year, or $151.25 per year. Four years later when the loan transitions to repayment status, that $605 (4 x $151.25) is added to the $5,500 and the graduate now owes $6,105 with interest accruing on the entire $6,105. A parent who borrowed the same amount under the Parent PLUS loan program would accrue $291.50 each year (5.3% interest rate) and owe $6,666 if they deferred loan payments.

Students (or parents) who make payments at any time during the college years or in the grace period get dollar-for-dollar reductions in their future loan balance for doing so. However, since the interest doesn’t capitalize until the end of the grace period, there’s no incremental benefit to making payments earlier in the process.

Once the loan enters repayment, each payment will consist of interest and principal, so it lowers the loan balance more slowly. However, there is one reason not to make payments before the end of the grace period: In-school payments are not “qualifying payments” for loan forgiveness programs. A student who is likely to be in public service loan forgiveness or an income-driven repayment plan might not be well-served by making these payments.

One final note about repayment: the grace period ends and interest capitalizes when the loan converts to repayment status, not when the first payment is due. For a student who graduates in the spring, the first payment is typically in January; however, the loan converts to repayment status in November or December.