What Students Need to Know Before They Borrow

As students complete the financial aid process the summer before school begins, one of the last requirements before federal funds can be released is to sign the Master Promissory Note — a legal agreement between the borrower and the federal government that sets the terms for borrowing and repaying federal student loans. Before signing a Master Promissory Note, it’s important for students and their families to thoroughly understand the conditions of this contract. These details determine how much a degree truly costs, and a basic grasp of the system can be the difference between manageable debt and a balance that grows out of control.

Understanding Loan Types

Understanding Borrowing Limits

Federal borrowing caps determine how much can be borrowed, as well as how much of the borrowed amount can be subsidized vs. unsubsidized.

Limits for dependent undergraduate students:

• Freshman Year: $5,500 total (up to $3,500 subsidized)

• Sophomore Year: $6,500 total (up to $4,500 subsidized)

• Junior & Senior Years: $7,500 per year (up to $5,500 subsidized)

Limits for independent undergraduate students:

• Freshman Year: $9,500 total (up to $3,500 subsidized)

• Sophomore Year: $10,500 total (up to $4,500 subsidized)

• Junior & Senior Years: $12,500 per year (up to $5,500 subsidized)

When the cost of attendance exceeds these limits, borrowers often turn to additional funding sources. This could mean relying on Parent PLUS loans (now capped at $20,000 annually) or private loans, which can cover the gap, but come with higher costs and more complex tradeoffs.

Accounting for Hidden Origination Fees

Before student loans are disbursed, the federal government deducts an origination fee:

• ~1% for undergraduate loans

• ~4% for Parent PLUS loans

This means the amount borrowed is not the same as the amount received.

For example, if $10,000 is borrowed through a Parent PLUS loan:

• $423 ($10,000 × 4.23%) is deducted as a fee

• Only $9,577 is actually disbursed, creating an immediate gap of $423

To avoid this, students should factor in origination fees when deciding how much to borrow so the amount disbursed actually covers the full cost.

How Interest Grows Over Time

Interest is where the borrowing amount can change the most, and it often happens quietly.

One reason for this is how federal student loans are structured. Students don’t receive one single loan for their entire time in school. Instead, each year they borrow, a new loan is originated for that academic year — with its own amount and interest accrual. 

For example, a student who borrows $20,000 over four years may not have one $20,000 loan, but instead four separate loans of $5,000 each. Each of those loans begins accruing interest based on when it was disbursed. Because of this, how interest is applied to each loan can make a meaningful difference in how balances grow over time.

Remember, interest behaves differently depending on the loan type. Subsidized loans don’t accrue interest while you’re in school, but unsubsidized loans do. And after graduation, any unpaid interest is added to the original loan balance—a process called capitalization. At this point, interest is calculated on the new, higher balance. What may seem like a small amount of interest during school can compound into a significantly higher loan balance.

Here’s an example of how loan balances change depending on type of loan and how interest is handled:

• Subsidized loans: No interest builds while you’re in school, so your balance stays the same

• Unsubsidized (interest paid): Interest builds, but paying it as you go keeps your balance from growing

• Unsubsidized (interest unpaid): Interest builds quietly and is added to your loan at graduation, increasing your balance

Important to note: After graduation, there’s typically a 6-month grace period before repayment starts, though interest may still accrue depending on the loan type.

The Difference Is in the Details

A student loan is one of the most significant financial investments individuals will take on in their lifetime. Yet the details that shape how that loan grows and is repaid are often overlooked. Taking the time to understand how interest works, how balances can change and what repayment will realistically look like can make a meaningful difference over time. With a clearer understanding upfront, borrowers are better positioned to make informed choices that support both their education and their long-term financial stability.

Practical Next Steps for Borrowers & Families

• Understand how a Master Promissory Note (MPN) works.

• Prioritize subsidized loans before accepting unsubsidized loans.

• Factor in origination fees when planning total borrowing.

• Once you are notified of loan disbursement by your loan servicer, work with them to sign up for interest autopay to make automatic interest payments during enrollment.

• Recently announced by the Department of Education—enroll in autopay before September 30, 2026 and get 1% rate reduction until June 30, 2028 when the autopay discount reverts to its standard .25% reduction. The discount applies once repayment begins.

What Institutions Can Do

• Embed financial planning tools into the student aid/enrollment process so students can make informed decisions from the start.

• Provide each student with a personalized financial aid plan that clearly outlines actual costs of attendance.

• Recommend loan amounts based on actual costs, rather than the maximum eligibility to prevent overborrowing.

• Read more about how WGU’s Responsible Borrowing Initiative uses a similar roadmap to decrease average student borrowing by more than 30%.